Why we can't have nice things

We can’t have nice things. That’s the message of Ed Davey’s speech yesterday, in which he called for a structural current budget surplus and denounced Labour’s spending plans as “fantasy economics”. Voters seem to agree. Although many individual Labour policies are popular, the majority think Labour’s plans are unaffordable, and very few trust Corbyn on the economy.

From one perspective, all this is wrong. Over the last 25 years, two big things have changed.

One is that real risk-free interest rates have slumped. This means government borrowing and investment is much more affordable than it used to be. Governments should therefore be investing more, especially where (as with fibre broadband) the private sector is not doing so sufficiently. The failure of private sector capex to respond to ultra-low interest rates vindicates Keynes’ point:

It seems unlikely that the influence of banking policy on the rate of interest will be sufficient by itself to determine an optimum rate of investment. I conceive, therefore, that a somewhat comprehensive socialisation of investment will prove the only means of securing an approximation to full employment.

Secondly, we used to think that the Nairu was high, so that increased aggregate demand would swiftly lead to higher inflation. But this is no longer the case. Even if it exists at all, the Phillips curve is quite flat, and anyway there is much more slack in the labour market than headline unemployment numbers suggest. Inflation, then, is less of a constraint on public spending than it used to be.

Economics, then, says governments can and should borrow more.

So why do so many people think otherwise?

There are legitimate objections to Labour’s plans. The party seems to have underestimated the annual cost of free broadband, and is ignoring the fact that some local providers of fibre to the door are doing a decent job. But these, I suspect are technical matters which can be sorted out.

Also, although “where’s the money coming from?” is the stupidest question in the world, “where are the workers coming from?” is not. Even though there is lots of aggregate slack in the labour market, specific shortages of doctors and engineers could stymie Labour’s ambitious spending plans. Again, though, I’m not sure this is a decisive objection: such shortages can be overcome with freedom of movement.

Instead, I suspect animus to Labour’s plans are founded – at least in part - in less rational considerations.

What we have here might be yet another example of what I’ve called good ideas going bad. The belief that a big fiscal expansion would run into trouble was reasonable once. But people often hold onto ideas long after they’ve ceased to be valid. One reason for this, as researchers such as Erin McGuire and Ulrike Malmendier (pdf) have shown, is that our ideas are formed in our youth and we stick to them even when their empirical base has vanished.

Secondly, there’s a halo effect. There are good reasons to worry about Mr Corbyn’s judgment; his support for the Palestinian cause has led him to some regrettable associations. Such misgivings can easily spill over into distrust of him on other issues.

Thirdly, centre-right politicians have for years played a rhetorical trick. They have invited us to believe that “tough” talk about “hard choices” is a sign of economic competence. But as Simon says. it isn’t. Sometimes, a hard heart is a sign of a soft head.

Finally, there is resignation. Frederic Jameson (or Mark Fisher or Slavoj Zizek) said that it is easier to imagine an end to the world than an end to capitalism – or even, I’d add, a transition to moderate social democracy. He had a point. Research shows that people resign themselves to poverty and inequality, and so stop imagining that a better world is possible.

One thing that reinforces this is cynicism. People have stopped believing that politicians can create a better world.

Another reinforcer is deference. Adam Smith was right:

The great mob of mankind are the admirers and worshippers, and, what may seem more extraordinary, most frequently the disinterested admirers and worshippers, of wealth and greatness. 

Even the most incompetent and parasitic monopolist will therefore find vocal defenders.

Now, here I part company with many on the left who like to blame media bias. Yes, this might well amplify these sources of hostility to Labour’s economic plans. But as Daniel Kahneman showed, people often go wrong without any prompting from the media. Cognitive biases matter in politics, as they do in all other walks of life.  

Comments

[Ralph Musgrave]

There’s a weakness in the popular idea that interest on govt deb is low, ergo govt should invest more. It’s that one reason govts can borrow at low rates is that there’s no chance of them not being able to pay interest and repay relevant capital sums: govts have dictatorial powers, that is, they can simply grab money off taxpayers when necessary to pay that interest etc.

Ergo interest should be charged to govt investment projects at the normal commercial rate.

[Blissex]

«Cognitive biases matter in politics, as they do in all other walks of life.»

Ah the usual wykehamist point of view of our blogger, which to me seems to be that politics is a debate about ideas among philosopher-kings, where some of them are afflicted by mere cognitive biases.

The more down-to-this-Earth view is that interests matter a lot in politics, and typical middle class voters want big capital gains for themselves, fueled by unlimited cheap debt, and a drastic squeeze for the "unaffordable" poor, resulting in tax cuts for typical middle class voters. The big capital gains and rents for their own benefit is what they call "economic competence".

Given the current level of such gains and rents, at least £30,000-£40,000 a year for the typical middle class family in southern England, "free internet" is something they care very little about, and they may regard it as something that only benefits low income non-proprietor families.

[Blissex]

«Ergo interest should be charged to govt investment projects at the normal commercial rate.»

Should that apply also to BoE lending to bankrupt banks, or are the "best and brightest" exempt?
Should that apply to mortgage debtors too, or are they exempt because of the "absolute security" of property prices as collateral?

Besides, what is the "normal commercial rate"? There are several different interest rates, from 0.5% to 753% (and more) APR, and the rate for base liquidity is set by those who manufacture it, that is the government.

[Ben Oldfield]

If the government offered free places at university for the urgently needed engineers, doctors, nurses etc. it would increase the supply.

[L]

Perhaps it is because no-one trusts Government costings. Let's just remember HS2.

Initial estimate about £18 bn
2010 (first firm costs) £33 bn for Phases 1 & 2
2013 £42 bn (excluding trains)
2015 £55 bn
2019 about £30bn overspend on 2015 figures.

https://www.bbc.co.uk/news/business-49048823

It's not that voters don't agree with Governments borrowing to build, it's that they don't believe the Government's figures about how much it will cost (BT's estimated cost for FTTH is almost five times Labour's estimated cost {strangely close to the increased cost of HS2 in a decade}).

There is an incentive for Governments to underestimate costs at the start as they can then use the sunk-cost argument (even though it is a fallacy) to justify more spending.

[Jim]

The State owning the Commanding Heights of the Economy worked so well last time, I can't think why we stopped doing it, what with all the profits the nationalised industries must have been making, State ownership being so much more efficient than the discredited capitalist owners............

[Blissex]

«The State owning the Commanding Heights of the Economy worked so well last time»

After 2008-2009 I guess that it is quite clear that the Commanding Heights of the Economy own the State...

[jim]

At the root of all this discussion about this or that boost to 'the economy' lies the awkward question 'what is the economy'.

Certainly money is cheap, inflation has gone away. Therefore we could spend a lot more, but on what? My feeling is that we are like children invited to max out uncle's credit card in (say) Hamleys or sweetie shops. In a few days all the toys are broken and we have scoffed the sweeties and grown fatter or puked them up. Money has moved around 'the economy' but there is that nagging worry about uncle's credit card.

That is how I think of Boris and Jeremy's election 'promises', spaff some cash, hope the animal spirits will shake a few monetisable ideas out the woodwork and go back to sleep.

Now my cynical soul (and experience) tells me that the animal spirits are all but dead. That Boris is a con artist and Jeremy means well but has a doubtful track record and is hated by uncle.

I wish I could believe that spaffing the cash will fire up our economy but although I can fix almost anything I still don't know what an 'economy' really is even though I did once read Econ101. I reckon we will be having the same discussion in 10 years time.

[theProle]

The problem is that borrowing to invest only works when the investment yields a return which is likely to exceed the value of the investment.

I borrowed a lot of money to buy a house on the basis that the saving on rent and the eventual ownership of the asset exceeded the cost of the investment (money spent and interest paid).

Currently, I can borrow money against my house almost for nothing (~1%). It doesn't follow from this that the best thing for me to do is to borrow as much as possible, then look for ways to spend it.

If I was to remortgage my house so I could dine at the ritz every night for a few years, that would be a poor investment regardless of how good a rate I got on the loan.

If I remortgaged my house to buy out a division of my employer's business, that might be a good investment even at quite a poor interest rate.

The real issue is that much of this so-called investment is no such thing. Giving everyone free broadband is not an investment, it's just spending, just like my meals at the Ritz.

Even connecting every single property in the country to broadband, whilst technically investment, is almost certainly a very poor investment (if it made economic sense, BT would have done it years ago - especially as they are already under a lot of pressure for this).

This is also where one Mr G. Brown went wrong. He firehosed cash round the place as "investment", when there was little or no prospect of getting a return, leading to a huge hike in spending without a sustainable matching hike in tax receipts. Doing all this at the peak of a boom (as we are now as well) didn't exactly help either.

[Dave Timoney]

@Jim,

"The State owning the Commanding Heights of the Economy worked so well last time, I can't think why we stopped doing it, what with all the profits the nationalised industries must have been making".

The British state has never owned the commanding heights of the economy, in the sense of a monopoly of the most profitable businesses, though it has long has a controlling interests in some, such as BP (since 1914).

Most nationalisations in the immediate postwar era focused on badly-run, low-profitability but strategic industries such as coal and steel. Integrated planning and protecting the balance of payments were the chief drivers, not profit.

Over time, nationalisation became a "bailout" for under-performing private industry, particularly where the market proved incapable of driving rationalisation (e.g. the car industry).

The contemporary focus for nationalisation is less on strategic infrastructure or rationalisation (though both can apply) and more on market failure. In other words, excessive profits and poor service.

[Jack Curtis]

How can anyone whose motives are inherently political rather than economic be called an investor? Seems a bit of a contradiction ...

[cjcjc]

"Regrettable associations." Yes - hundreds of them. With some very nasty people indeed.
One might almost think that Corbyn was a rather nasty person himself...

[Rob]

Davey says that current spending should be in surplus. The riposte that borrowing rates are low and that this justifies increased investments is irrelevant, because investment isn't current spending.

Osborne-era thinking looked at the total deficit, including investment. This breaks the link, effectively allowing unlimited deficits to fund investment, provided that an economic case can be made for the investments in question. This would seem to be sufficient to justify truly enormous investments in climiate change mitigation and prevent, since we've had a strong economic case for doing so since at least the Stern report.

The argument about whether current spending should be in surplus or deficit is about tax rates and spending levels, and a surplus could be just as easily achieved by raising taxes as by cutting spending. None of this seems to be obviously daft.

I sympathise with the annoyance at politicians couching their ideas in common-sense-but-actually-nonsense rhetoric, but in this case all I can hear is an argument for ignoring the deficit as a constraint on investment, and a pledge to ensure that tax receipts exceed spending, neither of which sound particularly objectionable.

[Jim2]

Apologies for duplicate handle on my uncle post.

Just suppose some AI-like system could advise politicians 'if you want to boost this part of the economy then do this and that, but you will upset these and these voters'.

Plainly the economy, the country and the voters (and other stuff) would need to be identified in some way and some model of economics and politics plus underlying assumptions made. Complicated and possibly not even do-able.

But even if do-able, would politicians want such a system? It might make things too explicit, the relation between haves and have nots too clear. Then with the levers and cogwheels of power made clear it might be too easy for outside influences to thwart political changes.

As things stand we appear to be in the position of aircraft designers with no concept of maths or physics and if we did learn these things we would have to endure many pilots on board all pulling joysticks in different directions.

The future is not bright.

[Zoltan Jorovic]

I take issue with TheProle when he argues that investment in broadband is just spending, like "your" meals at the ritz. Let's put aside the argument that in one of your meals at the ritz you might make friends with a wealthy widow who then leaves you her estate - in which case it would be a fantastic investment. Instead I contend that you make the mistake of thinking that fast fibre access is just a nice to have thing so that people can stream HDTV or play games. It is more than this. It is a necessary step to allow the full development of many technologies and to allow cyberspace to grow into a major part of the economy. As such, it is very much an investment in an enabling infrastructure. Without it, many technologies will remain niche, or, perhaps worse, only accessible to a minority of geographically privileged individuals. As part of the necessary infrastructure for the future, it shouldn't be looked at from a narrow financial perspective. You don't ask if a road will make money, nor gas pipes or water mains. Similarly treating fibre as a profit seeking service is a category error.