Tuesday, 25 April 2017

Economic Competence Revisited

My last post was designed to show clearly that the UK has not been a strong economy since the Conservatives started running it. Now I would be the first to say that this proves nothing about how competent the Conservatives are. It may be just bad luck. My point was about the media debate. This should be about whether it is the government’s fault that we have a weak economy, or alternatively whether they have done the best they could in the circumstances. Instead of that discussion, we have mediamacro’s presumption that we have a strong economy when clearly we do not.

The political debate should really be about economic competence. Mediamacro assumes that the Conservatives are more competent at running the economy because that is what the polls say, and the polls say that in part because mediamacro assumes it. It is a self-reinforcing loop, where the last thing the media thinks of doing is asking academic economists. How would I, as an academic macroeconomist, assess competence when it comes to running the macroeconomy?

The obvious thing to do is to look at key macroeconomic decisions made by governments, and how they turned out. I would be particularly hard on governments when they chose to go against the prevailing academic consensus, and this choice did not turn out well. I have written about this before on a few occasions: see here and here for example. Let me summarise why I think, once again, it is the Conservatives rather than Labour who have a lot of explaining to do.

We can start with monetarism, which in its most basic form is setting policy according to movements in monetary aggregates (the ‘money supply’). It was a short lived failure. A particular failure was the 1981 budget, raising taxes in the middle of a recession, which was famously opposed by 364 economists. The economists were right: the recovery (properly defined) was delayed by 18 months. This is not the story told by mediamacro, but it is an account that fits the facts.

The next economic disaster was the Lawson boom of the late 1980s, which combined a monetary and fiscal stimulus that increased inflation. I was once told by someone close to decisions at the time that Lawson wanted to reduce the top tax rate to 40% in 1988, and it was thought to be politically expedient to combine this was a standard rate cut even though we were in the middle of a boom. Monetary policy involved shadowing the DM, so could not counteract the fiscal stimulus and other inflationary pressures.

By 1990, the Lawson boom was becoming a recession, and the Conservative government decided to formally fix the exchange rate. Their chosen rate was much too high, as the work I carried out with colleagues at NIESR clearly showed. Black Wednesday, when the UK was forced to abandon the fixed exchange rate regime, rightly lost the Conservatives their reputation for economic competence for some time to come.

Between 1992 and 1997 the management of the economy was better, but without any major decisions or events. Widening the definition of policy you can justifiably credit Thatcher with weakening trade union power, but her failure to emulate Norway and establish a sovereign wealth fund from North Sea Oil revenues was a clear mistake.

Under Labour there were three major macroeconomic decisions, and all three were successes. First most academics agree with central bank independence, and I think most would agree that the design of the Monetary Policy Committee in 1997 was particularly good. Second, the decision not to join the Euro in 2003 was clearly correct, which was taken after extensive economic analysis. Third, the decision to embark on fiscal stimulus after the Great Recession was correct, in much the same way as Obama’s slightly later stimulus was correct.

Should we count the financial crisis, and the failure to prevent it happening, as a clear negative against economic competence? I would argue not, as (a) the opposition argued for less financial regulation, and (b) the government did follow the consensus view at the time. If any institution is to blame, it is the Bank of England for ignoring the rise in bank leverage. As to a profligate fiscal policy, this is simply a myth.

The incoming coalition government set up the OBR, which deserves credit just as setting up the MPC under Labour does. However their decision to embark on austerity in 2010 was a huge mistake, which once again probably went against majority academic opinion, particularly as it involved cutting public investment sharply. And then we have Brexit. Although arguably mandated by a referendum, the decision to leave the Single Market and customs union are down to the Conservative government alone.

We will be able to compare the economic policies of the two parties this time when they publish their manifestos. This post is about track records. It shows clearly that Labour tend to get things right, while the Conservatives have created a number of major policy-induced disasters. As with the ‘strong economy’, mediamacro have got it completely wrong about macroeconomic competence. But I’m afraid, as was the case in 2015 and 2016, it will be mediamacro rather than reality that carries the day. That, alas, is how democracy currently works in the UK.  

25 comments:

  1. When Mervyn King, reported in the Guardian Wednesday 2 May 2012 said,

    '"That isn't to say we were blind to what was going on", he said in the BBC Today Programme Lecture, adding that for several years the Bank of England and other central banks had warned that the financial markets were underestimating the risks they were taking.

    "So why, you might ask, did the Bank of England not do more to prevent the disaster? We should have. But the power to regulate banks had been taken away from us in 1997. Our power was limited to that of publishing reports and preaching sermons. And we did preach sermons about the risks."'

    '"With the benefit of hindsight, we should have shouted from the rooftops that a system had been built in which banks were too important to fail, that banks had grown too quickly and borrowed too much, and that so-called 'light-touch' regulation hadn't prevented any of this," King said.'

    And then he said in the same article,

    '"In the five years before the onset of the crisis, across the industrialised world growth was steady and both unemployment and inflation were low and stable. Whether in this country, the United States or Europe, there was no unsustainable boom like that seen in the 1980s; this was a bust without a boom."'

    I don't understand his bust without a boom concept.

    And I don't know whether he had the powers in 1997 to prevent 2008 as he says.

    What economic model has a bust without a boom?

    And what powers did the BoE lose in 1997?

    ReplyDelete
    Replies
    1. Dare we consider that the financial crash of 2008 was because of what was happening in the previous 10 years rather than in spite of it?

      Delete
    2. «"In the five years before the onset of the crisis, across the industrialised world growth was steady and both unemployment and inflation were low and stable. Whether in this country, the United States or Europe, there was no unsustainable boom like that seen in the 1980s; this was a bust without a boom."'

      I don't understand his bust without a boom concept.
      »

      It is the usual prevarication beloved of Economists like our blogger: the argument is that there was no boom because “growth was steady and both unemployment and inflation were low and stable” that is "boom" is defined in a very contrived way as "wage inflation" in practice. Of course there was a wild, irresponsible boom before 2008: just not a wage boom though. Immigration, asset prices, debt, imports all bubbled up, demonstrating that there was a wildly overheated economy. Despite that wages did not inflate because a number of mechanisms were put in place to limit wage growth, thus in effect redistributing from wage earners to rentiers. Dissembling Economists love to define "boom" only as a time where everybody's income zooms, not a time where income is also redistributed from workers to rentiers. They call that a "relative prices movement".

      «And I don't know whether he had the powers in 1997 to prevent 2008 as he says.»

      I reckon that if he had them he would not have used them. After all the BoE is not based in a croft in the Outer Hebrydes without a phone line: they work for the Chancellor of the Exchequer, and had they had any concerns about a bust M King would have asked and obtained the powers they needed.

      The reason why the BoE did not intervene has well been described by JK Galbraith in 1954 in his book "The Great Crash 1929", page 206:

      Action to break up a boom must always be weighted against the chance that it will cause unemployment at a politically inopportune moment. Booms, it must be noted, are not stopped, until after they have started. And after they have started the action will always look, as it did to the frightened men in the Federal Reserve Board in February 1929, like a decision in favour of immediate as against ultimate death. As we have seen, the immediate death not only had the the disadvantage of being immediate but of identifying the executioner.

      The massive, wild, unsustainable rentier boom 1997-2007 was extremely popular, at least among rentiers, and the Thatcher governments turned a lot of people into petty rentiers, with Right To Buy etc.

      Delete
  2. And that's before we even get to the Barber boom and bust.....

    ReplyDelete
  3. If you are going to comment on politicians' competence, at least pretend to take off the partisan blinkers and try to get the facts straight.

    "Third, the decision to embark on fiscal stimulus after the Great Recession was correct"

    Labour's fiscal stimulus was during, not after, the Great Recession.
    The "evidence" shows this stimulus was so successful we only had the worst fall in GDP since WW2.

    "After the Great Recession", Labour's policy was... fiscal austerity:

    "However their decision to embark on austerity in 2010 was a huge mistake"

    Labour was the incumbent government at the start of 2010, and also embarked on austerity at the time, with a large VAT rise and cuts to public sector investment starting at the beginning of the year.

    ReplyDelete
    Replies
    1. Whenever someone tells me to stop being partisan I know they are partisan. On your specific points

      1) It is generally agreed that the fiscal stimulus reduced the size of the fall in GDP, just as Obama's stimulus did the same.

      2) The VAT cut was always designed to be temporary - that increased its potency.

      3) If the best you can come up with is that Labour planned to have milder austerity than the Conservatives from 2010 then I think I've made my point.

      Delete
    2. The Labour plan still involved spending more than they had ever had in their best ever year. How is that 'austerity'.
      Ah, you may say, but it involved overspending by less than in 09/10 - but why is 31% overspending which is what occurred in 09/10 to be regarded as a benchmark, and any overspending ratio less than that is regarded as 'austere'
      And when in 07/08, after 10 consecutive years of growth when spending exceeded revenues by 6%, is that not considered an austere amount.
      A practical definition of austerity is in order Mr Wren-Lewis.

      Delete
    3. Andrew Carey. In 07/08 the net borrowing requirement was 2.6% of GDP. With debt at 40% of GDP and nominal growth of 4.5%, say, a 'neutral' deficit (that keeps debt/GDP constant) would be 1.8% of GDP. The general view at the time is the economy was at trend. So the deficit was 0.8% of GDP above its neutral level, which is tiny.

      I define austerity as fiscal consolidation that increases unemployment. That is what, according to the OBR, Osborne did. The idea that this unemployment was somehow Labour's fault is a complete myth.

      Delete
    4. "I define austerity as fiscal consolidation that increases unemployment"
      So have I missed an increase in unemployment since May 2010, because there's been plenty of austerity narrative about the period since then from yourself.

      Delete
    5. If you do not know why this statement is stupid, you really should read more of my posts. Austerity delayed the recovery, and kept unemployment high.

      Delete
  4. «mediamacro’s presumption that we have a strong economy when clearly we do not.»

    When an Economist uses the word "economy" in the aggregate as a rule it is to obfuscate distributional issues, because quite rarely everybody is doing well or badly at the same time.

    Currently in the UK there is indeed a “strong economy” for rentier owners, indeed asset prices and returns on assets are booming especially in southern England, and this is thanks to government-driven redistribution from workers to rentiers, and from the north to the south. Immigration, imports, credit, asset prices are all booming thanks to the “strong economy” for rentier owners.

    Since there is a tacit convention that the media report "the economy" from the point of view of investors, their claims of a "strong economy” are quite understandable: there is indeed one for investors, and the "little people" don't matter; rather, given that the earnings of workers are "inflationary" the Treasury and the Bank and England rejoice when the "little people" become cheaper.

    Now the people (like S Wren-Lewis and B DeLong) who publish prominently graphs of aggregate (or even average per-person) GDP being below the 1997-2007 trend seem to me to make the argument that because of that there is no “strong economy” and therefore the current asset boom is not huge enough and a much bigger asset bubble is needed to "lift all boats" to the levels implied in the 1997-2007 GDP trends; some people like L Summers have even wondered whether only repeated huge asset bubbles can lift back aggregate growth to the 1997-2007 trend, because of "secular stagnation". So I think that there are two policy choices in play:

    #1 A sustainable rebalancing between the rentier boom and the worker recession.
    #2 An even more unbalanced policy with a new round of rentier bubble that thanks to the "wealth effect" trickles down a bit and pulls up the workers' economy into being ok-ish like in 1997-2007 while the rentiers' economy sails again “into the wild blue yonder“ (as JK Galbraith wrote of the 1928 bubble).


    The impression I get is thus that claims that there is no “strong economy” while instead there is a strong economy for some and a bad economy for others are calls not for #1, but for #2.

    Our blogger has recently advocated a more expansionary fiscal policy to improve the recessionary part of the economy. B DeLong has also advocated a more expansionary fiscal policy in the USA. But he adds that since there is no chance of that happening in the USA, the only alternative is indeed an even more expansionary credit policy, that is choice #2. Sometime I suspect that our blogger's arguments have the same purpose, because of the focus on the aggregate, as per the following sequence:

    * Explicit part:
    - The aggregate economy is below the 1997-2007 trend.
    - The worker economy was non-recessionary only during the 1997-2007 period.
    - Therefore we need a more expansionary aggregate policy, with a more expansionary fiscal policy.
    * Implicit part:
    - But since a more expansionary fiscal policy is not going to happen, because policy is controlled by rentiers, we should have an even more expansionary credit policy as in 1997-2007, to create another huge rentier bubble, that will trickle down to workers.

    There is also the detail that in case #1 a more expansionary fiscal policy should come with a less expansionary credit policy, that is a proper rebalancing, and strangely I have the impression that B DeLong and S Wren-Lewis have been arguing for that a lot less than they have been arguing for a more expansionary aggregate policy; perhaps it is because of the implied conceit that there is no “strong economy” in the aggregate.

    ReplyDelete
  5. «seem to me to make the argument that because of that there is no “strong economy” and therefore the current asset boom is not huge enough and a much bigger asset bubble is needed to "lift all boats"»

    I have just noticed B Delong's recent post on what he claims shifts the labor share:

    http://www.bradford-delong.com/2017/04/a-low-pressure-economy-is-not-only-dark-but-invisible-in-the-horserace-noah-smith-is-running.html

    The argument in it is that it is FOMC expansionary credit policy (and only secondarily low tax policy) that raises the labor share, and viceversa.

    He does not mention anywhere trade union rights, or immigration controls, social insurance, or government spending, that is the New Deal, as having had any influence on the labor share, the message seems to be that only a “high-pressure economy” created by FOMC expansionary policy helps the labor share. Indeed all the cases he cites as having a “high-pressure economy” coincide with booming share prices, and viceversa.

    ReplyDelete
  6. «Black Wednesday, when the UK was forced to abandon the fixed exchange rate regime, rightly lost the Conservatives their reputation for economic competence for some time to come. Between 1992 and 1997 the management of the economy was better, but without any major decisions or events.»

    Black Wednesday perhaps lost the Conservative reputation mostly with the media; in 1992-1997 the "economy" (the usual obfuscating aggregate) perhaps did better in some sense, but there was a huge house price crash in the economy of swing voters of southern marginal seats, and this was the "incompetence" that pushed the polls to landslide levels for John Smith's Labour, levels which were inherited by Tony Blair's New Labour, who then drove policy through ten years of concurrent Lawson and Barber booms, thanks also to booming scottish oil production.

    ReplyDelete
  7. "My point was about the media debate.[...]
    [...]
    [...]Mediamacro assumes that the Conservatives are more competent at running the economy because that is what the polls say, and the polls say that in part because mediamacro assumes it."

    Also I think it matters who own the media. AFAIK the owners are far from neutral even when reporting the news. I've that the WSJ editorial pages were thought to be partisan in detriment of quality, but that the news pages were good and that this disappeared after Rupert Murdoch bought it.

    ReplyDelete
  8. I must admit that you have something here.

    In 1964, when Labour took over from the Tories, James Callaghan walked into Reggie Maudling's office and Maudling said something to the effect of "Sorry old cock to leave such a mess" - in this case a huge BOP deficit.

    I have for many years thought that the function of Labour was actually to clean up after the Tories and the case for this goes far back before the 21st century. The corollary is of course that Labour gets stuck with the unpopular decisions.

    The only main exception to this argument that I can see was 1992 when Kinnock wasn't elected and John Major was left to clean up his own mess after the ejection from the ERM.

    ReplyDelete
  9. Simon, how should economists organize? How can we make ourselves heard?

    ReplyDelete
    Replies
    1. In the same way scientists do, through their national organisations.

      Delete
  10. This is an updated version of something I've posted before.
    About two years ago, apparently, a massive survey was done throughout Europe where people were asked: "do you trust or mistrust the newspapers published in your own country?"

    The percentage who mistrusted the newspapers was subtracted from the percentage who trusted them. So a negative percentage indicates a majority mistrusted the press.

    Britain came bottom of this league of 33 countries with -51%.

    This means that about 25% of Britons trust their newspapers and about 75% do not. Despite massive mistrust of British newspapers, the numbers indicate that around 11 million people
    do trust them.

    The data are summarised on a bar-chart on the 'Stop Funding Hate' Facebook page showing "Net trust in the written press in 33 European countries in 2014 and 2015" .
    Here's the link:

    https://www.facebook.com/stopfundinghate/photos/a.320031038334233.1073741828.310006003218/320029888334348/?type=3&theater

    ReplyDelete
  11. Were Thatcher's curbs on the Unions really such a good thing? Don't we need effective Unions to ensure that a sufficient portion of production goes to workers and working conditions improve? We need labour to be expensive and scarce so as to drive innovation and efficiency.
    I also don't understand why you want a UK sovereign wealth fund. Norway has one because they tax more than they spend so as to keep everyone active and busy (I guess they like that). In the UK we have much less oil revenue per person. Our government deficit spends on the whole. So why would we deficit spend even more so as to buy up global stock markets? I don't see that society overall gains anything by having the government owning stocks that the private sector would otherwise happily own. Shouldn't governments focus on direct investments that are needed by society but that don't fit in with what the private sector would do? It would seem to me far more preferable if the UK government say financed decarbonization of the UK electricity system with a full fleet of nuclear power plants; or increased science funding; or provided free university education; affordable public housing; or even spent the money on current consumption such as free public transport.

    ReplyDelete
    Replies
    1. 1) In my view the unions had too much power in the 1970s. However Thatcher may well have gone too far in the other direction. What is really important is that demand is always strong so that labour is scarce.

      2) A SWF is what you should have if you discover a finite natural resource, so the wealth can be spread to future generations

      Delete
    2. You may be unaware that your original piece on the subject of a SWF appeared to kick-start a debate in Malaysia on the matter, led by the daughter of the now jailed opposition leader, Anwar.
      Personally I thought your argument was unconvincing and by comparing us with Norway failed to give sufficient weight to the fact that they were just lucky, in that their peak years of production were in the 2000s when oil prices were high. Our years of peak production were the late 1980s, when oil languished under $10 for a time and government revenue from North Sea Oil was negligible.

      Delete
    3. As far as Malaysia is concerned, I would be very surprised at any connection. Do you have any evidence?
      I do not think unanticipated price changes influence the argument for a SWF. Nor do I think NO oil revenues were negligible.

      Delete
    4. No direct evidence, but I recall a vigorous debate in KL (initiated by Nurul Izzah) shortly after your 2013 piece appeared. Maybe it was just coincidence?
      Depends how you define negligible, but in 1989/90 total UK oil & gas revenues were £2.36 billion, yet public spending was £210 billion.
      Singapore, not known for its mineral wealth, also has a huge SWF.

      Delete
  12. «In my view the unions had too much power in the 1970s. However Thatcher may well have gone too far in the other direction.»

    That's very agreeable, and it was not just Thatcher, but also Blair, as to “in the other direction”.

    «What is really important is that demand is always strong so that labour is scarce.»

    And here as usual I disagree, because it is a glib recipe:

    * Strong demand can result, and will result, also in higher profits or higher rents and capital gains or higher imports or higher immigrations, and will have those effects if the political power of business and property owners is not balanced by that of organized workers.

    * While our blogger always advocates fiscal expansion for “demand is always strong” we cannot be blind that because of the political power of business and property owners in practice expansionary policy has meant for several decades only expansionary debt policy, and that booms asset prices and rents, not wages and employment, except in small part via trickle down. And Economists like DeLong and Summers have indeed been arguing constantly that only repeated financial bubbles can counter "secular stagnation" and offer a bit of trickle down to middle and low income workers.

    I fear therefore that calls for “demand is always strong” are calls for trickle down if they are made independently or before calls for strengthening the political power of workers via unions.

    Which was the New Deal recipe, which DeLong seems to have reneged recently when he argued (as I understand it) that only FOMC expansionary credit policy and secondarily military spending and low tax policy can boost employment and wages:

    Lyndon Johnson created a high-pressure economy—he did not want to raise taxes to pay for fighting the Vietnam War, and did not want the Federal Reserve to raise interest rates. ... When the labor market became tight again in the internet boom of the late 1990s ... And then came the financial crisis and the disappointing recovery since. And the labor share fell some more

    No mention of the New Deal and its policies in an article about the labor share.

    ReplyDelete

Unfortunately because of spam with embedded links (which then flag up warnings about the whole site on some browsers), I have to personally moderate all comments. As a result, your comment may not appear for some time.