Darling in the hall of horrors

Unflattering comparisons to certain predecessors have dogged the Chancellor's week. He is damaged, w

By no stretch of the imagination can Alistair Darling be regarded as a chancellor who has chalked up unalloyed triumphs. The fumbled nationalisation of Northern Rock, the perceived U-turns on capital gains and the taxation of non-doms and the sharp deterioration in the public finances have framed him, in the public mind, as inept.

Indeed, a YouGov poll found that 44 per cent of those surveyed believe that Darling, once regarded as new Labour's "safe pair of hands", should be fired. Only 27 per cent of those polled could bring themselves to support him staying at the Treasury. In the City, where opinion turns on a sixpence, the calls for his head have become shrill. New Labour's traditional enemies have detected weakness and have pounced upon it.

Following Gordon Brown at the Treasury was always going to be a difficult task, even for someone who gave the appearance of being as calm as Darling. But no one could have predicted the opprobrium that has been heaped upon him.

Once Brown, with all his bustling ambition, had gone to No 10, all those critics and commentators who feared to cross the former chancellor saw his successor as an easy target. This has led to some very unfortunate comparisons for the current incumbent at No 11. In recent weeks Darling has variously been described as the worst chancellor since the late Anthony Barber and Norman Lamont. Neither comparison bears much scru tiny. Barber and Lamont were Tories and both held office for several years before shortcomings became apparent.

Barber's "Competition and Credit Control" unleashed the first great inflation and the secondary banking collapse of 1974-75. In that crisis the Bank of England, still in charge of financial supervision, launched a secret rescue of the kind which might have saved Darling the embarrassment of Northern Rock. However, even Darling's most bitter opponents cannot blame him for a Barber-style credit explosion.

As for Lamont, he presided over a huge public sector debt and the UK's chaotic exit from the Exchange Rate Mechanism, when interest rates went up and down like a Yo-yo as the chancellor famously sang in the bath.

Many of Darling's problems stem from next door at No 10. When Brown became Prime Minister he removed some of the Treasury's most skilled operators. On the ministerial front the biggest loss was the economic secretary, Ed Balls, in effect the City minister, who spent much of his time responding to the complaints of the Square Mile. There was also an outflow of senior officials, including John Cunliffe, Tom Scholar (now back), Michael Ellam and the gung-ho special adviser Damian McBride.

Huge anger

Brown rushed next door so quickly that he failed to clear his desk. Among the issues he left behind were two long-standing, delicate tax questions surrounding the super-rich. Huge anger was building in the media and in the Commons over the exploitation of tax loopholes by the private equity princelings - tearing the heart out of Brit ish business - and non-domiciled freeloaders.

The Prime Minister must also take his share of the blame for the Northern Rock fiasco. In the aftermath of the nationalisation decision, Brown in particular sought to depict the implosion at the Newcastle bank as part of a much broader international event. At his regular Downing Street press conference there was much talk of obscure branches of finance - US monolines, for instance, which insure financial instruments such as bonds.

Brown was right to point out that the credit crunch which struck on 9 August was born in America's trailer-trash mortgage market. But it was changes made by Brown to Britain's system of regulation in 1997 that led to months of dith ering, uncertainty, charges of incompetence and eventually, when all other escape routes had been closed, nationalisation.

The "Tripartite" system of regulation was designed by Brown and Balls. The intention was to remove responsibility for banking supervision from the Bank of England, so that it could concentrate on its core function of controlling inflation. Bank supervision was moved lock, stock and barrel to the new super-regulator, the Financial Services Authority at Canary Wharf.

But there was a fundamental flaw in the system. The Bank of England, like all central banks, controlled the liquidity - the ability to provide cash to institutions in difficulty - but it was the ineffectual FSA that determined when they were in trouble. This disconnection meant that no one was directly in charge and when Northern Rock hit the buffers because it ran out of ready cash, no one was willing to organise the kind of rescue by the banking industry that is the norm in almost every other country. This even though there was at least one offer on the table, from Lloyds TSB, the high street bank.

A member of the Bank of England's ruling court told me that as important as the institutional paralysis were the people at the helm. Imagine if (Lord) Eddie George were still governor of the Bank of England, Howard Davies (now at the London School of Economics) were head of the FSA and Brown were still at the Treasury. For sure, the willpower and leadership required for a secret banking rescue, which would have prevented the humiliating run on the Rock, would have been present.

Instead, the Bank, the FSA and the Treasury all seemed intent in mid-September to avoid responsibility and blame for a debacle that would run on until February. Again Brown must take a share of the blame. It was he who insisted that every private-sector route be explored before nationalisation took place, on the grounds that public ownership was too old Labour, a throwback to the dark days of the Wilson government and British Leyland and British Steel in the 1970s. Yet the long delays in taking firm decisions gave the impression of a vacillating administration that found it impos sible to make the tough political choice until all other options had run out.

Darling is also the victim of fundamental Budget failings. Brown, despite his reputation as the "iron chancellor", had taken his eye off fiscal policy, and public borrowing was soaring. The time to cut the Budget deficit is when the economy is growing. Instead, Brown chose to go on a public spending splurge in a vain attempt to deal with the problems of the NHS and education.

His ability to spend freely was heavily dependent on buoyant tax income, much of it from the City. Unfortunately, when the credit crunch set in, tax income from banks and those who work for them plummeted and a chasm opened up in the Budget. At the very moment when the Treasury might have adopted the Keynesian solution of spending or tax-cutting its way out of recession - as the International Monetary Fund now recommends - Darling found his hands tied.

As a consequence, when he delivers his first Budget next month, Darling will have to explain away a budgetary black hole similar to that faced by Norman Lamont when he introduced Britain's biggest ever tax-raising Budget in 1993. Not a comparison that Darling will relish.

Yet it was the unresolved tax issues that have been the real undoing of Darling. The rushed pre-Budget report in October took the decisive steps to tax the super-rich. Capital gains tax was to be simplified and raised from 10 per cent to 18 per cent. And Labour, stealing and wearing Tory clothes, would impose a £30,000 charge on the non-doms.

It is what followed that so damaged Darling's reputation. The City, supported by the CBI, the Financial Times and the Telegraph, launched a vitriolic campaign against both proposals, claiming they would destroy London's leadership as a financial centre and send the private equity princelings and non-doms fleeing to Monaco and Switzerland. Proposals that enjoyed the support of millions of ordinary, hard-working, taxpaying Britons were being attacked by a small clique of vested interests.

Was it avoidable?

In both cases the pressure on the Chancellor became so strong that No 10 orchestrated retreats which left Darling looking weak and indecisive. In the case of non-doms, Darling was specifically undermined by one from Brown's government of all the talents, the excitable former CBI boss Digby Jones - the trade minister.

Could all of this have been avoided? A more robust chancellor could have taken on his critics, rather than allow them to dominate the agenda. The private equity bosses and non-doms have no political constituency in the UK, apart from the disgraced bankers of the City. Yet the reality is that the tax retreats were not humiliating U-turns, as portrayed in lurid headlines, but mid-course adjustments of the kind that happen with all complex tax changes.

The assassination of Darling by a peculiar combination of forces from next door at No 10, the CBI and sections of the media has not been pretty to watch. They sensed weakness and attacked relentlessly. His image will not have been helped by his muddled media appearances after the nationalisation of Northern Rock was announced. As jobs in Newcastle are axed by his chosen company doctor, Ron Sandler, Darling may well come to regret the phrase "business as usual". It is also likely that "temporary" ownership could mean anything up to a decade, given the history of previous bank nationalisations on both sides of the Atlantic.

Darling needs to find the inner reserves to take on his enemies in the Budget on 12 March. Most importantly, he must stake out an aggressive, US-style growth strategy for keeping recession at bay. Otherwise he will find his survival at the Treasury foreshortened and could join the hall of horrors of Britain's worst chancellors.

Alex Brummer is City editor of the Daily Mail

This article first appeared in the 25 February 2008 issue of the New Statesman, Pakistan reborn

MILES COLE
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The new Brexit economics

George Osborne’s austerity plan – now abandoned by the Tories – was the most costly macroeconomic policy mistake since the 1930s.

George Osborne is no longer chancellor, sacked by the post-Brexit Prime Minister, Theresa May. Philip Hammond, the new Chancellor, has yet to announce detailed plans but he has indicated that the real economy rather than the deficit is his priority. The senior Conservatives Sajid Javid and Stephen Crabb have advocated substantial increases in public-sector infrastructure investment, noting how cheap it is for the government to borrow. The argument that Osborne and the Conservatives had been making since 2010 – that the priority for macroeconomic policy had to be to reduce the government’s budget deficit – seems to have been brushed aside.

Is there a good economic reason why Brexit in particular should require abandoning austerity economics? I would argue that the Tory obsession with the budget deficit has had very little to do with economics for the past four or five years. Instead, it has been a political ruse with two intentions: to help win elections and to reduce the size of the state. That Britain’s macroeconomic policy was dictated by politics rather than economics was a precursor for the Brexit vote. However, austerity had already begun to reach its political sell-by date, and Brexit marks its end.

To understand why austerity today is opposed by nearly all economists, and to grasp the partial nature of any Conservative rethink, it is important to know why it began and how it evolved. By 2010 the biggest recession since the Second World War had led to rapid increases in government budget deficits around the world. It is inevitable that deficits (the difference between government spending and tax receipts) increase in a recession, because taxes fall as incomes fall, but government spending rises further because benefit payments increase with rising unemployment. We experienced record deficits in 2010 simply because the recession was unusually severe.

In 2009 governments had raised spending and cut taxes in an effort to moderate the recession. This was done because the macroeconomic stabilisation tool of choice, nominal short-term interest rates, had become impotent once these rates hit their lower bound near zero. Keynes described the same situation in the 1930s as a liquidity trap, but most economists today use a more straightforward description: the problem of the zero lower bound (ZLB). Cutting rates below this lower bound might not stimulate demand because people could avoid them by holding cash. The textbook response to the problem is to use fiscal policy to stimulate the economy, which involves raising spending and cutting taxes. Most studies suggest that the recession would have been even worse without this expansionary fiscal policy in 2009.

Fiscal stimulus changed to fiscal contraction, more popularly known as austerity, in most of the major economies in 2010, but the reasons for this change varied from country to country. George Osborne used three different arguments to justify substantial spending cuts and tax increases before and after the coalition government was formed. The first was that unconventional monetary policy (quantitative easing, or QE) could replace the role of lower interest rates in stimulating the economy. As QE was completely untested, this was wishful thinking: the Bank of England was bound to act cautiously, because it had no idea what impact QE would have. The second was that a fiscal policy contraction would in fact expand the economy because it would inspire consumer and business confidence. This idea, disputed by most economists at the time, has now lost all credibility.

***

The third reason for trying to cut the deficit was that the financial markets would not buy government debt without it. At first, this rationale seemed to be confirmed by events as the eurozone crisis developed, and so it became the main justification for the policy. However, by 2012 it was becoming clear to many economists that the debt crisis in Ireland, Portugal and Spain was peculiar to the eurozone, and in particular to the failure of the European Central Bank (ECB) to act as a lender of last resort, buying government debt when the market failed to.

In September 2012 the ECB changed its policy and the eurozone crisis beyond Greece came to an end. This was the main reason why renewed problems in Greece last year did not lead to any contagion in the markets. Yet it is not something that the ECB will admit, because it places responsibility for the crisis at its door.

By 2012 two other things had also become clear to economists. First, governments outside the eurozone were having no problems selling their debt, as interest rates on this reached record lows. There was an obvious reason why this should be so: with central banks buying large quantities of government debt as a result of QE, there was absolutely no chance that governments would default. Nor have I ever seen any evidence that there was any likelihood of a UK debt funding crisis in 2010, beyond the irrelevant warnings of those “close to the markets”. Second, the austerity policy had done considerable harm. In macroeconomic terms the recovery from recession had been derailed. With the help of analysis from the Office for Budget Responsibility, I calculated that the GDP lost as a result of austerity implied an average cost for each UK household of at least £4,000.

Following these events, the number of academic economists who supported austerity became very small (they had always been a minority). How much of the UK deficit was cyclical or structural was irrelevant: at the ZLB, fiscal policy should stimulate, and the deficit should be dealt with once the recession was over.

Yet you would not know this from the public debate. Osborne continued to insist that deficit reduction be a priority, and his belief seemed to have become hard-wired into nearly all media discussion. So perverse was this for standard macroeconomics that I christened it “mediamacro”: the reduction of macroeconomics to the logic of household finance. Even parts of the Labour Party seemed to be succumbing to a mediamacro view, until the fiscal credibility rule introduced in March by the shadow chancellor, John McDonnell. (This included an explicit knockout from the deficit target if interest rates hit the ZLB, allowing fiscal policy to focus on recovering from recession.)

It is obvious why a focus on the deficit was politically attractive for Osborne. After 2010 the coalition government adopted the mantra that the deficit had been caused by the previous Labour government’s profligacy, even though it was almost entirely a consequence of the recession. The Tories were “clearing up the mess Labour left”, and so austerity could be blamed on their predecessors. Labour foolishly decided not to challenge this myth, and so it became what could be termed a “politicised truth”. It allowed the media to say that Osborne was more competent at running the economy than his predecessors. Much of the public, hearing only mediamacro, agreed.

An obsession with cutting the deficit was attractive to the Tories, as it helped them to appear competent. It also enabled them to achieve their ideological goal of shrinking the state. I have described this elsewhere as “deficit deceit”: using manufactured fear about the deficit to achieve otherwise unpopular reductions in public spending.

The UK recovery from the 2008/2009 recession was the weakest on record. Although employment showed strong growth from 2013, this may have owed much to an unprecedented decline in real wages and stagnant productivity growth. By the main metrics by which economists judge the success of an economy, the period of the coalition government looked very poor. Many economists tried to point this out during the 2015 election but they were largely ignored. When a survey of macroeconomists showed that most thought austerity had been harmful, the broadcast media found letters from business leaders supporting the Conservative position more newsworthy.

***

In my view, mediamacro and its focus on the deficit played an important role in winning the Conservatives the 2015 general election. I believe Osborne thought so, too, and so he ­decided to try to repeat his success. Although the level of government debt was close to being stabilised, he decided to embark on a further period of fiscal consolidation so that he could achieve a budget surplus.

Osborne’s austerity plans after 2015 were different from what happened in 2010 for a number of reasons. First, while 2010 austerity also occurred in the US and the eurozone, 2015 austerity was largely a UK affair. Second, by 2015 the Bank of England had decided that interest rates could go lower than their current level if need be. We are therefore no longer at the ZLB and, in theory, the impact of fiscal consolidation on demand could be offset by reducing interest rates, as long as no adverse shocks hit the economy. The argument against fiscal consolidation was rather that it increased the vulnerability of the economy if a negative shock occurred. As we have seen, Brexit is just this kind of shock.

In this respect, abandoning Osborne’s surplus target makes sense. However, there were many other strong arguments against going for surplus. The strongest of these was the case for additional public-sector investment at a time when interest rates were extremely low. Osborne loved appearing in the media wearing a hard hat and talked the talk on investment, but in reality his fiscal plans involved a steadily decreasing share of public investment in GDP. Labour’s fiscal rules, like those of the coalition government, have targeted the deficit excluding public investment, precisely so that investment could increase when the circumstances were right. In 2015 the circumstances were as right as they can be. The Organisation for Economic Co-operation and Development, the International Monetary Fund and pretty well every economist agreed.

Brexit only reinforces this argument. Yet Brexit will also almost certainly worsen the deficit. This is why the recent acceptance by the Tories that public-sector investment should rise is significant. They may have ­decided that they have got all they could hope to achieve from deficit deceit, and that now is the time to focus on the real needs of the economy, given the short- and medium-term drag on growth caused by Brexit.

It is also worth noting that although the Conservatives have, in effect, disowned Osborne’s 2015 austerity, they still insist their 2010 policy was correct. This partial change of heart is little comfort to those of us who have been arguing against austerity for the past six years. In 2015 the Conservatives persuaded voters that electing Ed Miliband as prime minister and Ed Balls as chancellor was taking a big risk with the economy. What it would have meant, in fact, is that we would already be getting the public investment the Conservatives are now calling for, and we would have avoided both the uncertainty before the EU referendum and Brexit itself.

Many economists before the 2015 election said the same thing, but they made no impact on mediamacro. The number of economists who supported Osborne’s new fiscal charter was vanishingly small but it seemed to matter not one bit. This suggests that if a leading political party wants to ignore mainstream economics and academic economists in favour of simplistic ideas, it can get away with doing so.

As I wrote in March, the failure of debate made me very concerned about the outcome of the EU referendum. Economists were as united as they ever are that Brexit would involve significant economic costs, and the scale of these costs is probably greater than the average loss due to austerity, simply because they are repeated year after year. Yet our warnings were easily deflected with the slogan “Project Fear”, borrowed from the SNP’s nickname for the No campaign in the 2014 Scottish referendum.

It remains unclear whether economists’ warnings were ignored because they were never heard fully or because they were not trusted, but in either case economics as a profession needs to think seriously about what it can do to make itself more relevant. We do not want economics in the UK to change from being called the dismal science to becoming the “I told you so” science.

Some things will not change following the Brexit vote. Mediamacro will go on obsessing about the deficit, and the Conservatives will go on wanting to cut many parts of government expenditure so that they can cut taxes. But the signs are that deficit deceit, creating an imperative that budget deficits must be cut as a pretext for reducing the size of the state, has come to an end in the UK. It will go down in history as probably the most costly macroeconomic policy mistake since the 1930s, causing a great deal of misery to many people’s lives.

Simon Wren-Lewis is a professor of economic policy at the Blavatnik School of Government, University of Oxford. He blogs at: mainlymacro.blogspot.com

 Simon Wren-Lewis is is Professor of Economic Policy in the Blavatnik School of Government at Oxford University, and a fellow of Merton College. He blogs at mainlymacro.

This article first appeared in the 21 July 2016 issue of the New Statesman, The English Revolt