Tactics Without Strategy: Brexit And The Politics Of Conceit

With two million Conservative voters seemingly ‘undecided’ last week and Labour voters preponderantly pro-Remain but susceptible to no-shows at the ballot booth, it was tempting to presume before the vote that an event of this magnitude might be decided by something so quintessentially British as the weather. Come Friday morning, it was abundantly clear that was not the case. The gap between Leave and Remain was just under 1.3 million votes, far greater than can be explained by a June downpour. The outcome is humbling.

In due course the referendum defeat will become the textbook reference for political hubris. Cameron’s referendum campaign showed a fundamental underestimation of public mistrust with the political establishment when it committed taxpayers’ money to the production of Remain leaflets. Similarly an appeal to the eminence of its leading voices on the risks of Brexit – prescient though they were – might work when it comes to winning over fearful middle class swing voters in marginal seats, but alienated a large and sceptical cohort who had not done particularly well since the 1990s. This played to Leave’s strengths who were only ever going to run a populist campaign with immigration as the issue ‘the establishment wouldn’t touch’. The more establishment figures Remain wheeled on, the more remote they seemed.  

The referendum loss symbolises Conservative leaders obsession with tactics at the expense of strategy. They built a machine to be elected not govern, perfecting the art of winning small political skirmishes which embrangled them in increasingly intractable commitments. Eventually one intractable position was not going to hold.

So where does the referendum result leave things? Economically, we are in a difficult place. The EU will push for an early exit to reduce uncertainty in other EU countries. The longer negotiations are drawn out, the more turmoil will be inflicted on our major trading partners within the EU - there is a good chance they may move into recession, as seems unavoidable for the UK. It is sadly true that they also must make an example of us or risk giving hope to Leave movements elsewhere. Investment, already weak, will retreat until some certainty returns. This is happening in real time, with huge swathes of construction now put on hold. Financial markets are not as robust as we are led to believe and the £250bn injection promised by the Bank of England - presumably a bid to stave off a prospective wholesale run as bank stocks fell 30% – would seem to support that. We have yet to see the effects of a ratings downgrade and sterling devaluation on the economy. It is doubtful that the devaluation will benefit the export sector radically: in four of the last six major periods of devaluation there has been no impact at all. These are not the conditions under which the politics of optimism thrive.

This takes us to the Leave campaign. The campaign was built on an anti-establishment/anti-intellectual ticket led by an old Etonian and another Oxford graduate. It traded on the conceit that many of the UK’s problems could be solved by ‘taking back control’ – an organising metaphor abstract enough to galvanise a body of voters with quite different perceptions about what this meant. The usual accusations about Leave being ‘old, uneducated people in the North’ have already surfaced but the reality is much more complicated: 43% of ABs voted Leave, for example – that’s a lot of skilled workers and professionals. Similarly, the geography of the Leave vote is split between cosmopolitan centres like London, Bristol, Manchester and Liverpool on the one hand and smaller towns and rural areas on the other. The most important indicator of a Leave voter is value-based according to Ashcroft’s polling data: in other words, we are witnessing the reawakening of a particularly cynical, conservative English authoritarian personality which cuts across class and geography. ‘Taking back control’ in this context signalled a variety of things: release from the EU’s institutional sclerosis and immured power bases; rejection of the neo-liberal grip on policy formation; devolution and an improvement in accountability and sovereignty. But for many it primarily meant control of immigration. And the Leave campaign was happy to let people believe that this was precisely what we were voting for.

The problem now is that this puts Johnson and Gove in precisely the predicament of Cameron and Osborne.  The latter were outmanoeuvred tactically, but it is Johnson and Gove who have the larger strategic quandary. The flipside of the Leave campaign’s amorphousness is that all of its voting tribes will expect their vision of Brexit to be delivered: that is the risk with summonsing ‘end-of-truth-and-reason’ politics. Putting aside the inconceivability of honouring the £350m per week to the NHS pledge, they have a much larger problem regarding immigration. If they opt out of the pledge to stop free movement, as pro-Leave campaigner Daniel Hannan has already indicated, those who voted Leave believing it was a vote to control immigration will feel betrayed.

This is ultimately why I am pessimistic. If you lead a populist, anti-immigrant campaign on an anti-establishment platform, and then support an EFTA model that retains free movement, you will discredit yourself and the democratic process. Add to that a rapidly deteriorating economic climate and the resurgent nationalism you were complicit in stoking, and voters will begin to embrace the extreme right. It will take considerable political skill for Johnson and Gove to manage this next phase should they replace Cameron and Osborne. I am not sure it is within their capabilities. Both have a facility with the blunt instrument of populism, but they do not possess the political guile and sophistication to deal with the subtle intricacies of a perceived volte face in such a febrile climate. Farage, however, does have the necessary nous and aggression to point out their deceit.

Can the Left stop this? They are in a difficult position, not least because we are seeing the working out of the legacy of New Labour - its mishandling of the financial crisis and intransigence towards its heartlands. This instilled a sense of injustice, of powerlessness, of being cut adrift. Atavism fills the space left by the dismantled social and economic institutions that build solidarity and community. The Labour Party were correct to move to the left to reconnect with those communities as voters began to defect to UKIP, but they have the wrong leader to deal with the fight to come. The Labour Party needs a brawler, not a history teacher.

Whoever that might be, they will need to address some of the profoundly reactionary sentiments of their ex ‘core vote’. Anti-immigration is now a deeply ingrained and increasingly animating ideology that will be difficult to reverse. A politics of trust, tolerance and understanding to support vibrant communities of difference is needed. This requires a redistributive politics to fund the rebuilding of the economic and social institutions that embed harmony: better jobs, better public services, better social housing. That may grate with the business elites of London and other cosmopolitan centres, but social dislocation is not good for trade and growth either. As Duncan Weldon has pointed out: capitalism needs social democracy to function. The state now has a duty to stabilise capitalism by acting against the interests of its most vocal proponents and greatest beneficiaries. This is the challenge for Labour.

Stanley

Panama Leaks In The Context Of Austerity

I always thought the austerity rhetoric had something of ‘the spirit of the Blitz’ about it. Austerity (the rhetoric) instilled a sense of togetherness and inclusion in the British public even if austerity (the programme) had a highly uneven impact on different groups, and was largely ineffectual in improving our country’s economic fortunes. In a country steeped in nostalgia for the Second World War, this kind of appeal to mass public sacrifice had a galvanising effect. The British public accepted the idea that some personal short term pain was necessary, even if they privately wanted to see more of that pain passed on to those they deemed less deserving. It conjured images of rationing, of a British public without heed to class distinctions responding stoically to a time of crisis - we were ‘all in it together’, showing our unity and our mettle in times of adversity. Even our cultural artefacts said ‘Keep Calm And Carry On’, before the Hoxtonistas got their hands on them.

It is perhaps because of the success of austerity (the rhetoric) that the Panama leaks are so potentially damaging. The unpalatable situation that confronts the Conservative party this morning is that at the time David Cameron announced the absolute necessity of austerity to UK citizens, his father had employed the services of Mossack Fonseca to avoid making the sacrifices perceived to be the duty of others less well off than himself. Time will tell if Cameron stood to gain personally from this arrangement, but it is now difficult to avoid the sense that we were never all in it together: it was always one rule for the privileged and another for the disabled, the homeless, the council workers, the nurses, the junior doctors and multiple others who were told that there was no alternative and that we all must give up something for the sake of the many. For a party steeped in family and other money, much of which may prove to be mobile, there will be nervousness amongst Tories tonight because that image is potentially toxic.

The British electorate do not like hypocrites and they don’t like to be taken for fools. It was, after all, the hypocrisy of the Back To Basics programme that undid the previous Conservative administration, as revelations about extra-marital affairs, romps and exotic sexual encounters undermined the party’s authority to wag its finger at ordinary people and preach the merits of self-discipline and the sanctity of the family unit. The routine scandals made the party a laughing stock and robbed them of power for nearly a generation. We are now potentially in Back To Basics Mark II. When asked to make sacrifices, we like to think it is not beyond those who stand to lose least proportionately to muck in; particularly when the financial crisis was in large part an elite debacle in the first place. What we learn from the Panama leaks is that for the rich, including allegedly a relative of our leader, even these modest sacrifices were unacceptable.

Cameron has said that this is a private matter, but it cannot be this time. The context of his own austerity rhetoric makes this new revelation unavoidably public. This can’t be handled like the pig-gate affair which was successfully starved of oxygen; his one-line response is of similar intent. Cameron now stands accused of something much worse: he is accused of being a hypocrite and of taking the British public for fools. And that is much more serious politically.

Stanley

The End Of The Experiment? Part 4

Changing the economic frame/ Making a political difference

“There is nothing more difficult to take in hand, more perilous to conduct, or more uncertain in its success, than to take the lead in the introduction of a new order of things. For the reformer has enemies in all those who profit by the old order, and only lukewarm defenders in all those who would profit by the new order, this lukewarmness arising partly from fear of their adversaries … and partly from the incredulity of mankind, who do not truly believe in anything new until they have had actual experience of it.” ( Machiavelli, The Prince, 1532, Chapter 6)

“For the overriding economic problem discussed in this book, the first necessity is not technical devices but the public acceptance necessary to make them work” (Hirsch, Social Limits to Growth, 1977, conclusion)

It has long been understood that it is politically difficult to introduce a new and untried order of things which upsets the economic status quo. With the slow motion economic failure of the 30 year experiment, it is nevertheless important to ask:  how can we make a difference politically and begin to organise a better world. The answer is not obvious. We have accumulated so many critiques of neo liberalism that, if they were all piled up one on top of another, they would surely by now reach to the moon. And yet, after several decades, we are no closer to defeating neo liberalism.

This disconnect between critical thought and effective action isn’t a problem for everybody. As we have argued in our blog about Thomas Piketty’s Capital, the sales success of that book can be attributed to the way in which it combines fact driven critique of growing wealth and income inequalities with an utopian solution of higher income and wealth taxes. This solution will never be enacted when we live in post democracy where the mass party is no more and the organised working class have been disempowered

But it is a big problem for the team that wrote The End of the Experiment because we wanted to write a book that moved from critique of the thirty year experiment to new political proposals for action and intervention.  Of course we are academic scribblers not political practitioners. But we can break with the dismal TINAF (There is no Alternative Framework) assumption that frames current centre left and centre right politics; and hope that  our arguments can have some performative impact in the next phase of ongoing crisis

In our book, the distinctive form of our critique shapes our concept of the alternative. Because the one centralised, Westminster led dogmatic experiment has failed, we recommend much more diversity of regional and local experiments which provide the basis for discovering answers. Because our critique shows that the generic fix of competition and markets has led to sectoral mismanagement, we recommend a different approach which recognises the heterogeneity of the economy and engages with activity specifics in what we call the foundational economy.

The argument on these points in The End of the Experiment  is dense but it can be simplified and systematised.  The book’s policy argument starts from a contrarian insight about how there is more than one economy. It then focuses on part of the economy by proposing the foundational  economy as an alternative object before proposing chain value and social license as policy principles do which could be developed and articulated through local experiments 

1) The contrarian insight

After thirty years, it is not difficult to see the problems inherent in the current framing of our politico- economic problems in a country like the UK. It is increasingly realised that our economic problems do not have technical solutions with existing management tools. It is widely accepted that the current UK recovery is consumption based, debt fuelled and unsustainably driven by house price rises: if that observation is set in the context of boom and bust over the past thirty years, the implication is that there is no setting of the macro policy levers (fiscal and monetary) which will deliver sustainable UK growth.

The main stream response is denial. The Thatcherite revolution fails because it is incomplete, the answer is more of the same (and please don’t talk about debt based growth). The generic fix of competition and markets is now applied with more force to energy, banking and every other sector; this structural reform is backed by bolt-ons like industrial policy to deal with market failure in the commercialisation of early stage innovation.

This kind of obsessive compulsive behaviour may be increasingly incredible; but it is at the same time difficult to reframe issues and propose an alternative that works. The difficulty relates to habits of thought and organisational peculiarities which are embedded in main stream British politics.

In terms of overall vision, the centre left’s question has always been why can’t we be more like Germany and their difficulty is that they have no policies which would move the British economy away from financialization and onto a more virtuous productive path. Manufacturing output shows no sustained output growth because the aspirations of foreign owned branch firms are limited as are the capabilities of British firms who prefer to compete in sheltered sectors; adding more finance for production or up-skilling the workforce will achieve little without radical changes elsewhere because UK supply chains are constructed around low skill and investment.

As a way of breaking out of this impasse, we turn to the insights of the French historian, Fernand Braudel. First, “there is more than one economy” because the economy is heterogeneous and includes zones that are not competitive. Furthermore, capitalism is as much about monopoly as competition because local monopolies are what many firms want and the state can franchise. These contrarian insights are the basis for our break with main stream thinking.

In the 30 year experiment, the economy was represented as the unitary sphere of competition where all should submit to the imperatives of globalisation; this conceptualisation was reinforced by the aggregation of everything into national income measures with growth and jobs then promoted as the objectives of policy. Against this we argue that a large part of the economy (more than one third) is sheltered from competition; while growth and jobs are socially meaningless objectives when the income gains from growth are captured by the top 10% of households by earnings and because low wage jobs spread welfare dependence

2) Our object is the foundational economy

After recognising the heterogeneity of economic activity, the question is about how to think about the different zones and their interaction. Our focus is on the zone or sphere which we call “the foundational economy”. The foundational has never been an explicit object of policy and (we would argue) has been mismanaged insofar as it has been subjected to the competition and markets fix.

What’s inside the foundational economy? On our calculations, we include the pipe, cable and wireless utilities that deliver water, energy and broadband, transport utilities like rail and bus, food processing and distribution through supermarkets and most of the lower levels of health, education and welfare. Their outputs are mundane goods and services, from processed food to primary education, which lack the glamour or attractiveness found in high tech or knowledge based “key sectors” like aerospace or the creative industries.

The activities inside the zone are diverse in terms of outputs or ownership because the foundational economy produces a bewildering variety of goods and services under private and public ownership. Yet these activities also have a series of shared characteristics which are the basis for our classification.  These goods and services are all foundational because they are necessary to everyday life, consumed by every citizen regardless of income and distributed according to population through branches and networks. They are also typically sheltered and often politically franchised so that the state (through regulation and planning laws) gives the cable tv operator or the big box retailer an effective local monopoly.

When these activities are bracketed together, the foundational economy appears as a large and strategic zone for several reasons. Large because the foundational economy employs one third or more of the UK workforce; strategic because the cost, quality and security of foundational goods and services (such as energy supply and health care) are key determinants of citizen welfare. Indeed foundational activities are funded by a kind of lien on tax revenue and household expenditure; foundational expenditure accounts for 30% on average of weekly consumption in households who have little choice about paying utility bills or buying supermarket groceries.

After a period when low cost provision of many of these goods was taken for granted, the price and security of foundational supply is increasingly an issue. The crisis of foundational supply is related partly to the limits of our small planet and partly to the failed thirty year experiment; thus, our privatized utility operators like BT are investment averse and British infrastructure is increasingly being half-heartedly renewed by billing the customer or taxpayer for investment.

3) Our economic principle is chain value

Our argument on the foundational economy starts from a distinction between two concepts of value (point value and chain value) which is then developed into an argument about how the foundational economy is being mismanaged on point value principles and would be better managed on chain value principles.

Point value means that the measure of success is least cost or highest profit in an individual transaction (or basket of transactions) at a node in an economic chain. Point value is an active and now ubiquitous principle in the calculations of private and public sectors.

It is represented in the public company imperative of shareholder value through quarterly earnings and higher stock price; or in private equity through cashing out by selling a portfolio company to meet the equity investors’ demand for high returns which are levered up with cheap debt. But it is also represented in the public sector response to budget cuts and value for money when, for example, in adult home care the local authority cuts the hourly rate paid to the agency supplying care workers.

Point value has considerable intellectual prestige; because it is in one form materialised in all the post 1930s business school calculations of return which take account of the time value of money; as with discounting to calculate net present value. At ordinary rates of interest, such calculations are socially questionable because they devalue the future by attaching a very low value to returns more than 5 or 7 years away.  Practically also, they are place bound because point value represents a trader mentality which ignores broader social consequences.

Point value is embedded in private business models which then pass problems down the chain as with supermarkets which use their power to capture supplier margins. In the public sector, the problem is that the state gains on one account only to lose on another account. Thus, wage cuts will reduce the cost of providing council services but increase the demands for housing benefit and other kinds of welfare support.  Pervasive point value therefore spreads unsustainability as private and public actors trumpet their point success when supply chains are undermined and the welfare bill spirals out of control.

So our alternative is back to the future with the alternative principle of chain value.  We should recover the idea of value as a stream of benefits for (internal and external) stakeholders over time. Benefits are not only financial and measurable through one master calculation because there are several orders of worth and long term uncertainty requires defensive prudence. This requires a different kind of economic calculus which balances the interests of different stakeholders (rather than privileging the investor); and introduces political objectives around the ideal of connected economies which deliver both the benefits of re-localisation and of national standards and inclusive national networks 

One of the central problems is that much of this calculus about interconnection is not actionable within the current British system and is equally unlikely to be realised through  the forms of decentralisation which are currently on offer. The British way after the 30 year experiment is to dispense with intermediary institutions and combine self-governing operating units with centralised political power which micro manages in an interfering way; hence the decision makers are the PLC board or the Academy School governors subject to interference by Vince Cable or Michael Gove. As for devolution and decentralisation, in the bi partisan view, articulated in the Heseltine and Adonis reports, this is a matter of handing decision making and central money to dominant regional elites with very few questions asked.

4) Our political principle is social license

The operationalization of chain value thus requires not so much more government as a different concept of what nested levels of government are and can do. As well as very much less reliance on governance at operating unit level which always promises much more than it delivers.

We are against the post 1979 concept of business friendly government which has dominated in the period of the thirty year experiment. In this frame, government’s role is facilitative as it creates the space in which the incentives of markets and competition do their work; hence the structural reform agenda of lower taxes, market liberalisation, deregulation and privatisation. The only acceptable forms of local and regional policy are infrastructure and training which make the market work better (and now help create competitive agglomerations); industrial policy is about rectifying market failure in commercialising innovation. 

Against this, we make another back to the future argument which revives the 1930s ideas of US thinkers like Berle about how business and community are in a relation of mutual dependence because all business exists under a social contract whereby the corporation should offers responsible behaviour in return for the privileges which allow market access and secure profit taking. This is especially so in the foundational economy where the privileged business gains a local monopoly on the household spend of an immobile population in communities and user groups

Hence our arguments for social license in the foundational economy with the aim of enforcing the obligations of business to the community (which are much broader than those of customer care). The explicit analogy is with the mining industry where a social license about benefits for the local community is the quid pro quo for the right to exploit immobile natural resources. Social licensing in the foundational economy would impose relevant conditions on specific activities. Thus, councils would be obliged to pay living wages while supermarkets should attend to local sourcing; this would need to be backed by social innovation to change business models.

All this has fierce political pre- conditions in that change through experiments with scope and scale requires decentralisation with intermediate institutions under electoral and civil society pressure for change. But, if we do not have the answer and favour diverse experiments, then regional and local government can begin right away with experiments in areas, like adult care, where resistance to change is weakest. The question is whether regional and local governments, under pressure from civil society, can rise to this challenge and through experiments and “ actual experience” demonstrate the potential of this approach in ways which increase not just “public acceptance” but public demands for change.

Manchester Capitalism

The End Of The Experiment? Part 2

The free market experiment began with the Thatcher government of 1979 and continued under Major, Blair and Brown. Looking back, many of the changes that occurred in the UK were not well anticipated by the arguments made for markets at that time. Yet despite these undisclosed outcomes, our political classes have yet to consider a 'null hypothesis' result.

The 1980s experiment was premised on a set of visionary promises about what the market could deliver. The vision centred on a critique of the State as a blockage on jobs, growth and competitiveness and a distorter of price signals in a market setting. Drawing on the sentiment, if not the detail, of the Bacon and Eltis thesis, it was argued that the public, non-marketed sector ‘crowded out’ private sector investment and enterprise. Similarly the debate over the public utilities was transformed by an Austrian view that the market would bring the rigour of competition and efficiency of co-ordination to cumbersome public utilities industries. The solution was wholesale de-regulation and privatisation to release entrepreneurial spirit and build an enterprise culture that would benefit ‘the public’ in its multiple identities: as producers, consumers and taxpayers.

The reforms may have had effects, but they were often not the effects that were expected. Surprisingly, public sector job creation increased, both absolutely and relative to private sector job creation under Tory administrations (figure 1). 86.4% of net new jobs created from the beginning of the Thatcher administration to the end of the Major administration came from the public sector. Whilst some of that is explained by the economic cycle, it was mostly the result of a secular decline in manufacturing jobs (over 3m net jobs were lost) which the growth of financial services could not rebalance (only 250k net new jobs were created). By the end of New Labour in 2007 this figure had risen: 4.4m manufacturing jobs had been lost since 1979, with only 330k new financial services jobs created to compensate. What the Conservatives - and later New Labour - discovered was that public sector jobs were a necessary cost, ‘filling in’ for (not crowding out) anaemic private sector job creation and buying in public quiescence at a time of unrest.

Figure 1

Equally unanticipated  was the lack of new entrepreneurial sole traders and SMEs, despite the promise that deregulation extended. From 1992 (when our time series began), the number of full time self-employed workers was virtually flat, until redundancy forced expansion after the 2007 crash. Instead, there was a growth in casualised, insecure low paid jobs: part-time self-employed jobs increased 116%, while part time workers for corporations increased 32% (figure 2). At the same time, large firms failed to show the entrepreneurial flair promised in the discourse of free markets, choosing often to sacrifice high risk/high return activities for modest returns, low risk activities plus scale. The free market experiment, in other words, created an environment where capital satisfices: large companies calcifying around the apparatus of the state, lobbying hard for the release of ever more low return but safe public activities.

Figure 2

This pattern of satisficing was also evident in investment, which always carries risk because it is a gamble on management's strategic and orgranisational competences. The free market experiment promised to stimulate investment, but these problems stubbornly remain. Investment as a % of GDP fell from 17.6% in 1980 to 14.4% in 2013; and the UK continues to have the lowest investment share of GDP among all G7 countries (figure 3).

Figure 3

If the hypothesis that markets would stimulate private sector job growth and investment proved faulty, it equally did not capture unexpected drivers of growth in a more marketised economy. Both Tory and Labour administrations assumed that growth would come from operating efficiencies, competitiveness and specialisation forged within dynamic markets. What they did not anticipate was the importance of credit and asset prices as key sources of growth in a liberalised economy. The push of newly minted credit against real estate assets allowed households to cash out equity gains as income. That income was spent, and GDP rose. It is a staggering fact that housing equity withdrawal was equal to 104.2% of GDP growth under the Thatcher administration and 101.7% of GDP growth under Blair (figure 4). And whilst equity withdrawals were not always spent on items accounted for under GDP measures, its contribution to growth should not be underestimated.

Figure 4

So what were the outcomes? It is clear that the opportunity culture did appear for some: house-flippers, upper income employees in the state subvented sectors, the (subsidised) financial services industry and certain professions all did well. But for many, the disposable income inequalities that emerged put a ceiling on opportunity as income mobility rates fell. By the end of the 1970s the tenth richest households (D10) had five times as much disposable income (before indirect taxes) as the tenth poorest households (D1). By the 2000s the average ratio was almost ten times. These effects were further amplified by the shift from direct to indirect taxes which hit the poor disproportionately: D10 to D1 inequality was 13.4 times on average over the 2000s, up from just over 5 times at the end of the 1970s by this measure (figure 5).

Rising inequalities between households should be understood within a broader context of disenfranchisement as household's lost their stake in GDP growth. At the beginning of the 1980s average disposable household incomes were – effectively – a lien on growth. That changed by the mid-1980s, so that by 2011 (when our series ends) the disposable household income growth of the bottom 90% of households had not kept up with GDP (figure 6). And even the top 10% of households had only just kept pace with GDP growth. Where did this share go? Labour’s pre-tax share of GDP fell 3.5 percentage points from 1979 to 2010 - this was almost identical to the growth of financial corporation gross operating surpluses share of GDP, which increased 2.9 percentage points; although taxes on products and production also claimed a similar increased share of GDP.

Figure 5

Figure 6

These unexpected outcomes may truly surprise us. But surprises are commonplace in all experiments. Learning from those unanticipated results – in this case – seems something that our political classes are less willing to contemplate.

Part 3 will be posted next week...

Manchester Capitalism

Piketty, or “Just the Facts”

“Just the Facts, Ma’m” is the catch phrase credited to Sergeant Joe Friday of the LA Police Department in Dragnet, the US television series of the 1950s. Friday wanted the facts because they would lead to a cycle of purposive effective action with arrest leading to conviction and detention of criminals who should be afraid when Sergeant Friday is onto their case. Professor Thomas Piketty of the Paris School of Economics also offers us the facts, in this case on the history of income and wealth inequalities. But these facts fit into a different kind of cycle of guaranteed inaction whereby society can recognise the problem of growing inequality without any prospect of effective redress so that the rich can sleep soundly in their beds

This is our explanation for the  bestselling success of Capital in the 21st Century (here after Capital), the English translation published of Le Capital au XXI siècle, published last year by Editions de Seuil (Piketty 2014). This is a prolix and inelegant 700 page doorstop of a book, published by an American university press and written by a little known author. It garnishes the facts on the historical development of income and wealth inequalities in twentieth century France, Germany, Sweden, Japan, the UK and the US with some musings on fictional inequality in the world of Balzac and Austen.

This book which failed to gain attention when published in French, has suddenly become a global must read. It has been on the top 100 non-fiction bestseller list of Amazon for thirteen uninterrupted weeks and on the New York Times bestseller list for nine weeks, topping the list for three of those nine weeks. Capital has been lauded by at least two Nobel-laureates (Krugman and Stiglitz) as the most important book in economics since the Wealth of Nations (1776) (Krugman 2014), has been reviewed by every serious economist and has been deconstructed and reassembled in hundreds of economic blogs.

While other economics professors grade essays, Professor Piketty has toured two continents as if he was a true rockstar, has been received for a private tête-a-tête at the White House by Obama himself, has talked to the great and good from the worlds of global finance and politics, has been invited to talk to the Dutch parliament and has earned enough in the form of royalties, according to his own assessment, to buy a piece of prime real estate in the 16th arrondissement of Paris – which easily amounts to four, five million euros.

The central exhibits in his text are U shaped curves of the shares of wealth and income claimed by upper groups. While the U shaped curve of wealth distribution is new (and now challenged in the FT), his curve which shows income inequality returning to pre-1914 levels is not new because (in one form or another) it has featured in a series of academic publications by Piketty and his associates since the mid 2000s. The central finding is also no surprise. Income and wealth inequalities since the 1970s in most developed economies have increased to levels typical of the ‘patrimonial capitalism’ of the late 19th century. But Piketty himself has been arguing this since 2003 (see Piketty 2003), alone or together with his compatriot Emmanuel Saez (see Piketty & Saez 2003). The doyen of comparative inequality studies, Tony Atkinson, has been ringing the warning bell for at least two decades (see Atkinson 1996). The web site with their data, the World Top Incomes database, has been public for at least three years.

This raises the question why Capital has become such a big success, and especially: why now? Our answer is that Piketty’s fact-led discourse suits mainstream thinkers in the present conjuncture.  Before 2008 distributional problems were covered up by growth figures artificially beefed up by debt-driven asset inflation, especially in real estate; after the outbreak of the crisis in September 2008 nobody can deny that financialized capitalism rewards the few and simply does not deliver for the many. Financialized capitalism is a benefit for multinationals and elites but a disaster for citizens and the masses. And this verdict is no longer radical critique from the Occupy movement, Los Indignados or a few elderly socialists, it is endorsed by economists like Paul Krugman, Joe Stiglitz and Larry Summers.

In the background, the high priests of neoliberal liturgy like the IMF, the World Economic Forum and the OECD have recently voiced grave concerns over the political effects of rising income and wealth inequalities in developed economies (see IMF 2014). Under the banner of inequality threatening the legitimacy of capitalism, the IMF has even bracketed its traditional aversion to cross border capital controls (IMF 2012). An even starker illustration of the concerns raised by increasing inequality among the global financial elite is the May 27 London conference on ‘Inclusive Capitalism’. Organised by an heir to the Rothschild fortune, the conference allowed the great and the good such as Martin Wolf, Christine Lagarde, Prince Charles and Mark Carney to lament increasing inequality (see Lagarde 2014).

Against the back ground of disaffection with main stream politics, it is hardly surprising that the great and good are now recognising that they have a problem about the legitimacy and attractiveness of financialized capitalism. While bankers’ bonuses in the City and on Wall Street are back at the level of 2008, ordinary households in the US and the EU are still facing declining disposable incomes, resulting in pretty severe cost of living crises on both sides of the Atlantic. The stock markets are at record highs with  price records being set again on art markets and in markets for prime real estate in New York, Paris and London. The unconventional monetary policies which central banks hoped would beat the ‘great recession’ have instead benefited the wealthy by boosting asset prices.

Led by Amazon and Starbucks, and advised by para-financial accountants and lawyers, large firms have succeeded in paying an ever smaller share of overall taxation, and hoard ever larger amounts of cash which is not invested. Households by default have to bear the brunt of both the austerity policies enacted throughout the EU and through higher prices or taxes pay for investments in the renewal of material and immaterial infrastructure (roads, rule of law, education) on which large corporates depend. Corporate lobbyists with trade narratives shield politicians and confuse citizens who nevertheless by majority in countries like the UK typically support policies like renationalisation of utilities.

Enter Thomas Piketty: a French economist with a reassuring CV that includes a PhD from the LSE and a stint as economics Prof at MIT. On the basis of carefully assembled historical data and an impressively sounding law of capitalism ( R > G ), Piketty warns that ceteris paribus we are returning to the  patrimonial capitalism of the late 19th century. Capitalism is an inequality machine because the return on capital (R) in a context of demographic decline will always be three to four times larger than overall economic growth (G), implying that income and wealth inequalities due to the forces of compounded interest and multiplication will by necessity grow. Mid twentieth century equality is according to Piketty an anomaly based on unrepeatable historical contingencies including war, destruction, financial repression, inflation, the rise of mass democracy and redistributive welfare states.

The strength of Capital lies in its careful presentation of the historical facts. As Piketty writes in the Acknowledgement: ‘this book is based on fifteen years of research devoted essentially to understanding the historical dynamics of wealth and income’ (p. vii). No more, no less. Thence the 18 Tables and 97 Figures, that have to prove beyond reasonable doubt that the phase before 1914 was capitalist normality, that the period between 1914 and  1970 was capitalist exception, and that in the past thirty years we have embarked on a trajectory which will bring us irrecoverably back to that earlier normality.

The book derives its unmistakable political seductiveness from it’s a-theoretical, empiricist factuality. Although Karl Marx figures prominently in Capital, the spirit in which it is written is one of classical (not radical) political economy. Piketty’s devices include accounting identities, economic laws (‘the first fundamental law of capitalism’) and echoes of classical demographic arguments; Capital resembles Thomas Malthus much more than radical theorists like Karl Marx who employed the labour theory of value of Adam Smith and his ilk to critique the exploitative nature of industrialized capitalism and predict its ultimate demise through crises of over accumulation.

The reader looks in vain in Capital for Marxist or Marxisant theoretical explanations around class and accumulation or bourgeois radical explanations around business  models, agents, power relations and politics. Piketty asserts R > G as an explanation for growing inequalities, but it is of course no such thing. One section poses the crucial question as to why the return on capital should be greater than the growth rate (p. 353 ff); but this section does not contain any answer other than a summary of the historical record. Growing inequalities are inherent to capitalism au naturel, that’s just the facts.

And facts have a value which is enlightenment. ‘Intellectual and political debate about the distribution of wealth has long been based on an abundance of prejudice and a paucity of fact,’ writes Piketty in the Introduction where he explicitly refers to Kuznets and his Whig expectation that economic progress would bring less not more inequality. Thus the main aim and the huge success of Capital (p. 2). This is the book which brings light where darkness reigned – not to debunk or demythologize or accuse, but to put the political debate on inequality on a more secure, empirical footing and (implicitly) when we know the facts, will we be able to assess, judge and act. Piketty hence subscribes to the positivistic view of science which colours to this day the self image of economics: positive economics is about facts not values, the technical facts not the political choices.

Piketty is the samurai hero of positive economics who lays about him with fearless sword play. Progressive readers can only cheer his skewering of the marginal productivity explanation for the rise of supermanagerial rewards since the late 1970s (p. 330 ff.). As Piketty contends, increased bargaining power does a much better job in explaining rising income inequalities than any other explanation. Yet this line of argument is not connected with the political economy and political science by scholars like Wolfgang Streeck (2014), Colin Crouch (2004) and Peter Mair (2013),on the increasing malfunctioning of democratic policy making in the late 20th century. The political backdrop for the return of patrimonial capitalism is never explored.

From this point of view, our core problem is disconnect between the median voter and his representative. This is explicit in the Eurozone troika countries, indirectly in the excessive deficit countries of the Eurozone, implicitly in all the other representative democracies. Everywhere it has created a democratic vacuum in which large banks and multinationals have been able to push through a silent coup. Just as the rise of mass suffrage marks the beginning of the great anomaly period of increased equality in the 20th century, so the end of mass democracy and the rise of post-democracy marks the back to the future return of income and wealth inequalities. But all this is never explicitly discussed in Piketty who simply avoids any kind of political explanation for the phenomena he describes.

In our opinion, this political reticence explains Capitals phenomenal success. In a conjuncture when capitalism is malfunctioning politically and economically, Piketty lets the undeniable facts speak for themselves. Thus, Piketty has succeeded in making his message about increased inequality palatable to an audience of important people who would have bridled at anything that smacked of contrarian leftism which in Marxist and Social Democratic  forms has always sought to organise politically on the basis of its economic analysis. Piketty does not offer an activist ideology; he deals in facts. No wonder that Larry Summers and Paul Krugman have claimed to see in Capital the birth of a new style of empirical economics. Away with models! Away with ideology! Away with theory! Here come the facts!

That is why Chris Giles launched his attack on Piketty in the Financial Times of late May and why it appeared so threatening to Pikettyites (Giles 2014). What if all those carefully assembled, speaking-for-themselves facts were wrong? What if the facts had overstated real inequalities? Would that not suggest that ideology lurked behind Piketty’s a-theoretical, a-political empiricism? If the facts did not speak for themselves and instead required political interpretation maybe there was nothing self-evident about Piketty’s facts? Inevitably, Piketty responded to Giles attack by claiming empiricist virtue: his work was transparent because ‘all Excel-sheets are available on Internet’; it was necessarily incomplete because ‘more data and more collaboration are needed’; and the adjustments were not biased because ‘colleagues have looked at off shore centres, suggesting that real inequality is larger rather then less’ (Piketty 2014a).

So far Piketty has done enough to see off Giles and other positivist economic critics who have until now only disputed the facts about the problem of wealth inequality and cannot find gross errors of the kind which the Amherst team found in Reinhart and Rogoff’s This Time is Different (see Herndon et al. 2013).  But, given his style, Piketty cannot do enough to see off political critics who would instead focus on his recommended solutions as the point of weakness.

When it comes to fixes for inequality, in Chapter 15 Piketty presents his widely discussed ‘useful utopia’ of a global progressive wealth tax and is the first to acknowledge that politicians are unlikely to implement a wealth tax due to insurmountable collective action problems. Piketty can then present himself as the high intellectual in a low political world: ‘for reasons of natural optimism as well as professional predilection, I am inclined to grant more influence to ideas and intellectual debate’ (p. 513). Or, as we would put it, the more a-political, a-theoretical and empiricist the analysis, the less likely it is to have credible fixes as corollary.

The fixation on a global wealth tax is however revealing.  If the problem of capitalism is R > G, merely analytically there are at least two different economic pathways and one more political pathway out of the predicament of increasing inequality. One could choose to structurally limit the return on capital, by means of an estate tax for example. That is Piketty’s preferred solution: < R. Alternatively, one could also choose to ensure that growth increases, either through investment, re-framing management and redefining economic activity.  An alternative economic solution is > G  through massive investments in infrastructure, managing the sheltered foundational economy through social licensing and innovation and redefining what goes into GDP

Finally, one could choose to change the distribution of rewards between capital and labour ( R : G ). This is a political solution because the means to do so are labour union renaissance and new modes of corporate governance with a stronger say for labour and other stakeholders. The aim would be to encourage demands for higher wages by recreating the bargaining power which organised labour had in the mid twentieth century and deny capital the gains it has made since the late 1970s when liberalisation loosened up the exit options of capital.  As Thomas Frank has argued, if we strengthen labour against capital, the market will deliver the outcome which Piketty seeks through progressive taxation (Frank 2014).

Piketty’s preference for the pseudo technocratic fix of progressive taxation is revealing of his rationalist concept of management which again helps to explain his brilliant success. Progressive taxation is the rationalist solution because the logic of the ratios and aggregates is countered by an adjustment to the one element of government taxation which finance ministries can vary (but never will with the present balance of economic forces in high income countries). But this helps smooth the reception of his book amongst elites and opinion formers who market the book to a much wider circle. Piketty has a seminar room solution for inequality which is economically thinkable but not politically possible and the importance of his book is that it allows us all to acknowledge the problem of inequality without danger that we might be endorsing or licensing any effective solution. Read Capital and demonstrate your concern while doing nothing.

References

Atkinson, A. (1996) Income Distribution In Europe and the United States, Oxford Review of Economic Policy 12(1): 15-28.
Crouch, C. (2004) Post-Democracy (Oxford: Polity Press)
Frank, T. (2014) The problem with Thomas Piketty: “Capital” destroys right-wing lies, but there’s one solution it forgets, Salon, May 11, http://www.salon.com/2014/05/11/the_problem_with_thomas_piketty_capital_destroys_right_wing_lies_but_theres_one_solution_it_forgets/
Giles, C. (2014) Data Problems with Capital in the 21st Century, May 23, http://blogs.ft.com/money-supply/2014/05/23/data-problems-with-capital-in-the-21st-century/
Herndon, T. et al. (2013) Does high public debt consistently stifle economic growth? A critique of Reinhart and Rogoff, Cambridge Journal of Economics, doi: 10.1093/cje/bet075
IMF (2012) The liberalization and management of capital flows; an institutionalist view, November 14, 2012, http://www.imf.org/external/np/pp/eng/2012/111412.pdf
IMF (2014) Redistribution, Inequality and Growth, IMF Staff Discussion Note, February 2014, http://www.imf.org/external/pubs/ft/sdn/2014/sdn1402.pdf
Krugman, P. (2014) Why We’re in a new Gilded Age, New York Review of Books, May 8, http://www.nybooks.com/articles/archives/2014/may/08/thomas-piketty-new-gilded-age/
Lagarde, C. (2014) Economic Inclusion and Financial Integrity—an Address to the Conference on Inclusive Capitalism, May 27, https://www.imf.org/external/np/speeches/2014/052714.htm
Mair, P. (2013) Ruling the Void: the Hollowing of Western Democracy (London: Verso)
Piketty, T. (2003) Income inequality in France, 1901-1998, Journal of political economy 111(5): 1004-1042.
Piketty, T. (2014) Capital in the 21st Century (Harvard: Harvard University Press)
Piketty, T. (2014a) Rebuttal, http://piketty.pse.ens.fr/files/capital21c/en/Piketty2014TechnicalAppendixResponsetoFT.pdf
Piketty, T. & E. Saez (2003) Income inequality in the United States, 1913-1998, Quarterly journal of economics 118(1): 1-39.
Streeck, W. (2014) Buying Time: the Delayed Crisis of Democratic Capitalism (London: Verso)


Dyfal Donc & Dutchman

Boris Johnson: Cheer Leading For Inequality

When he gave the annual Margaret Thatcher lecture Boris Johnson’s praised inequality in a calculated way. He was positioning to challenge the Tory leadership from the right, if and when Cameron and Osborne fail to increase Tory seats at the next election.

Perhaps in an attempt to block Johnson’s manoeuvring, George Osborne, in a softer way, repeated those sentiments in his comment on Johnson’s lecture: inequalities of outcome are inevitable; the important thing is to ensure equality of opportunity through schooling:

"I think there is actually increasingly common agreement across the political spectrum you can't achieve equality of outcome, but you should be able to achieve equality of opportunity… You should give everyone, wherever they come from, the best chance, and, actually, education is the key to this."

This is partly wishful thinking when schooling in so many ways reinforces inequalities driven by catchment areas and the residential segregation of different income groups. But the more troubling point is that the Tory Right are now trying to break with the Westminster consensus in several ways.

First, the five Tory back benchers who wrote Britannia Unchained have blamed our lazy workers for continuing underperformance: “The British are among the worst idlers in the world. We work among the lowest hours, we retire early and our productivity is poor. Whereas Indian children aspire to be doctors or businessmen, the British are more interested in football and pop music”.

Now Boris Johnson praises the deserving rich who are smarter so that they will inevitably succeed against the masses who, on his account, have low IQs not a deficient work ethic. Johnson presents us with the cornflakes pack account of social reproduction and income inequality:

“Whatever you may think of the value of IQ tests, it is surely relevant to a conversation about equality that as many as 16 per cent of our species have an IQ below 85, while about 2per cent have an IQ above 130. The harder you shake the pack, the easier it will be for some cornflakes to get to the top”

This analogy rests on a farrago of unjustified assertion about competitive struggle, half-truth about the contribution of the rich and sleight of hand about the IQ evidence topped off by a failure to distinguish between income and wealth inequalities.

1. Johnson’s whole argument is framed  in a familiar way by the assertion that our country and individuals within it are all engaged in ceaseless, striving competition:

  “Like it or not, the free market economy is the only show in town. Britain is competing in an increasingly impatient and globalised economy, in which the completion is getting ever stiffer. No one can ignore the harshness of that competition, or the inequality it inevitably accentuates; and I am afraid that violent centrifuge is operating on human beings who are already very far from equal in raw ability, if not spiritual worth.”

This is really a quite peculiar perception which hardly fits the facts. The balance between internationally exposed and sheltered activities in Britain has been decisively changed by the competitive failure of British tradeable goods. Real manufacturing output has not increased in the past forty years and manufacturing now accounts for no more than 11% of GDP; our export success is narrowly concentrated in financial services from London finance whose activity brings public risks as well as private rewards.

Johnson’s argument completely ignores the sheltered “foundational economy” of private and public organisations producing everyday goods and services. Pipe and cable utilities, transport infrastructure, food processing, supermarkets, health, education and welfare altogether now employ 40% or more of the workforce. In these sectors, pay relativities and minimum wages are not determined by competition from Guangdong Province but are a result of social choices intersecting with business models

2. Johnson tries to legitimise income inequality by making disputable claims about how “the rich” contribute to society through paying taxes.

“ When Margaret Thatcher came to power in 1979 they ( the rich) faced a top marginal rate of 98% and the top 1% of earners contributed 11% of the government’s total revenues from income tax. Today, when taxes have been cut substantially, the top 1% contributes almost 30% of income tax, and indeed the top 0.1%- just 29,000 people- contribute fully 14% of all taxation. That is an awful lot of schools and roads and hospitals paid for by the super rich”

We‘re fairly sure the 30% figure exaggerates the contribution of the rich. A quick google  search highlights a BBC story from 2009 which suggests that the figure is below a quarter for the top 1%. The 30% figure does not come from any kind of academic source since but seems to have been put into circulation by a stockbroking firm Oriel Securities which explicitly says it is doing “non independent research which constitutes marketing communications “

And the 30% of taxes claim represents the same sleight of hand as in the old trade narrative about London finance’s contribution which we dissected in our Alternative Banking Report of 2009. London finance highlighted its 30% contribution to corporation tax and ignored the fact that its contribution to all taxes paid was half as large and a sector like manufacturing paid more. So it is in this case where Boris Johnson highlights share of income tax without discussing the broader picture. Mrs Thatcher did not reduce state expenditure’s share of GDP, but cut income tax rates and shifted the burden of taxation onto regressive consumption taxes. So the share of all taxes paid by the rich is much lower than 30% and it is the poor and middle income groups who are paying for their own schools and hospitals

3. Johnson’s category of “ the rich” conflates inequality of income and wealth; if we dis-aggregate the two groups, the relation between IQ and income is positive but the relation between IQ and wealth is almost certainly non existent

Here is a standard sociologist’s take on the correlation between IQ, income and wealth. 

There is a loosely positive correlation between IQ and income, but it is not immensely strong. That is because, for example, there are many examples of institutions which pay modest wages to high IQ individuals – public universities being one good example. But the more interesting finding is that the correlation between IQ and wealth is completely absent. And the obvious explanation for that is because wealth is inherited without conditions as to intelligence, diligence or anything else.

Inherited wealth is the big problem for the new social Darwinists like BoJo. Not least because the past 30 years of widening income inequality will be followed by congealed wealth inequalities because the rich cannot easily be prevented from having children who will often be dim scions. These inevitabilities would be best addressed by a system of death duties and inheritance tax which (unlike the present regime) could not easily be dodged by setting up a family trust.

The fundamental problem is always the economic and social reproduction of inequality. But that is always invisible in Johnson’s discourse.

Dyfal Donc and Stanley

Doing What’s Easy: The Unbalanced And Unstable 2013 Recovery

“We cannot go on with the old model of an economy built on debt. An irresponsible public spending boom, an overblown banking sector and unsustainable consumer borrowing on the back of a housing bubble were the features of an age of irresponsibility that left Britain so exposed to this economic crisis. They cannot be the sources of sustainable growth for the future…We will build a more balanced economy which does not depend so heavily on the success of financial services, and where all parts of the country share in the gains…In the coming months we want to unite the country behind this new British economic model” George Osborne (2010) ‘A New Economic Model: Eight Benchmarks for Britain’, p.1.

Back in February 2010 the Chancellor wrote the above as a preface to a document which outlined the Conservative vision of a new economic model for Britain. The theme of rebalancing featured prominently in the eight benchmarks outlined in the document, which were to provide the gauge against which the performance of a Conservative government might be judged[1]. But with our economy apparently on the mend, we seem much further from the kind of sustainable model described in Osborne’s 2010 vision. We have instead done what’s easy and embarked on a strategy of reflating the housing bubble, predominantly in London, creating all kinds of uncertainties going forward.  

The basic post-crisis story is one of a two speed economy. This can be seen in the regional breakdown of the UK’s GVA growth (GVA being the standard ONS measure of output). The two charts below show that in the pre-crisis period between 1997-2006, London and the SE accounted for 37.3% of all GVA growth. Post crisis, this figure rises to 47.7%. If we were to strip out inflation, the picture is even more bleak with many regions still below their pre-crisis peak, illustrating just how far London has pulled away from the rest of the UK economy since the crisis. I am fairly confident the 2012-2013 picture will, if anything, show London taking an even greater percentage of national GVA growth.

Figure 1

The regional GVA figures only run up to year end 2011. But it is possible to get a sense of the form and extent of the current recovery using output GVA by sector. Figure 2 below shows that by end of year 2012 only three sectors had recovered their pre-crisis output performance: i) Agriculture, Forestry & Fishing (which represents a negligible part of the UK economy in monetary terms and broadly reflects rising commodity prices) ii) Business Services & Finance and iii) Government & Other Services. And even here growth was concentrated in a few narrow areas: motor vehicle repairs, admin and support services and real estate (mainly in London, but more on that later). Meanwhile health and education spending kept government services on the up. However since 2013 there has been broader sectoral growth (figure 3), particularly in professional, admin and support services and also in the wholesale and retail trade. Some growth is to be expected as concerns about the Eurozone crisis recede, as pent up demand relaxes and business confidence improves. But the precise form of the recovery and its sustainability are shaped by government programmes. So are we seeing the kind of economy that Osborne envisaged?

Figure 2

Figure 3

The answer to that really depends on the way the economy moves. Growth in one market or region can unexpectedly transmit confidence, investment and job growth to other parts of the economy in ways that are difficult to predict. But I am not too confident about this scenario and the immediate signs do not augur well.

The particular form of the recovery in the UK has been shaped by three central interventions: Quantitative Easing, Funding For Lending and Help To Buy. First, QE which was supposed to (among other things) lead to more lending to the productive economy, fostering a ‘march of the makers’.  This was supported by Funding for Lending, which to date has pumped a total of £17.6bn into banks and building societies. Neither has met their perceived aims. Net lending to business has in fact been negative on an annual basis since QE began in March 2009 with little deviation from that trend as Funding for Lending was rolled out in July 2012 (figure 4). Corporates have instead paid back bank debt and bought back shares by issuing bonds to massage EPS figures and trigger bonuses for the board; meanwhile investment is still pretty insipid – hovering at around 20% below the August 2007 figure. Unsecured lending to individuals however has increased: credit card loans were up 4.5% on an annualised basis in August 2013, while other unsecured loans were up 4%. Secured lending has also been rising steadily since mid-2012, perhaps showing some benefits of Funding for Lending; but there is evidence to suggest that these mortgage-related loans have been regionally concentrated in the London area, pushing up prices above the already eye-watering pre-crisis highs – which takes us to Help To Buy.

Figure 4

Source: Bank Of England ‘Trends In Lending’ October 2013, p.4

Help To Buy equity loans and mortgage guarantees have effectively pump-primed housing demand (with negligible effects on supply). Via the equity loan, government lends homebuyers up to 20% of the purchase price of a new build house up to £600,000. The more controversial mortgage guarantee provides banks with free insurance on up to 15% of the value of any mortgage loans issued. All of this is geared towards top-down growth - encouraging the upper middle classes to dis-save in the hope that ‘dwellings investment’ (private new builds plus extensions on private houses) would restore confidence and kick start consumption spillovers. This is also why the government has also been so keen to relax planning regulation on building extensions.

The benefits of all three interventions have disproportionately accrued to London. Figure 5 shows an index of average regional house prices rebased to August 2007, illustrating just how far London has pulled away from the rest of the UK housing market: prices in the capital are now 14% above where they were back then. This has not just been driven by hot money from rich, foreign investors in the prime market where 60% are cash buyers. Despite the hullabaloo about prices in Kensington, the prime market in London is only around 7% of the capital’s total; in fact London is the region with the lowest percentage of cash buyers in the country by a distance (24% vs 39% in the SW). This means a greater proportion of buyers require borrowing in London relative to elsewhere. And although transaction volumes appear to rise and fall in lock step across the country, London’s volumes are now the highest relatively at around 62% of the August 2007 peak compared to other regions which run from the low 40%s to high 50%s from peak (figure 6). So London has a higher number of transactions relative to peak with a smaller percentage of cash buyers.

Figure 5

Figure 6

The house prices and the growing volume of transactions in London have been driven by an expansion of secured lending, under-written in various ways by government. This has been reinforced by an expansion of unsecured credit, also underwritten by recent interventions. These, in turn, have kicked multipliers into the London economy. But can this last?

It is difficult to escape the image of London breaking free from its moorings in the national economy, just as the value of its real estate becomes detached from any fundamentals. If London real estate is 14% higher than peak on just over 60% of volumes, then London houses look increasingly like a kind of (state-subsidised) collectors market bubble whereby it is the imagined attributes of the asset within a relatively small community of buyers that drives prices beyond underlying fundamentals. The fundamentals in question are wages. As figure 7 shows, median house prices are now virtually unsustainable at around 9 times FTE earnings in London; with the Midlands, North and Wales hovering around a more modest 5.5X to 6.5X. We should also not forget that intra-regional inequality is just as important as inter-regional inequality. London has rafts of low and modestly paid workers – and at the lowest paid end, those conditions are worsening (figure 8). These income constraints represent a kind of risk threshold – prices can continue to rise relative to income, but they can only do so at greater risk of collapse. Only this time when the bubble goes pop, the government and the Help To Buy generation who have invested some equity will be the ones who take the downside.

Figure 7

Figure 8

Source: Annual Survey of Hours and Earnings (ASHE), cross-sectional dataset. http://www.ons.gov.uk/ons/about-ons/business-transparency/freedom-of-information/what-can-i-request/published-ad-hoc-data/labour/october-2013/low-pay-in-london--1997-2012.xls

So here are some troubling questions:

1. London prices are 14% above the pre-crisis August 2007 level on just over 60% of the volumes. Can those low volumes support high prices over the longer term? Or alternatively can volumes increase without prices falling, given the income constraint? Either way, the sustainability of the price boom (and the multipliers that accrue during an uplift) look shaky.

2. If prices were to waver, how would government respond, given it has taken on a £130bn contingent liability – equivalent to 8% of GDP - through the mortgage guarantee scheme? Should it extend its equity involvement to 25% or 30% to make mortgage payments more manageable for households and bring in a greater volume of buyers? Should it extend larger guarantees to the banks to lubricate the wheels of debt issuance and ensure prices move upwards? What looked like an initial injection to spark the recovery, very quickly becomes mission creep.

3. Inflation is an inconceivable threat in the short to medium term, but what about in 5 to 7 years time? Government, as an equity holder in the UK’s housing stock and guarantor of banks’ mortgage loans, now has a vested financial interest in stable/rising house prices. Given that high house price to income ratios are only sustainable in a low mortgage interest rate environment, how might government respond if the Bank of England concludes that interest rate rises are necessary at some point in the future? Or what happens if ruptures in the interbank/money markets reappear and cause mortgage rates to rise? Even modest rate rises could lead to mortgage defaults, collapsing confidence, fire sales and falling prices when households are geared to the max in a low rate environment. By taking a directional bet on property, government is invested in a ‘close to zero’ interest rate regime, irrespective of what uncertainties lie ahead. This stores up all kinds of potential economic and political tensions going forward.

Through Help to Buy and other interventions, government has gone long Britain. That may sound like a good thing, a patriotic thing even, but it is not. This is an all-in move by the Chancellor, which is a problem. Like any complex system, an economy needs buffers and release valves to prevent overheating or interference in one area that might cause total seizure. His interventions have done the opposite. What if Eurozone problems resurface? What if another bank is hit by unexpected losses, and LIBOR rates rise? This growth model is not built with what ifs in mind; there are few system redundancies to deal with the unexpected. We are long house price growth, long low interest rates, long consumer appetite for debt, long the Eurozone, long bank stability, long consumers’ ability to transcend their financial constraints and keep buying more expensive houses.

Finally, what of Osborne’s noble ambitions set out at the top of this post? When push came to shove he bottled it. He did what was easy: state intervention to help rebuild fractured supply chains and invest in growth requires skill, guile, political and economic nous and courage to fend off the vultures. The de facto part-nationalisation of the private housing stock (and that’s what Help To Buy is, in effect) to prop up an over-heated property market and save the banks from further write-downs is the easiest thing you can do as a Chancellor in such times, with an election looming. This recovery looks much less like the new model promised by Osborne, and much more like an unstable version of the old one.

Stanley

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[1] Although the original link to those eight benchmarks has disappeared from the Conservative website, it is possible to access the whole report via the search function.