Origins of the Tory implosion

The implosion of the Tory party suggests I was wrong.

I had thought that economic stagnation - which has seen real wages fall below 2007 levels - would benefit the Tories. As Ben Friedman showed, a weak economy leads to illiberalism and reactionary politics which creates a constituency for culture war politics and attacks on migrants, "wokesters" and the EU. Also, the low real interest rates caused by stagnation sustain house prices thus giving older home-owners an illusion of wealth, whilst at the same time boosting the profits of some financiers who back the Tory party.

This seemed to be the case until recently: the Tories led Labour in the polls until this year, and even in the summer had only a small deficit. But no longer. Labour now has a 30pp lead, predicting the wipeout of the Tory party at the next election.

So what changed?

Putin, that's what. His invasion of Ukraine caused energy prices to soar, with the result that the cost of living crisis increased in salience, whilst culture wars diminished. Which has revealed a division in the Tory party.

This division arises from a brute economic fact. You can have both low taxes and decent public services only if you have a strong economy: history tells us that the shares of taxes and state spending in GDP are driven more by economic fluctuations than by government ideology.

Fifteen years of economic stagnation therefore forces Tories to choose: you can have tax cuts, or you can avoid cuts to welfare benefits and public services. But you cannot have both.

For years, the Tories have dodged this question by talking little about economics and more about culture wars, of which Brexit is a part. That is now no longer an option: those Tory MPs who moan about migrants and Harry Potter courses at universities merely embarrass themselves.

Kwarteng tried to dodge this question by pretending that tax cuts would stimulate growth or that the government could easily borrow to cut taxes. Neither claim survived more than a few days.

For one thing, there is little (pdf) evidence that lower taxes do stimulate growth. The UK economy grew much better when the Kinks complained that "the taxman's taken all my dough" than it did in the years after Nigella's dad cut the top rate to 40%*.

And for another, government borrowing has gotten more expensive: five-year nominal yields have jumped from 0.8% to over 4% so far this year. That's partly because of a rise in global yields, and partly because we are now closer to full employment and the point at which looser fiscal policy leads to inflation rather than real growth. It's also because the government has reduced confidence in UK assets by sacking Sir Tom Scholar and sidelining the OBR; the US can afford to elect a braindead ideologue because it has exorbitant privilege but the UK cannot be so cavalier about international perceptions and so doesn't have that option.

The Tory dilemma is therefore acute: tax cuts or public services? Of course, many Tories have an ideological instinct for tax cuts. But they also have a predilection for "sound finance" and - even more so - for getting elected. And with voters not wanting a smaller state (pdf) they cannot have all three.

Let's be clear, though. The issue here is not only ideology and electoral considerations. Underpinning it is 15 years of economic stagnation. Just as poverty-stricken individuals face horrible choices, so too do countries. In fairness to them, Truss and Kwarteng realize this - hence their concern to raise economic growth. Sadly, though, they are unaware that achieving this requires years of hard slog and that the enemies of growth exist in their own party - in Brexiteers, nimbys and financiers and rentiers who benefit from the low interest rates that stagnation usually brings.

The Tories had the luck or skill to avoid these choices for years by fostering culture wars, which led me to think stagnation would continue to benefit them. I was wrong, because economics has now become the centre of party politics again. Tory divisions and unpopularity are not just the unfortunate result of having profoundly inadequate personnel. They are the product of underlying economic forces.

* Between 1948 and 1971 (when the top income tax rate averaged 90%) UK real GDP grew by an average of 3.3% a year: since 1988, when it was cut to 40%, it has grown only 1.9%.

Another thing. All this, I think, is an example of a point the great Jon Elster made in Nuts and Bolts for the Social Sciences. The social sciences, he wrote, are a box of mechanisms. But we often cannot foretell which mechanism will operate more strongly. So whilst there are some mechanisms linking stagnation to Tories thriving, there are others linking it to their demise. What we've seen is a shift from one to the other. As Elster wrote, "sometimes we can explain without being able to predict." (Personally, I don't see this as a great defect in the social sciences - but that's another story.)

Comments

[rsm]

Rather than retelling the trite old economic story of "you can have tax cuts, or you can avoid cuts to welfare benefits and public services. But you cannot have both" in response to the recent gilt yield rise, can we tell instead a financial story of a couple traders bumping gilt yields up for arbitrary reasons probably more connected to their technical short hedging positions than any macroeconomic events; then momentum traders get on board; then pension funds are exposed through margin calls; then fire sales start occurring and isn't this how irrational panics start?

So rather than stale old stories of economic trade-offs between taxes and spending, aren't we really dealing here with market manipulation and irrational emotion, whose instigators opportunistically seize on weak old theoretical economic stories to spread rumors in chat rooms, the better to profit from their technical short hedges?

In short how does the proposal and subsequent withdrawal of a tiny $2 billion in tax receipts change yields so much, unless a lot of psychological noise is going on?

[ltr]

Chris Dillow:

Between 1948 and 1971 (when the top income tax rate averaged 90%) UK real GDP grew by an average of 3.3% a year: since 1988, when it was cut to 40%, it has grown only 1.9%.

https://www.nytimes.com/2022/09/23/opinion/uk-truss-tax-cut-economy.html

September 23, 2022

Wonking Out: The tax-cut zombie attacks Britain
By Paul Krugman

[ Chris Dillow's analysis here, adding to that of Paul Krugman, strikes me as perfect. ]

[Graham Jones]

You wrote: "The social sciences, he wrote, are a box of mechanisms. But we often cannot foretell which mechanism will operate more strongly."

This is because the "social sciences" are not a science. In a science, an understanding of the mechanisms leads to an explanatory theory, and in turn the theory is confirmed by its ability to predict outcomes.

[Joseph]

@Graham Jones

Is paleontology not a science because it cannot predict outcomes?

Is Svante Pääbo not a scientist because he does not predict outcomes?

Is meteorology not a science when it gets the weather wrong but becomes a science when its predictive success gets above 50%?

The demarcation debate is a fool's errand.

[Dipper]

The level of debate over the mini budget has been awful.

'Unfunded tax cuts'. What on earth? Is there a more Orwellian phrase in economics? The underlying notion that all money belongs to the state and the state decides what is fair for you to keep is a highly dangerous one.

'Raise benefits by inflation'. well why stop there? Why not double them and give claimant a free car? Once you start spending on the basis of what people deserve rather than what we can afford we are finished.

The OBR will pronounce shortly and no doubt say that as the extra growth rom tax cuts is uncertain they will assume it is zero. Which is nonsense.

Everybody on here knows that people and organisations respond to incentives. In particular that people respond massively to financial incentives. But we are being asked to believe that is not true and we can move money around with no consequence.

We can face our bankrupt state now, or we can do it again in five years time when the crisis will be that much worse. But we cannot escape facing that reality.

Truss/KK are right.

[Dipper]

The frustrating thing about the whole Remain/Blairite blob outlook is it is so limited. It just looks one step ahead all the time. It never asks the question "And what then?"

windfall tax. "And what then?" as if companies don't respond to incentives.

raise benefits by inflation not earnings. "And what then?" once you have reduced the incentive to get a job an increased the burden on those working.

[P Chernanko]

@Dipper. Your response is pretty awful tbf. Lots of strawmen:
The 'right' to tax...well start out at the other end of your ridiculous spectrum and levy no taxes and end all pretence of the 'State' right there. Happy now?

Windfall tax and incentives?
Ever heard of something called 'unearned income'? ...or monopolies (especially of natural resources) and rentiers?
...see Wealth of Nations.Adam Smith.

"Raise benefits by inflation"...so when its clear after 12yrs of Tory rule we all know on here that after tax and benefit changes there has been a rather large transfer from bottom decile to those on mid and upper deciles you think it appropriate to see how much slack remains in the bottom decile?

Incentives?
Everyone on here knows you dont need to earn 100 times the average wage in your firm in order to get out bed but some silly folks pretend otherwise.

'Incentive to get a job...'
But surely you know we already have the lowest regulatory 'burden' on hiring and firing in western europe and with wages so low (40% of universal credit recipients are 'working') the state has to subsidise business to employ.You like the idea of lower real wages though...

Truss/KK are clueless. Thats what spooked the markets and even half the Tory party know it!

[Dipper]

@ P Chernanko

'levy no taxes and end all pretence of the 'State' right there.' Well yes, start at that end and ask what is it that we can spend better collectively than individually. Better that way round than start at the 'all money is the state's and we should judge what someone should be allowed to keep'. We all know where that ends. How many times do we have to go down that road before we find there is nothing but mass poverty and corruption down that road?

'tax and benefit changes ' etc just a reminder that the irresponsibility of the give away minibudget restored the overall tax levels of 2021

40% of universal credit recipients are 'working'. Exactly. Try find a low paid job that isn't 16 or 22 hours because it interferes with Universal Credit. We face a labour shortage but the benefits system effectively prevents that shortage being addressed. The last thing the benefits state wants, once it has people in its clutches, is to let them go.

I'm sure you have lots of stats but I keep a regular close eye on our local labour market and particularly our local working class town, and the Blairite state has nothing for those folks, only endless dependency.

I don;t like low wages. I don't like poverty. I voted Brexit so workers would not have their wages constantly undercut. But you don't end poverty by making people more dependent on handouts. That just increases it.

I know, as a Truss/KK supporter, that our enterprise is doomed. That Starmer/Reeves will be PM and Chancellor before long. And that after three years of heavy state high tax induced economic torpor and the thundering reality that with no growth that debt is never going away and will be forever round our necks, that a debt and currency crisis will appear, and then the Truss/KK folks will be back to say we told you so, we knew we would end up here, and that's why this mini-budget was right.

[Dipper]

... and Ashworth going on about the large number of long-term sick people. As if that's a real thing. I understand that long-covid has been particularly hard on social workers and health workers in the public sector. I wonder why that would be?

People respond to incentives, and respond very strongly to financial incentives. One you make being long-term sick a paying job, you will get lots of people being long-term sick.

But that will be your problem soon. Reeves will be standing at the dispatch box saying that the unprecedented and completely unexpected surge in long-erm disability requires the top tax rate to be increased from 60% to 80%. And the OBR will pretend that incentives don't exist and they can just take that 20% without any consequences. And you will know it is a road to disaster but you will fear saying that out loud.