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Guided by an invisible hand

The bank meltdown marks a turning point in our thinking about how the world works writes the Nobel L

Make no mistake: we are witnessing the biggest crisis since the Great Depression. In some ways it is worse than the Great Depression, because the latter did not involve these very complicated instruments - the derivatives that Warren Buffett has referred to as financial weapons of mass destruction; and we did not have anything close to the magnitude of today's cross-border finance.

The events of these weeks will be to market fundamentalism what the fall of the Berlin Wall was to communism. Last month in the United States almost 160,000 jobs were shed - making more than three-quarters of a million this year. My guess is that things will get considerably worse. I have been predicting this for some time, and so far, unfortunately, I have been right.

There are several reasons for my pessimism. The extreme credit crunch is a result of the banks having lost a lot of capital. And there is still uncertainty about the value of the toxic mortgages and other complex products on their balance sheets. The US economy has been fuelled by a consumption binge. With average savings at zero, many people borrowed to live beyond their means. When you cut off that credit you reduce consumption. This, in turn, will dampen the US economy, which helps keep the global economy growing. The American consumer has not only sustained the US economy, he has sustained the global economy. The richest country in the world has been living beyond its means and telling the rest of the world it should be thankful because America fuelled global economic growth.

There are further reasons for my pessimism about short-term economic prospects, in America and Europe. In the second quarter of this year, growth in the US would have been negative were it not for the growth in exports. But with the slowdown in Europe and problems in Asia it is difficult to see how we can maintain net export growth. The strengthening of the dollar - due not to greater confidence in the US but to reduced confidence in Europe - will make matters worse. The fall of energy prices will help a little, but not enough.

Treasury Secretary Hank Paulson has now come up with a new bailout scheme. The original plan - buying up the thousands of "troubled assets" (read: bad loans and complex products based on them that Wall Street created) - was badly designed and rife with problems. How would they have been priced? Call in the same Wall Street experts who got us into the mess and mispriced risk before? It is a heads I win, tails you lose situation.

The worry is that the taxpayer will be left holding the short end of the stick.

The British approach, which Paulson seems to be following, is far better, involving capital injections into banks, with preferred shares to protect against losses and warrants to share in some of the upside potential. This is the approach that I - along with most US economists and people with good street sense, like George Soros - had been saying America should adopt.

Ironically, though Paulson wouldn't listen to us, he seems to have listened to Gordon Brown.

Many of the problems our economy faces today are the result of the use of misguided models. Unfortunately, too many took the overly simplistic models of courses in the principles of economics (which typically assume perfect information) and assumed they could use them as a basis for economic policy. Many central banks use the notion of inflation targeting - that they should focus exclusively on inflation, raising interest rates when inflation increases. But I would argue that central banks have a broader responsibility; they are supposed to ensure the stability of a country's economy. While monetary authorities in the US and elsewhere focused on price stability, they allowed the financial system to undertake risks that put the whole economy in jeopardy.

This crisis is a turning point, not only in the economy, but in our thinking about economics. Adam Smith, the father of modern economists, argued that the pursuit of self-interest (profit-making by competitive firms) would lead, as if by an invisible hand, to general well-being. But for over a quarter of a century, we have known that Smith's conclusions do not hold when there is imperfect information - and all markets, especially financial markets, are characterised by information imperfections. The reason the invisible hand often seems invisible is that it is not there. The pursuit of self-interest by Enron and WorldCom did not lead to societal well-being; and the pursuit of self-interest by those in the financial industry has brought our economy to the brink of the abyss.

No modern economy can function well without the government playing an important role. Even free marketeers are now turning to the government. But would it not have been better to have taken action to prevent this meltdown? This is a new kind of public-private partnership - the financial sector walked off with the profits, the public was left with the losses. We need a new balance between market and government.

Professor Joseph E Stiglitz is chair of the Brooks World Poverty Institute at the University of Manchester and a 2001 Nobel prizewinner

This article first appeared in the 20 October 2008 issue of the New Statesman, My year with Obama

MILES COLE FOR NEW STATESMAN
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The Tory civil war

Even if David Cameron clears the fence marked Brexit, he will find a very deep ditch on the other side.

We all know families who fight and argue in the privacy of their own homes but put on a flawless display in public. So it was, for a few days at least, with the Conservative Party when the campaign for the EU referendum began. Both sides were keen to keep it that way, in the long-term interests of their party. Last month, one MP dressed down Norman Smith, the BBC political reporter, for going on the airwaves and talking about “the Tory civil war”. At that stage, he was perhaps right to do so.

Tempers are, however, beginning to fray. Members of White’s, the St James’s Street club and a foremost lair of the Tory grandee, were recently alarmed to see two of that species, Nicholas Soames MP and David
Heathcoat-Amory, an MP until 2010 and a former Europe minister, going at it hammer and tongs about the European question during the lunch hour. Anyone familiar with Soames’s entertaining Twitter feed, which is currently devoted mainly to savaging fellow Tories in Vote Leave, will know that he is no stranger to technicolor vituperation.

It was, according to the account doing the rounds, a ferocious argument, though no blows were struck. “Nicholas and David have known each other since school,” a friend of both men told me. “They have more in common than separates them. It just shows how fraught things are.” That is certainly true. I well remember Soames, a lifelong pro-European, expressing his genuine dismay that Heathcoat-Amory was defeated in 2010 because a Ukip candidate, standing ironically against a devoutly Eurosceptic Tory, split the vote in his Wells constituency and let in a Lib Dem.

Another MP, using an appropriate public school metaphor for a gentlemen’s club packed with Old Etonians, likened them to boys who are friends but who, once on opposite sides of the sports field, let all hell loose at each other. One does not doubt that Soames’s and Heathcoat-Amory’s regard for each other will survive the referendum. Whether the same can be said for the two sides of the Conservative Party – unequal sides at that – come 24 June is quite a different matter.

The way David Cameron has conducted his wing of the Remain campaign in recent weeks has horrified many Tory MPs, even some who are or were notionally on his side. “The personal attacks and crude propaganda have really upset the party and I don’t think he understands how badly this has gone down in the constituencies,” a Remainer told me.

The personal attacks are certainly out in force. Downing Street has started to brief the media about those in particular disfavour. The Sunday Times reported on 15 May that Priti Patel, the employment minister, had behaved “appallingly” (her crime seemed to have been pointing out the government’s failure to supply enough school places to cope with the recent influx of eastern European immigrants). It also claimed that Cameron was especially angry with Michael Gove – which, since Gove has behaved with politeness and a complete lack of hysteria towards the Prime Minister, suggests that the latter must have a very thin skin indeed. Gove does annoy Cameron and his friends, not because of bad behaviour but because his detailed and measured analysis of what is wrong with the EU is hard to rebut, in contrast to more emotive outbursts by the likes of Boris Johnson that can be swatted aside.

Meanwhile, Cameron has sought to ridicule Bernard Jenkin, one of the most vocal Leavers among MPs, for making a perfectly reasonable observation about the dilution of trade union legislation in return for the unions’ support of Remain. The snide side of the Prime Minister’s character, depressingly familiar to those who deal with him in private, is becoming more and more unchecked as tensions in the campaign rise. There have also been briefings against
Penny Mordaunt, the armed forces minister, and, of course, Johnson. One attempt to terrify the country was to have the Sunday Times splash that, Brexit or not, Johnson would be the next leader and, therefore, prime minister. Downing Street seems not to realise that such an outcome is, for reasons few can fathom, one the general public seems to want.

***

The Tory party has long been a coalition. Most diehard Leavers had no social or personal relations with their colleagues in Remain anyway, so that has not changed. Any breakdown in civilities among others at the moment is, for the most part, temporary. Many take the view of Jacob Rees-Mogg that the result must be binding whatever it is and the party must move on. Equally, many don’t, and if the outcome is a narrow victory for Remain it will be the worst possible result for the Prime Minister.

Those trying to maintain peace in the parliamentary party – and it is important to note that a few dozen MPs have never really been interested in Europe and are showing little interest now – believe that things could have been worse. Veterans say the atmosphere is better than it was during the Major government, in the arguments over the ratification of the Maastricht Treaty and Britain’s inglorious departure from the Exchange Rate Mechanism. That, too, is probably true, when one recalls that nine MPs had the whip withdrawn, John Major described some of his cabinet colleagues as “bastards” and he felt constrained to call a leadership contest to prove his mandate to lead the Tories. However, the vote is still a month away and there is scope for things
to worsen.

With the government and the Whitehall machine distracted by the referendum, other aspects of Conservative rule are causing irritation within the party. There is a sense that the whips and Downing Street have given up trying to take MPs with them on other issues, or to explain why changes of policy are being made. There is little doubt about the fragility of the economy, or that it could go south even if the UK remains in the EU – and George Osborne is felt to be doing too little to demonstrate the proverbial firm hand on the tiller, or to inspire confidence among his colleagues.

The recent U-turn on academy schools has caused particular rage among MPs who had gone to great lengths to explain and defend the previous policy to their constituents. Now they find themselves having to do the opposite and, as one of the less self-regarding said to me, “No pompous Tory MP likes being made to look stupid.” There is a widespread belief even among the more feminist MPs – and, believe it or not, the Tories have them of both genders – that Nicky Morgan has proved she is nothing more than a token presence in the cabinet.

Speculation about what would happen in the event of Brexit – and none of the 20 or so MPs I spoke to in preparing this piece, whatever their allegiances, would rule it out – is now starting to grip the Conservatives and is causing tempers to rise. Nobody seems to want Cameron’s immediate departure if the vote goes against him. There is talk of a “managed, orderly withdrawal” to see the party and the country through the initial shock of the change, with a contest getting under way formally at the Tory conference in October and the process – a vote of the parliamentary party, followed by a plebiscite of the membership to decide between the two most popular candidates – over by early December.

Johnson’s high-profile Brexit campaign is, in effect, the start of his bid for the leadership and why Cameron is so agitated about him. Johnson, as I wrote here in March, has not made the best impression on his fellow MPs since returning to the House last May and it is far from assured that he will be one of the final two candidates. There is also an uncomfortable recognition that he achieved little for London as mayor, other than traffic chaos and a series of vanity projects. “We’d like to do a Checkpoint Charlie-style swap, halfway across Westminster Bridge, with Sadiq Khan,” a Remainer told me.

However, Tory activists forcefully tell their MPs that Johnson is a “winner” who merits support in a leadership vote. Some younger MPs, yet to learn the difference between being a representative and being a delegate, are nervous of disagreeing. Three of them – Nigel Adams, Ben Wallace (a junior Northern Ireland minister and former soldier) and Jake Berry – are running a campaign for Johnson, organising lavish drinks parties for colleagues so the candidate can press the flesh. This irritates older MPs, who see it as a provocative manifestation of ambition and vulgarity that the party could do without.

A prominent Brexiter is almost certain to be in the last two in the leadership contest, be it later this year or in 2019-20, whatever the outcome of the referendum. Whether that is Johnson depends on if he self-destructs during this campaign – his reference to Hitler in his Sunday Telegraph interview on 15 May suggests that is quite possible, given the opportunities ahead. What might entertain the general public – and his unrestrained remarks, such as about President Obama’s Kenyan heritage, probably do –
increasingly angers his colleagues.

It may then be up to Michael Gove to offer himself, something that is said to be unlikely at the moment but that may become less so if things go badly for Johnson. Whatever Cameron thinks of his Justice Secretary, his colleagues have nothing but praise for the way in which he has conducted himself. It is widely thought that, in the event of a Remain victory, Cameron will promote Gove, possibly even to deputy prime minister, as a very public healing of wounds, in an attempt to unify his fractured party.

The favourite to end up in the last two with a Brexiter if there is an early leadership contest is Theresa May, described by one who knows her well as “cold, unfriendly, charmless, not as clever as she thinks she is, lacking imagination, unable to think outside the railway lines and intellectually dishonest”. However, he said that were the choice to be between her and Johnson, “I would, of course, vote for her.”

The wider party probably would not. It is accepted that if Johnson reached the last two, the party in the country would elect him leader. His fate, therefore, lies in the hands of his parliamentary colleagues, whenever the contest comes.

An MP who is a constitutional authority told me of his belief that even if Johnson became leader he would struggle to form a government, because a hard core of pro-Europeans might refuse to support him. Others, knowing the ambitions of their brethren, doubt that but the thought was recently echoed by the former MP Matthew Parris, probably the most articulate columnist writing in support of Cameron, who said on BBC radio that if there were a vote for Brexit he and others like him would leave the party.

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A victory for Remain might end Johnson’s prime ministerial ambitions and the prospect of such a realignment. But unless that victory is substantial – at least as large as the 55-45 vote in the Scottish referendum – Cameron will struggle: and even that margin of victory in Scotland has not squashed demands for another vote.

The Prime Minister has failed to grasp how many of his MPs are against the EU. A former cabinet minister, not known for hyperbole, told me that “more than 200” of the party’s 330 MPs would vote for Brexit in the privacy of the polling booths. The proportion of Leave activists is even higher. Some MPs still maintain that they can find hardly anyone in their shrunken constituency bases who wants to stay in.

What we are witnessing is the expression of the resentments and tribal hatreds of many years, in a party that has never recovered from the splits after Margaret Thatcher’s 1988 Bruges speech and the Maastricht arguments, or indeed from the conduct of the debate over the UK’s entry into the then EEC during the passage of the European Communities Bill in 1972.

A former minister, a pro-European, said: “Dave is going to have to bring in the people he has alienated but even then it is going to be hard for him to do more than limp on for a couple of years.” Another said the government now, with its small majority, deals with the Tory party on a “issue by issue” basis, seeking just to get over the next hurdle. Even if Cameron clears the Becher’s Brook-style fence marked “Brexit”, he may find a very deep ditch on the other side.

Simon Heffer is a columnist for the Daily and Sunday Telegraph

Simon Heffer is a journalist, author and political commentator, who has worked for long stretches at the Daily Telegraph and the Daily Mail. He has written biographies of Thomas Carlyle, Ralph Vaughan Williams and Enoch Powell, and reviews and writes on politics for the New Statesman

This article first appeared in the 19 May 2016 issue of the New Statesman, The Great Huckster