Stumbling and Mumbling

When failure succeeds

In politics, failure sometimes works better than success. This is the message of this piece by Janan Ganesh, wherein he argues that it is in Trump’s interest to fail on his promise to control immigration, because if he does so it will remain a big issue which will attract voters to him. Janan says:

It is perverse, I know, that a president could make so little progress on his number-one priority during four years in office, only to be rewarded for it. 

Maybe not so perverse. There are other examples.

One, as he says, is Brexit. If Brexiters get their way, voters will see that it is in fact no solution to our problems. And Farage would then lose his schtick of being able to claim that the political class is out of touch with the people. If you are practicing the politics of grievance, the last thing you want is for the grievance to disappear.

But there are other examples. Authoritarian governments use crime, unrest or terrorism as excuses for removing freedoms. For them, failing to suppress crime works better than succeeding. Technocrats and managerialists need to maintain the prospect of further incremental improvements, which requires them to maintain a gap between the actual and the feasible best.

And rightists have sometimes accused leftist parties of wanting to create a “dependency culture” and to maintain inequality and poverty, because doing so ensures the continuation of a constituency that will vote for them. As Gilles Saint-Paul and colleagues write:

Policies that reduce the income of the poor relative to the average income, such as failing to upgrade the skills of the workers and preventing their erosion by new, skill-biased, technologies, paradoxically consolidates the political power of the Left. This is because these policies make the natural constituency of a left-wing party endogenously more dependent on it.

The converse is also true. Success can be failure. Post-war social democracy worked well in raising real wages; it was one of the greatest peacetime policy successes in history. But this helped to foster individualist consumerism which supplanted class consciousness and reduced support for collectivist institutions.  As Nye Bevan wrote in 1952, in anticipation of J.K.Galbraith’s theory of “private affluence, public squalor”:

As modern industry produces new and attractive forms of private consumption, the individual citizen is made all the more reluctant to see his income taken away from him for remote purposes. (In Place of Fear, p134 in my copy)

As Avner Offer has written more recently:

Towards the end of the 1960s, attitudes began a slow shift away from the common welfare and public services as sources of well-being, and towards private benefits…The choice to “go private”, which is widely perceived as a driver of affluence, is perhaps one of the consequences of affluence. (The Challenge of Affluence, p7-8)

In the same vein, the creation of high-quality council houses created a constituency with a strong interest in buying them cheaply from Thatcher.

In these ways, social democrats’ success was also their failure. Corbynomics might suffer the same fate. If it succeeds in the medium-term, it will enable young people to buy houses – but this will create a client base of older property-owners in future who’ll have an incentive to support the status quo.

My point here is a simple one. We flatter ourselves that we live in a meritocracy in which success is rewarded and failure punished. But in many cases, this is a myth. Sometimes we live instead in the world of snake-oil salesmen as brilliantly described (pdf) by Werner Troesken, in which it is failure that is rewarded. Our economic and political institutions are all selection mechanisms, and sometimes they select not for success but for failure.

Note: my target audience is discerning enough to understand the picture reference. 

Broad-spectrum policies

Is there a case for the Bank of England to target house prices? The debate, I suspect, highlights a difference in how we think about economic policy – between what might be called a single-issue technocratic approach versus a broad-spectrum approach.

Many of us, I suspect, agree that high and rising house prices are a cultural and economic menace. They encourage high debt which is potentially destabilizing (pdf). They divert spending towards rent and mortgage payments (and sometimes housebuilding) and away from new goods and services, thereby reducing dynamism and innovation. They encourage people to commute long distances, which increases stress and cuts productivity. And they encourage “property development” at the expense of more productive forms of entrepreneurship.

There’s therefore a case for limiting them. Equally, though, there are reasons to question whether this can be done merely by giving the Bank of England a target for house price inflation alongside its CPI target.

Granted, such a target might work simply by reducing house price expectations, thereby deflating speculative buying – especially if the target is set as low as Grace Blakeley has suggested (pdf).

There are, however, legitimate doubts about its effectiveness. The Bank’s only policy for curbing house prices would be to limit mortgage availability. But how effective would this be if overseas or shadow banks fill any gaps caused by conventional lenders withdrawing? Also, housing booms are often localized, so how would limiting mortgages in Leicester curb London’s high prices? Such restrictions would also be inegalitarian: they’d deny mortgages to young people without deposits but grant them to those who have access to the Bank of Mum and Dad. And, of course, one policy might not be sufficient to cut prices. We might need others such as taxing land, encouraging renting, changing planning laws or simply building more houses. Such policies are outside the Bank’s competence.

Ms Blakeley replied to criticisms such as these by saying, reasonably, that a house price target should be part of a radical reform of the banking system.

Which brings me to the issue. Sometimes – often – there is no single magic bullet policy. Instead, we need a whole range of them. This isn’t true only of curbing high house prices. Here are two other examples:

 - How should we improve the bargaining power of workers? I’d advocate a range of policies: a high basic income; job guarantee (arguably); support for trades unions; and macro policies aimed at sustained (over-)full employment.

 - How to raise productivity? There are countless possibilities: better infrastructure; more vocational training; stronger competition policy; more open international trade; encouraging finance for R&D, capex and intangibles investment; shifting tax from incomes to land; better migration policy; encouraging coops; and so on.

Such a range of policies is a sensible reaction to ignorance and uncertainty. If we don’t know what’ll work we should throw lots of possible solutions at the problem in the hope that something will stick – in the way that doctors, when faced with a patient with a strange condition, might put them on broad-spectrum antibiotics in the hope that something will work.  

Of course, this is only sensible if the policies in question have little or no downside – if they are free hits (which is not true of prescribing antibiotics!). But in the examples I’m considering here, this is largely the case. Even if land taxes don’t reduce house prices much, there’s still a case for them. Similarly, most policies to raise productivity wouldn’t do much harm even if they fail. A few Harberger triangles are not a big problem: as Adam Smith said, there is a great deal of ruin in a nation.

Herein, however, lies an oddity. What I’m advocating seems inconsistent with the empirical turn in academic economics. The use of randomized control trials or other clever identification strategies give us (at best) precise answers to narrowly defined questions. In some cases, however, what we need are rough answers to big questions.

Marxism for Tories

The Tories have discovered a new boo-word. In the last few days, Iain Duncan Smith, Esther McVey and Suella Braverman have all used “Marxism” to mean a self-evidently Bad Thing. From one perspective, this is odd because in fact Tories should find some aspects of Marxism quite sympathetic.

Not least of these is an admiration for capitalism’s dynamism. Marx wrote that capitalism “has given an immense development to commerce…has accomplished wonders far surpassing Egyptian pyramids, Roman aqueducts, and Gothic cathedrals…draws all, even the most barbarian, nations into civilisation…[and has] rescued a considerable part of the population from the idiocy of rural life.” We don’t deny that capitalism has been a progressive force. We just wonder at what price this has been achieved, and whether the progress can continue.

And let’s get one obvious thing clear. Just as Conservatives no longer believe in locking up homosexuals or hounding them to death, so Marxist don’t want to send their opponents to gulags. Quite the opposite. There has always been a big libertarian strand within Marxist thought. Marx thought that the ideal society was one in which "the free development of each is the condition for the free development of all" and looked forward to the abolition of the state. The nanny state of which libertarians like Christopher Snowdon complain is emphatically not a Marxian notion.

In fact, Marxists share with Tories a scepticism about what state intervention can achieve. Whereas social democrats think that the right macroeconomic and redistribution policies can alleviate the worst features of capitalism, Marxists are not so sure. One reason why we want to supersede capitalism is precisely that we share with Tories doubts about the efficacy of piecemeal reform.

I’ve used that word “supersede” advisedly. Most Marxists no longer believe in violent revolution, or even revolution at all. If you want to find ideologues who’ll wreck the economy by imposing a  utopian fantasy upon it, you should look at Brexiteers rather than Marxists. Instead, we favour accelerationism or interstitial transformation (pdf) – finding non-capitalist forms of organization such as coops or community self-help groups (what Burke called “little platoons”) and encouraging their development.

In this sense, Marxism is empirical and anti-ideological. One reason for this is that we have no dog in lots of conventional political fights. For example: would a much higher minimum wage destroy lots of jobs? If no, then fine; we have a way of helping the low-paid. If yes, then it just shows that capitalism is incompatible with decent living standards for all. Or: can some monetary and fiscal policies prevent recessions and promote longer-term growth? If yes, we’ve got something useful. If no, then we’ve evidence that capitalism is destined for crisis and stagnation. Because we’ve no preconceived ideological answers to such questions, we can let ourselves be guided by the evidence.

What’s more, Marxists are not moralists. We don’t think social ills are the result of bad people doing bad things. They are instead, systemic problems which emerge independently of the intentions of individuals. As Marx said, “external coercive laws [have] power over every individual capitalist.” Marx, like Adam Smith, was an early theorist of emergence.

Some Tories might also be surprised that some apparently Marxian positions are not uniquely Marxist. The labour theory of value and tendency for the rate of profit to fall were both Marx’s elaborations of the ideas of Smith and Ricardo: when Paul Samuelson called Marx a minor post-Ricardian he was saying that there’s less originality in Marx than you might think. And if you’re looking for a belief in the sort of historical determinism attacked by Popper, you should look not to Marxists but to Blair: as Will Bott has shown, his talk of globalization as an “unstoppable force” is more crudely deterministic than most of us Marxists would accept.

It should be clear from this that Duncan Smith is wrong to say Corbyn is a Marxist: that pays him too great a compliment. Labour’s 2017 manifesto was mostly mainstream European-style social democracy.

All this, though, leaves me ambivalent. On the one hand, I think the Tories are right to be scared of Marxism: it poses an intellectually coherent challenge to their class privilege in a way that centrism and much of social democracy does not. On the other hand, though, using Marxism as a merely derogatory term is to misrepresent the history of thought. It is crude philistinism. But then, perhaps that is all the Tories have nowadays.

Why rent matters

Philip Green doesn’t get much public sympathy, but he deserves our thanks for doing one thing: he is reminding us that economists have wrongly neglected David Ricardo’s theories of rent.

Mr G is fighting landlords to cut rents – as indeed are several other high street names. Which evokes Ricardo. He showed that profits can be squeezed not by worker militancy but by rising rents.

The basic idea here is straightforward. Imagine, said Ricardo, there were an abundance of fertile land. A landlord could not then charge farmers rent: the farmers would just move onto other land. As the economy and population grows, however, the best land becomes fully occupied so farmers must use less fertile land. As they do so, the owners of the best land can demand rent from their farmers. And as worse and worse land gets brought into cultivation so the difference in the output of the best and worst land increases, giving owners of the best land even higher rent. As Ricardo wrote:

By bringing successively land of a worse quality, or less favourably situated into cultivation, rent would rise on the land previously cultivated, and precisely in the same degree would profits fall; and if the smallness of profits do not check accumulation, there are hardly any limits to the rise of rent, and the fall of profit….In a progressive country…the landlord not only obtains a greater produce, but a larger share.

This isn’t just true of farmland. It also applies in retailing. Owners of the best sites – those with the highest footfall and greatest accessibility – can charge shop-owners a rent up to the difference in revenues they get between the best and worst sites. As Tim says:

Even in busy London stations coffee sellers don’t make much money because the landowner simply increases the rent. In other words, it’s the landowners via rents who make money in prime locations, not the operators of businesses. 

Retailers such as Mr Green have got the hump with this.

But it’s not just retail space of which this is true. It’s also true of housing. As Josh Ryan-Collins writes in his superb book, Why Can’t You Afford a Home?, “desirable location (typically in large cities) is inherently limited.” And Econ 101 tells us that if demand increases when supply is inelastic, we see big price rises. As Londoners get richer, everybody wants to live in Hampstead, with the result that only Russian oligarchs can afford to do so.

Historically, there has been a mitigation of this. In a lovely paper (pdf), Katharina Knoll, Moritz Schularick and Thomas Steger show that house prices were actually flat in many countries for years in the first half of the 20^th century. A big reason for this was the development of commuter train lines. The opening of the Metropolitan line, for example, allowed workers to travel easily from Neasden to central London. That reduced the monopoly which landlords in the city centre had, thereby squeezing their rents – just as cheap fertilisers would have squeezed farmland owners’ rents in Ricardo’s model.

This effect, however, was only one-off – at least it will be until we invent teleportation. And it has been replaced by another more powerful effect – financialization. Credit liberalization in the 1980s removed the constraint upon house prices imposed by current incomes by allowing people to borrow more. The upshot is that there has been a strong correlation between house prices and interest rates: as the latter have fallen, house prices have risen relative to earnings.

For this reason, as Ryan-Collins explains, high house prices are due in large part to financialization. This, he believes, means that there is a case for banking reform and a land value tax.

The point here, though, isn’t just about policy. It’s also about how economists approach their discipline. As Ryan-Collins writes:

Land and money are two of the most neglected concepts in economic theory. Land is immobile, irreproducible and appreciates in value over time due to collective investment – none of these features apply to capital goods. Yet modern economics and national accounts treat them as one and the same.

Herein lies one reason (of several!) why economists should study the history of economic thought. Doing so can show that classic economists knew things which modern ones have forgotten.

The rise of moral simplicity

One of my best friends here in Rutland is a keen Brexiter. I fear, though, that our hysterical political times are jeopardizing such cross-divide friendships. Instead, as Dorian Lynskey has said, many people have fallen into a “childlike moral binary: only people who hold the all correct positions merit empathy or respect.”

Dorian is speaking of Momentum telling us not to feel sorry for Nick Boles. But I think the point generalizes. Not only do Remainers and Leavers have little mutual understanding, but much of the left persists in the “evil Tories” meme whilst some on the Right seem to think that anyone to the left of Tom Watson wants to reopen gulags. We see a similar thing in the debate about whether Michael Jackson’s music should still be played: the urge for simplistic moral binaries stops some people seeing (despite many historical examples) that a man can be both a criminal and a great musician.

What interests me is: why do so many people fall into such childlike binaries?

One reason, I suspect, is a simple cognitive bias – a version of the halo effect. We tend to believe that people who have one quality have others, so that if they agree with us on an important matter they must also be intelligent and kind-hearted. The converse of this is that if they disagree with us then they are stupid or evil.

A second reason is that – for psycho-political reasons I don’t fully understand – we have lost what Richard Rorty called liberal irony (pdf). Many people are no longer “always aware of the contingency and fragility of their final vocabularies, and thus of their selves”. Instead, our political beliefs have become important part of who we are. The debate about Brexit is not a dry technical matter about our relationship with the EU. It has become just another form of identity politics. This might be a symptom of what Ben Friedman pointed out back in 2006: hard economic times, he showed, produce intolerance and fanaticism. I’m not sure, though, that this is the only explanation.

Related to this is something Richard Sennett described in 1970. People, he said, want to create “purified identities” for themselves, “making oneself a fixed object rather than an open person liable to be touched by a social situation.” One way they do this, he said, was by denying the reality or legitimacy of dissonant experiences or opinions.

I suspect that there are also sociological factors at play. It’s easy for many of us to stay in intellectual ghettos and only meet those with like-minded opinions: how many Brexiters does the typical academic meet? This is reinforced if you are a political activist who spends his/her leisure time with fellow partisans.

Perhaps, though, the media is also to blame. If my only exposure to Brexiters came from the BBC I would believe that Brexiters are arseholes because this is what the likes of Rees-Mogg, Johnson and Francois seem to be.

In fairness to them, this might be because we see all political interviewees out of context, separate from any evidence of any wit, self-doubt or decency they might have. Just as footballers often wrongly come across as stupid because we only see them answer simple questions when they are tired, so perhaps politicians are also systematically misrepresented by the very nature of interviews.

Or maybe there’s something else. The media select for gobshites, egomaniacs and fanatics. It’s these that push themselves forward. And the interviewee who says “I dunno, it’s complicated” makes for lousy  TV or radio.

I concede that this list of reasons is vague and incomplete. But in a sense, this is the point. Some people are calling for a gentler, more understanding politics. What this misses, though, is that there are powerful sociological and psychological mechanisms driving us towards a morally simplistic mutually hostile politics.  

 

Decadent Tories

The Tory right’s obsession with Brexit might be a symptom of a deeper malaise – the fact that they have nothing else to offer.

To see what I mean, contrast today’s Tories with Thatcher. She could credibly offer material improvement for millions of people. She offered them the chance to own their homes –by selling off council houses and by credit liberalization that made it easier to get mortgages – and to make big profits on them. She offered tax cuts for mid-to-high earners. Professions such as finance and law were opened up to people from previously-excluded backgrounds. The reduction in trade union power was a relief not only to company owners but to thousands of junior managers. And the resumption of growth after the 1981 recession delivered good income growth for those workers who had kept their jobs and for those who could afford to save. And her Conservatives could – especially after the 1981 recession – credibly claim to be the party of business, to represent a serious reality-based people.

Thatcherism, then, put money onto the table of a big constituency. Not everybody of course – as miners as industrial workers knew too well. But enough to be a serious (if in my view mistaken) economic project.

Contrast that with her epigones today. What material offer are they making?

None. All we have are a handful of trade deals of minimal effect with small countries, and Johnson’s message, “fuck business.” The Tories are silent on questions such as how to kickstart productivity and real wages. In place of Thatcher’s offer of material betterment, we have nationalist fantasies. As Phil Burton-Cartledge has been saying for months, the Tories are a decadent party.

How did this happen? The answer is of course a long and complicated one. I’ll just sketch a few reasons.

One is that Thatcherism was a time-limited offer. Insofar as her reforms did raise output, they gave only a one-off boost to the level of GDP rather than an ongoing stimulus to growth. Also, tax cuts were financed in part by high oil revenues which have long since fallen and by privatizations. If, as Thatcher said, the problem with socialism is that you eventually run out of other people’s money, the problem with Thatcherism is that you eventually run out of other people’s assets to sell. And of course the capital gains on housing were only one-off: we’ll not see them again.

Secondly, Thatcherism sowed some seeds of its own destruction, such as:

 - The financialization she began has pushed house prices out of the reach of young people: Josh Ryan-Collins’ Why You Can’t Afford a Home is good on this. Whereas young urban professionals were Thatcherites in the 80s, their children, cheesed off by high rents, are definitely not.

 - Thatcher hoped to create a society of people like her father – diligent, benevolent entrepreneurs. But instead we got one of people like her son – amoral chancers. Social norms of trustworthiness, sympathy and moderation have broken down, unleashing not beneficial entrepreneurship but exploitation, socially useless financial innovation and sky-high bosses’ pay.

 - The assertion of “management’s right to manage” has led not to sustained increases in productivity but to rent-seeking, the demotivation of professionals and hostility to productive innovation.

A third reason for the demise of Thatcherism lies in some changes in world capitalism. Job polarization has worsened (pdf) the career prospects of non-graduates: there is no 2010s equivalent of Loadsamoney. And secular stagnation – whether due to a falling rate of profit, lower innovation or whatever – means we’re not getting the income growth many people had under Thatcher.

These changes mean that what is true of Blairism is also true of Thatcherism: the economic base that gave their ideas such power has disappeared and so new policies are needed. Just as centrists have failed to rise to this challenge, however, so too has the Tory right. Quite why this should be is another story: I suspect that both selection effects and incentives (some arising from our piss-poor media) militate against Tory MPs having the ability or willingness to meet the challenge.

Whatever the cause, though, the effect is the same. The Tory right’s inability to recognise changes in the economic base mean that they have become mindless obsessives living in a fantasy world.

The consistency illusion

The British Social Attitudes survey reports a fall in the proportion of people saying they voted Leave in the 2016 referendum and a rise in the numbers saying they didn’t vote. This is probably due to panel attrition. But it draws our attention to what is certainly a real phenomenon – a tendency to misremember our past preferences in a systematic way.

This was pointed out (pdf) by Gregory Markus back in 1986. He showed that when people were asked about their views on political issues such as gender equality or drug legalization nine years earlier their recall was poor. Their beliefs as they remembered them was much closer to their current ones than was in fact the case. They understated the extent to which they had changed their mind.

What was going on here is a desire for consistency. We want to believe that we are the captains of our soul rather than just a bundle of neurons responding erratically to stimuli and we redescribe our past to make it easier to believe this. There is a line in a lovely Kate Campbell song about a woman who “convinced herself she never needed a man”. And when Orwell has the Ministry of Truth claiming that we have " always been at war with Eastasia" he is highlighting the public's willingness to change their perception of history to maintain their self-image of consistency. Giuliana Mazzoni says such false recall is common:

Picking and choosing memories is actually the norm, guided by self-enhancing biases that lead us to rewrite our past so it resembles what we feel and believe now. Inaccurate memories and narratives are necessary, resulting from the need to maintain a positive, up-to-date sense of self.

This echoes Adam Smith:

The opinion which we entertain of our own character depends entirely on our judgments concerning our past conduct. It is so disagreeable to think ill of ourselves, that we often purposely turn away our view from those circumstances which might render that judgment unfavourable.

But we don’t just misremember the past to maintain a stable self-image. We also reinterpret the present to avoid telling ourselves we were wrong. Psychologists call this choice-supportive bias. If we buy a car that’s slower than we wanted, for example, we congratulate ourselves on its fuel efficiency. Disappointed lovers or voters want to believe they were betrayed rather than that they made the wrong choice. And Brexiters downplay economics and focus on the benefits of sovereignty and need to respect the will of the people. As Robert Cialdini wrote:

Once we have made a choice or taken a stand, we will encounter personal or interpersonal pressures to behave consistently with that commitment. (Influence, p57)

This is one reason we are prone to the sunk cost fallacy: having made a bad choice, we stick with it.

Such self-deception devices mean, as Daniel Kahneman has noted (pdf), that our remembered utilities don’t accord with what we experienced at the time. But it’s memory rather than reality that shapes our choices. And this, he says, means we have “poor accuracy” in predicting what we’ll want in future.

Here again, our attitudes are shaped by an urge for consistency. Just as we wrongly think that our past preferences are like our present ones, so too do we over-estimate the extent to which our future preferences will resemble our present ones. Matthew Rabin call this the projection bias (pdf): we project our current tastes into the future. This is why people pay too much for houses with swimming pools or convertible cars in the summer: they fail to anticipate these will be little use in the winter. It might also explain the well-known tendency for share prices to be too high in the spring and too low in the autumn: investors wrongly project their springtime optimism and their autumnal pessimism into the future. (And fund managers have always been loath to recognise this because they want to see themselves as consistent rational people rather than skittish mood-driven flibbertigibbets.)

All this suggests that we do not have the stable preferences we think we do. Stability and consistency are to some extent illusions which we impose onto our memories, perceptions and expectations. Which poses a question. If an individual’s preferences are unstable to a greater degree than we think can we really speak of a stable “will of the people”? Maybe this is an emergent phenomenon – something that’s true of groups but not of the individuals that compose the group. Or maybe it’s just a fiction.

Against retail politics

How did we get into this mess? The story is of course a long one, in which I would argue that austerity plays a big part. But there’s another strand I want to pick out. It’s the rise of a conception of politics as being just another consumer service and the eclipsing of Burke’s notion that MPs should place their judgment above the opinion of voters.

It was this “customer is king” idea of democracy that led Cameron to call the referendum and which allowed May last night to pose as being on the side of voters against MPs. And it lays behind the anger of some Leavers at not getting what they’ve voted for: they see it as being like Amazon not delivering the items they’ve ordered.

Quite why this idea emerged is another story. Some of you might blame “neoliberalism” for promoting the idea that politics should be just another market place. Others might blame the MPs' expenses affair for diminishing trust in parliament.

Whatever the cause, there’s a basic problem here. Politics is not – and cannot be – just another domain in which consumer sovereignty holds. I say so for three reasons.

First, in ordinary customer markets people have to pay to exercise their choices. This forces them to think, because if you buy rubbish you lose money. Our votes, however, carry no such cost. Which gives us no incentive to think properly. The result is that, as Jason Brennan says “when it comes to politics, smart doesn’t pay, and dumb doesn’t hurt.”

The second difference is that in most situations customers make regular choices and so can learn from experience; if they buy overpriced rubbish they don’t return to the store. In fact, with sufficient skill and experience and a bit of luck, you can even sometimes buy a drinkable pint at Wetherspoons. In politics, however, it is often otherwise. The choices we face are new, one-off ones where we have no experience and so we lack one vital source of learning. We've never had Brexit before, so even the tiny minority of people who know some history had no experience to guide them. .

Thirdly, and maybe most importantly, your political choices impose externalities onto others. If you choose to spend you money on worthless tat it makes no difference to me. Your vote, however, does. As Brennan says:

When a democratic majority picks a policy, this is not akin to you picking a sandwich from a menu. When the majority chooses, it chooses not only for itself, but for dissenting voters, children, foreigners, nonvoters and others who have no choice but to bear the consequence

This, he says, means that an ill-informed vote or – worse still – one based upon vicious motives might be a form of injustice. We have a right to expect that decisions which affect us will be taken properly. Bad voters thus violate our rights.

In these respects, politics very different from most consumer behaviour. In fact, not only are there differences on the demand side, but there are also big differences on the supply-side too. Shops do not ignore the preferences of 48% of their customers. Nor do they expect us to choose a job lot of groceries in advance only once every few years. And nor do they regard increased demand as a problem: we don’t hear the boss of Tesco complain that immigrants are putting pressure upon Tesco’s services.

For all these reasons, politics cannot be just another market place. It must be a separate sphere requiring different rules. We need, therefore, to rethink the very basics of politics: what is a good democratic decision? What institutions must be in place for such decisions to be likely?

A few good people are asking these (pdf) questions. Most partisan politicians, however, are not. They are like bad parents in a bitter divorce: they are fighting for control of the child whilst completely neglecting its well-being.  

Beliefs and interests

“It is difficult to get a man to understand something, when his job depends upon not understanding it.” The spectacle of rightist and centrist journalists trying to absolve the MSM of blame for the rise of Islamophobia reminds me of Upton Sinclair’s famous quip.

They, of course, are by no means the only people at whom one might direct this accusation. Many of you us might also point it at: fund managers who deny the efficient market hypothesis; mainstream economists who reject some heterodox approaches; managerialists who stick to using crude targets; or centrist MPs who fail to see the need for new economic policies. And so on.

But I wonder: what exactly is the mechanism that Sinclair and those who quote him have in mind?

I doubt that many of us deliberately and consciously adapt our beliefs to our interests. We don’t think “X is false but it serves my interests so I shall believe X”. For example, a Tory government is probably more in my financial interest than a Labour one, but I struggle to find sympathy for the Tory party.

I suspect instead that other mechanisms are at work.

One is wishful thinking. This is not a deliberate process. Instead, as Jon Elster has said, it operates behind our backs, subconsciously. An experiment by Guy Mayraz has shown just how easy it is to induce this. He asked subjects to predict future moves in the price of wheat. Before doing so, he randomly divided them into two groups: "farmers" who would profit from a rising price, and "bakers" who would profit from a falling one. He found that farmers predicted higher prices than bakers. And they continued to do so even when they were given incentives for accurate predictions.

We all want to believe we are the good guys, and the wish is father to the belief; nobody really wants to believe they have contributed to mass murder. The joke in David Mitchell’s famous question “are we the baddies?” is that he and his comrades had not asked that before.

A second mechanism is that we can distort our evidence-gathering. Jon Elster describes this:

Initially, let us assume, the evidence does not support the belief that I would like to be true. I then proceed to collect more evidence, adjusting and updating my beliefs as I go along. If at some point the sum total of the evidence collected so far supports my preferred belief, I stop. I can then truly tell myself and others that my belief is supported by the available evidence (Nuts and Bolts for the Social Sciences, p 37-38)

This is one reason why many clever people can (perhaps) be just as biased as stupider ones: they have more ways of gathering evidence and rationalizing it.

A third mechanism is professional deformation. This is the tendency for our training – into all professions, including economics – to inculcate not only techniques and knowledge but also biases, groupthink and blind spots.

Take, for example, Andrew Norfolk’s reporting of the Rotherham child sex abuse scandal. Here, there was a trade-off, between a strong and important story on the one hand against the danger of stoking up Islamophobia on the other: Mr Norfolk saw at the time that his story was “a dream for the far-right” and the Christchurch murderer wrote “For Rotherham” on his ammunition. Journalists’ professional upbringing is to favour publishing the story. And rightly so: it was true, and only a warped mind would see it as a reason to hate Muslims.  

If that case is clear cut, though, what about Newsnight inviting Generation Identity onto their programme. Does the desire for “good debate” overcome the risk of publicizing fascism? And what about countless comment columns disparaging Muslims? Does the truth-value of these really outweigh the danger of encouraging the far-right. 

In all these cases, journalists’ professional presumption is to “publish and be damned.” This is often a laudable instinct. But it is only a partial perspective, one which a journalist’s training perhaps exaggerates*: journalists are often selected for and socialized into a strong belief in free speech. That biases them against seeing that such speech has a cost - and they are especially slow to see this if they don't want to. 

My point here should be a trivial one, but I fear is overlooked in our histrionic environment. We are all prone to countless biases: yes, all, not least me. Sinclair’s remark should be seen not as a description of a conspiracy, but of how these biases can operate together.

* The cost of trashy right-wing columns isn’t just (or even perhaps mainly) the stoking of Islamophobia. It’s the denial of space for discussion of other issues: if we’re debating fascism we are not debating other things.

On class difference

A friend tells me that when I started my first job in an investment bank I did not speak for the first three weeks. He exaggerates, but not much. What I was doing was working out the unwritten rules of how to behave in an alien environment.

I was reminded of this by reading Tony Connelly’s description* of Geoffrey Cox’s behaviour last week in Brussels: he boasted of not having visited the city for 40 years and angered Sabine Weyand by calling her "my dear." Mr Cox did not do what I did -  shut up until you've learned what to do.

Herein, I think, lies a class difference. If you are upwardly mobile from a poor background, you have to learn how to fit in. If you are posh, you don’t. You glide from school to Oxbridge to the city or bar all the time surrounded by like-minded people so you know the rules. The upshot is that in the unusual contingency of ever being outside of that environment – as Cox was in Brussels – you put your foot in it.

We should read Cox’s behaviour alongside Boris Johnson’s claim that the inquiry into historic sex abuse is money “spaffed up a wall”. (Mr J, of course, is no stranger to wasting public money). Both, I suggest, are examples of the arrogant insensitivity that results from not having to work out how to consider the sensitivities of those outside your group. (When those sensitivities are upset, of course, it is political correctness gone mad, rather than what it is – the result of crass behaviour.)

At about the same time I was in purdah my contemporary Mr Johnson was being sacked by the Times for lying. Which highlights another class difference. Those of us from poor backgrounds know we don’t get many chances so we must take those we get: there are no second acts in working class lives. Had I been sacked from my first job for dishonesty, I doubt I’d have got another chance. Posh people do get other chances. And both sides know this.  

My point here should be a trivial one. Background determines character, so rich backgrounds tend to generate different characters than poor ones. I’d suggest other differences, all of which should disqualify most posh people from politics:

1. If everything comes naturally to you, you don’t need to think so much about how to get it. So you under-invest in learning how to hustle, negotiate or strategize. (Is it really an accident that the western politician who most mastered these arts, Lyndon Johnson, came from a poor home?) This might be one reason why Brexit has gone badly. Having spent his entire life thinking he could get what he wants simply by asking, Jacob Rees-Mogg has been disturbed to find that the EU doesn’t work like that.

2. Posh people have confidence – too much of it: it was overconfidence that led Cameron to call that referendum. Because people mistake confidence for actual ability, this lends them a credibility denied to others, which is reinforced by the dominance in the media of other posh folk. If Johnson and Rees-Mogg had thick Brummie accents, how would the media treat them?

3. The rich don’t appreciate just how important money is. For a poor family, an extra fiver at the end of the week can make the difference between relief and misery. This warps their political priorities. Whereas I regard economic growth and redistribution as the main political issues, the rich have others – Brexit if you are on the right, Palestine if on the left.

4. If you are surrounded from birth by other rich people, you lack a gut understanding of how others live. You are prone to the middle England error – of over-estimating the incomes of ordinary people. This means that even the most well-meaning are apt to conflate the national interest with that of the wealthy. What’s more, you never get a true grasp of what poverty really means. It’s not just about a lack of money, but about a lack of opportunities and role models: the first people I met with degrees who did not work in the public sector were the guys who interviewed me for that investment bank job. And it’s about insecurity too: if you are “just about managing” you are only one decision away from abject poverty. One of the greatest days of my life was the realization, sometime in my thirties, that I would never be homeless. Some of you reading this won’t understand that. As one of the key texts on class has it:

You will never understand
How it feels to live your life
With no meaning or control
And with nowhere left to go

5. Trust. We naturally trust those like ourselves. Which means that posher politicians are apt to surround themselves with other posh people. This isn’t a purely rightist trait: think of Andrew Murray and Seamus Milne working for Jeremy Corbyn. It also means they are more likely to take advice from other posh folk, leaving then vulnerable to undue influence from the rich.

Now, I should caveat all this. It is possible – with effort - for the rich to understand this. One or two do. But even for these, there’s something missing. Just as religious converts lack the visceral knowledge of their faith that comes from having been raised in it, so posh people lack such understanding of poverty. As Bill Shankly said: “the trouble with you son is that your brains are all in your head.” Perhaps the tragedy of Tony Blair embodies this. His success lay in an awareness of what mattered to working people: money and crime. His failure came when he forgot this and was seduced by foreign policy.

Here, though is the thing. Despite Disraeli's famous quip that rich and poor are two nations formed by a different breeding this hasn’t always been the case. For much of the 20th century there was a massive mitigation of these tendencies. Military service forced posh men into close relationships with poor ones, thus broadening their perspective. As the Times’ obituary of Lord Carrington says:

He found himself sleeping in a hole beneath his tank with his four crew who came from poor backgrounds and had suffered hardship during the pre-war years. The experience shaped his politics, he said later. “You could not have got a finer or better lot than they were. They deserved something better in the aftermath of the war.

This is not atypical: in my first job most equity salesmen had army backgrounds and so were accustomed to working with people from working class backgrounds.

One cost of living in a less militaristic society, however, is that this influence is much diminished and that posh men are therefore more distant in consciousness from the rest of us: the contrast between Lord Carrington and Boris Johnson – both former foreign secretaries – perhaps embodies this.

* an account which shows that Irish coverage of Brexit is an order of magnitude superior to the British.

The need for class politics

We need to talk about class. Since Jess Phillips’ interview with the Times there’s been a lot of talk about whether she is authentically working class. This is, as Suzanne Moore says, mostly guff.

We need a Marxist perspective here. To us Marxists, class is not just another identity or another lifestyle – a matter of whether you drink in Wetherspoons or wine bars or shop at Waitrose rather than Lidl. Instead, it is an objective fact about your relationship (pdf) to the means of production. If you lack ownership or control of these, then you are working class – in a position of exploitation or domination. If you do have ownership or control then you are capitalist, or bourgeois.

There are of course nuances here. You can be an exploiter without dominating someone: we can, for example say that footballers exploit systematically loss-making club owners, or that senior bank managers and traders exploit shareholders. Conversely, you can be a dominator without being an exploiter: think of low-level managers on poor wages tyrannizing their staff. And then of course there are what Erik Olin Wright called contradictory class locations – such as middle managers who can extract some rents for themselves but who are also subject to control from above. Nor is all wealth the product of capitalist exploitation: we wouldn’t really call, say, J. K. Rowling a capitalist.

These nuances, however, don't alter the fact that by this standard the working class is not the libelous fantasy that much of the metropolitan media pretend. It is not a homogenously white group of racist northerners. It contains people of all races, and even those earning very good money.

Does this notion of class matter? Of course, it has never been a perfect predictor of political attitudes. Working class Tories and leftist capitalists are as old as capitalism, and racism can be found among the bourgeoisie as well as workers. And I think there is something to be said for non-Marxian conceptions of class: for example, there are reasons to distrust the prevalence of posh people in politics.

Nevertheless, the Marxian idea of class does matter. For one thing, it is an objective fact that millions of people live lives of poverty, unfreedom and insecurity because they lack access to capital*.

And for another, it does help explain the popularity of Corbynism among the so-called “middle-class”: at the last election, 35% of “ABs” voted Labour. Many people even in erstwhile good professions have no hope of owning property and face stress and domination from their managerialist overlords. The harm caused by class division extends far up the income ladder. Even quite posh people are working class – however many avocados they eat - and many of them vote accordingly.

You might argue that if so many people are working class then the definition is useless. Far from it. The fact that they are vindicates Marx’s claim that “the lower strata of the middle class sink gradually into the proletariat." It also means that class makes for a less divisive type of politics. Whilst identity politics risks splitting us into countless hostile groups – made more bitter because they are personalized - class politics can unite most of us**. And it can do so in a more humane way. Class is a matter of social structure, not of goodies against baddies. This should take personalities out of political discourse and so permit more sober analysis. I know it is an odd thing to say given the historical record, but Marxism has the potential to be a more civilized type of politics than we currently have.  

* But remember Joan Robinson's quip: "the only thing worse than being exploited by capitalism is not being exploited by capitalism."

** Well, actually you. By the definition I’m using I’m less working class than most of you. My shareholdings are sufficiently big that I can almost afford to retire. (And I’ve never been into Greggs, although I often go into Wetherspoons, albeit in Stamford and Oakham.)

Why government borrowing has fallen

Phillip Hammond said yesterday that the public finances “continue to improve” “thanks to the difficult decisions we have taken in the last nine years.” This is not quite correct.

To see why, imagine that people and companies were to save a constant fraction of their disposable income, come what may, in the face of fiscal austerity. As their incomes fall in the face of that austerity their spending would therefore fall one-for-one. That would further reduce aggregate demand which would in turn cut the government’s tax receipts and add to government borrowing. We’d then suffer a severe paradox of thrift, in which everybody’s efforts to save more would lead to weaker incomes for all and hence to lower savings.

This tells us that governments can borrow less if and only if somebody else borrows more or saves less. This is in fact trivially true. Every pound borrowed is a pound lent. One person’s net borrowing can therefore fall if and only if somebody else’s net lending falls.

My chart shows the point for the four main sectors of the economy. It shows that government borrowing has steadily declined since 2009. The counterpart to this, however, has been a sharp swing in household net lending. For example, in the 12 months to September 2010 they were net lenders of 4.8 per cent of GDP: they were saving a lot and borrowing little. In the 12 months to September 2018 (the latest period for which we have data) they were net borrowers of 1.3 per cent of GDP. This swing of 6.1 percentage points is by far the biggest counterpart to the 8.2 percentage points fall in government net borrowing. It is mainly due to a decline in the household savings ratio.

We can therefore tell a different story about why government borrowing has increased. It’s because, in response to austerity, households saved less and borrowed more in an attempt to maintain their spending: companies have also borrowed a bit more too. This supported aggregate demand and hence employment and wages – which allowed tax revenues to hold up as spending was squeezed.

In this sense, the government has not cut borrowing. It has only privatized it – shifted it from its own account onto households.

Herein lies the reason why the OBR foresees only a small further reduction in PSNB – from 1.1% of GDP this year to 0.5% by 2023-24. It’s because it foresees no great change in households or corporates net borrowing: see chart 3.28 on page 59 of this pdf.  

My point here is that the public finances are never fully “under control”, despite the claims of many people who should know better. Government borrowing depends upon the actions of the private sector – actions over which policy-makers have only limited control. If the private sector chooses to borrow a lot (as it did at the turn of the century) the government will be a net saver. And if the private sector borrows a lot – as it did after the 2008 crash – government will be a net borrower.

One Big Fact tells us this. It is that official forecasts for government borrowing are usually wrong. Since 2000 the average error (regardless of sign) in forecasts for PSNB made in the spring for the following fiscal year has been 1.1 percentage points of GDP - £24bn in today’s money*. Even excluding 2008-09 (when borrowing was 4.4 percentage points of GDP more than forecast) the average error has been 0.9 percentage points of GDP. Such big errors are inconsistent with borrowing being fully under control: if it were, it’d be perfectly forecastable. But they are consistent with borrowing responding to the private sector’s decisions to save or borrow.

So, Mr Hammond is wrong. The fall in government borrowing is not due to his government’s “difficult decisions” – difficult for other people of course. It is due to a decline in private sector savings.

* Historical forecasts are here. Out-turns are in table PSA5A of this pdf.

Matches matter

Jess Phillips thinks she’d be a good PM. I tweeted this morning that this is more a sign of her overconfidence than it is of her ability. I did so for two reasons.

First overconfidence, whilst not universal (pdf), is widespread among those in prominent positions. Underconfident people don’t apply for such jobs, unless pushed, and so are filtered out whilst there is no similar filter against the overconfident. Quite the opposite. Hirers tend to mistake overconfidence for actual ability and so hire the overconfident: one can easily imagine Ms Phillips fluent confidence making a good impression at her CLP.

My base rate probability, therefore, is that Ms Phillips is expressing an opinion typical of MPs – or at least those who court publicity – rather than giving us a diagnosis of her actual ability.

Overconfidence, though, can be hugely damaging. Daniel Kahneman has called it the most dangerous of all cognitive biases. The three worst decisions in the UK in the last 20 years – Blair’s war in Iraq, RBS’s takeover of ABM Amro and Cameron’s calling a Brexit referendum having created the conditions in which he might lose one – were all motivated in large part by overconfidence.

A useful corrective here has been provided by Charlie Munger. It’s important, he says, to know the edge of your competence – to know what you’re good at and what you’re not.

There’s a second reason why I think she’s being overconfident. It’s that the honest and true answer to the question: “would you be a good PM?” is “I don’t know.”

Ole Gunnar Solskjaer shows us why. His CV as a manager is vastly inferior to Jose Mourinho’s, comprising a mediocre spell at Cardiff and some success in a third-rate league. But he seems to have transformed Manyoo. This is because Mourinho was a terrible match for the Manyoo job: his brand of safety-first football was ill-suited to a squad of young attacking players and to a fanbase that expected expansive football. Solskjaer on the other hand is a much better match.

This applies to many top jobs in business and politics: what matters is not just somebody’s strengths and weaknesses but rather the match between these and the job requirements. If a company’s problem is poor cost management, for example, it needs a cost-cutter as CEO rather than a marketing man, and vice versa. As Boris Groysberg has shown (pdf), what matters for corporate performance isn’t so much a bosses’ CV as the match between his strengths and the company’s needs.

Winston Churchill’s life embodies this point. He was a terrible match for the job of First Lord of the Admiralty in 1915 and for the job of Chancellor (pdf) in 1925. But he was the right match for the position of PM in 1940.

Which is why we cannot say whether Ms Phillips would be a good PM or not, leaving aside her personal policy preferences. For any complex job we must ask what qualities it requires and what personal weaknesses can be forgiven or glossed over, and we must then ask who fits those strengths and weaknesses. Churchill was a great PM in 1940 because we needed his belligerence. Cameron was a disaster because his overconfidence was misplaced, and May is doing badly because her lack of interpersonal skills is a terrible weakness when we need a good negotiator.

But we don’t know what exactly the job requirements of PM would be at the time when or if Ms Phillips becomes a plausible candidate for the job. She might make a good PM. Or she might not. It depends upon the circumstances.

Herein lies one of my (many) beefs with politics. Many people don’t think this way. Instead, they have a cargo cult mentality. We saw this in the recent row about Churchill: too many wanted to see him as either hero or villain and not as what he was - sometimes the wrong man for a job, and sometimes the right. Too many people think a great leader will transform an organization without asking what the mechanism is or whether what makes a great leader is context-dependent. Churchill and Attlee were both great PMs, despite having utterly different characters: they were good matches for what was needed at the time. Many people rightly deplore the cult of Corbyn. But they themselves fall into a similar error. I’ve called Bonnie Tyler syndrome – holding out for a hero.

The truth is, though, that there are no heroes – or at least we cannot rely upon one turning up. All we can look for is to put round pegs in round holes. And this requires sober analysis, not wishful thinking.

Postmodern politics

In an interview with the Times Jess Phillips says of May and Corbyn:

There is an old-fashionedness about both of them. They are of a bygone era. It’s a bit like The Good Life – she’s Margo and he’s Tom. Their politics are so seventies. It’s hate migrants, love miners. They’re both in this terrible situation where they’re very traditional, very stubborn, bloody difficult people.

This is a false equivalence. There’s a massive difference between the two. May’s hatred of migrants has ruined lives: caused the deportation of British citizens, forced people out of work and denied them healthcare. Corbyn’s 70s politics has had done much less damage*.

What we have here is an example of a dominant but under-appreciated feature of our age - a postmodern politics in which words and appearances are everything and consequences and reality are nothing.

Now, I stress that Ms Phillips is perhaps the least of offenders here: her stance on domestic violence, for example, betokens a lively awareness of ground truth.

Instead, what she’s given us is an example of something described elsewhere in the Times by Janice Turner. As she says “deeds matter far less than words”. So, for example, Davos men “espouse philanthropy while recoiling at any mention of tax”, and men who take private jets can establish their green credentials with just a few words.

There are though, many more examples:

 - Brexiters obsess about trade deals, oblivious to the fact that these do little to actually boost trade, and to the fact that membership of the EU is not the binding constraint upon the UK exporting more to non-EU countries. This makes sense only if we regard trade deals as an end in themselves, an expression of our sovereignty rather than as a means to greater prosperity.

 - The Tories and centrists – with the connivance of the BBC – have redefined the economy to mean the public finances, where what matters is giving the impression of being in control of government borrowing: the truth, of course, is that no such control exists as government borrowing is the counterpart of private net saving. As John Kay has said, we have “government by announcement” in which policy statements are all that matter to the exclusion of ground truth.

 - The BBC is keen to report splits and gaffes but recoils from detailed policy analysis. As John Humphrys said when asking what type of Brexit Leavers wanted, this is “all getting a wee bit technical and I’m sure people are fed up to the back teeth of all this talk of stuff most of us don’t clearly understand.” That was more than two years after the referendum; in a rational reality-based policy the issue would have been resolved long ago.

 - The likelihood that austerity has shortened life expectancy and caused tens of thousands of deaths has been under-reported on the BBC. And when somebody tries to mention this fact – as Aditya Chakrabortty did on Question Time last year – they are treated as if they have committed a gross solecism. Which in fact they have – of bringing reality into a politics which attempts to deny it.   

 - For the centre and right, the financial crisis was like the Gulf war for Jean Baudrillard: it did not take place (pdf). They show no sign of having learned that capitalism is more fragile and less dynamic that we thought in the 1990s, and so we require very different economic policies.  

What we have, therefore, is a politics of hyper-reality wherein:

What passes for reality is a network of images and signs without an external referent, such that what is represented is representation itself. 

Our problem is not merely that politics has been distorted by fake news and Russian money. It is that mainstream politicians, and much of the media, has effaced reality almost completely.

* Yes, he might well have emboldened anti-semites – but the material damage this has done to Jews is not (yet?) comparable to that done to many of the Windrush generation.

Against the output gap

“We should throw out all self-contradictory propositions, unmeasurable quantities and indefinable concepts” said Joan Robinson. I’m not sure if this is universally true. But there’s one place I would like to start – with the output gap.

The idea here is that there is a difference between actual and unobservable potential GDP, such that inflation falls when actual GDP is below its potential but rises when it is above it.

My first beef with this is an empirical one. As Eric has said, “the striking property of inflation of the last 20 years has been its complete invariance to shocks and policy changes.” UK inflation hasn’t varied much since the early 90s – compared to its variance in the 70s and 80s - despite significant cyclical swings. And insofar as it has moved, it has been largely due to moves in oil prices and sterling. Since 1996 (when the current vintage of retail sales data begins) there has been a significant negative correlation – minus 0.65 – between CPI inflation and annual changes in retail sales. That’s hard to reconcile with the idea that inflation rises when demand hits a “potential” level, but easy to reconcile with the notion of inflation being driven by shocks to supply, sterling or commodity prices*.

It’s not just in the UK that the idea of the output gap has been unhelpful. The same has been true in the euro zone. Zsolt Darvas has pointed out that the ECB has over-predicted inflation for years. It’s belief that a closing of the output gap would lead to rising inflation has been systematically wrong. For example, Mario Draghi said 12 months ago that “the economy has been growing consistently above current estimates of potential growth.” And yet core inflation today is exactly the same as it was then – 1.2% (pdf).

Granted Mr Draghi went on to say that “the responsiveness of inflation to slack has weakened in recent years” and that “estimates of the size of the output gap have to be made with caution.” But these look like what Karl Popper called “immunizing strategies” – tricks to defend a theory from any attempt to falsify it.

So, what’s wrong with the output gap in theory? I’d suggest three things.

 - Potential output, or capacity, is not fixed. A study (pdf) of a US steel mill by Igal Hendel and Yossi Spiegel has shown this. They show that the mill doubled production over 12 years even with the same plant and workforce because every time the mill seemed to be at “full capacity” its managers found ways of tweaking production methods to eke out more output. “Capacity is not well defined,” they conclude. This suggests that a closing of the “output gap” leads not to rising prices but to higher productivity. Which means that if monetary policy tightens as the “output gap” closes policy-makers will deprive us of productivity gains.

 - Companies don’t necessarily respond to higher demand by raising prices. Back in 1986 Julio Rotemberg and Garth Saloner showed (pdf) that they might well cut prices in a boom simply because there are more customers around then and so firms will fight to win them in the hope of winning more return business in future. (This should be more likely to happen when real interest rates are low or negative, because they increase the present value of future revenues.)

 - The notion of potential output doesn’t apply to the intangible economy. It might make sense to speak of a restaurant as having a level of full capacity: it has only a limited number of tables**. But what is Google’s capacity? Or Spotify’s? Or that of the computer games industry? As Jonathan Haskel and Stian Westlake say, one feature of the intangibles economy is its scalability. But scalability renders the notion of potential output redundant.

I suspect, then, that the idea of the output gap is a bad one. But is it dangerous?

In one sense, no. In fact, it serves a useful purpose. A central bank that targets inflation can use the idea of an output gap to conduct counter-cyclical policy. In a downturn it can say “there’s a large output gap which will reduce future inflation, so we’re cutting interest rates.” Even if inflation doesn’t depend upon the output gap, this is the right thing to do.

In another sense, though, the idea is dangerous. If you believe the output gap is zero then you will infer that all government borrowing is “structural”. There will therefore be pressure upon governments to conduct unnecessary austerity.

And here lies a big and under-appreciated distinction. It is one thing to use unmeasurable quantities in one’s own personal thinking where the costs of error are small. It is quite another to use them for policy-making where bad ideas do real damage and even destroy lives. The bar for what represents a good idea should therefore be high in policy-making. And I don’t think the idea of an output gap gets over it.

* Yes, I know the omitted variables bias. Feel free to point out what these are in this case, and show their empirical importance. 

** In truth, of course, the restaurant business has had excess capacity in recent years, despite the Bank of England’s belief that the aggregate output gap is small.