Featured

A blob-chart way of dissecting Britain’s prosperity failure

It’s been a fairly bad 15 years or so for economic growth, hasn’t it? There are plenty of ways of discussing this – charts of a line rising steadily up to mid 2008, turning sharply down and then never quite getting back on track. I have quite a few in this somewhat downbeat attempt from two years ago, still as relevant as the day it was posted.

Here is another way to look at it – through consumption, and prices. Consumption is the ultimate purpose of economic production, and prices are the major information tool within our grasp. Throw in quantites, and you have a fairly complete picture of economic change, from the consumer point of view. Brace yourselves: it looks like this.

Don’t throw up and close this down; I swear it makes sense.

The chart depicts the change from 2008 to 2023.

The horizontal axis shows how much more, in cash, the representive household spent on each category. The vertical axis is how much they got in that category. So, for example, we spent around 39% more on clothes, and got 32% more clothing for that.

The position of the bubbles tell us about technological change, and changes in habits/spending propensities.

There are a few obvious observations. Firstly, the blobs veer to the right, because there has been inflation; incomes are about 50% higher, so is spending. But, secondly, we get about the same amount of stuff as before – the chart is as much above the horizontal as below. If incomes had grown a lot, and prices and consumption habits were constant, the chart would look the same, but higher

Thirdly, the blobs MOSTLY sit along a straight line sloped line. A lot of the economy displays little in the way of productivity gains over those 15 years. Habits have changed – we have apparently increased our real consumption of household appliances, and cut that of package holidays – but these items neither helped nor hurt prosperity. Here we can zoom in on those bogstandard things:

These are about 60-70% of the whole consumption basket* and mostly but not all services, and therefore classic cases of Baumol’s Cost Disease. Largely provided by humans, with steady real productivity, their price just rises with wages, more or less. Read your Vollrath and you learn that they are inevitably a bigger part of our future.

But we have had 15 years of technological change, no? Um, yes we have, but in terms of the weight in the final consumption basket, it isn’t so enormous. Here they are in blue:

This buckets together quite a few varied items, for their virtue of being well above the line. All they have in common is that the fall in their effective prices means that they have contributed towards the consumer being better-off, all together. Their price has not risen with incomes. Ergo: prosperity. See clothes and shoes:

The only direct experience of the tech miracles from the smartphone era is found in “Audiovisial etc”, which means: Reproduction of Sound, Making photos and videos, “Data processing” i.e. computers. These have shown spectacular price falls. For example, the price series for “Data Processing Equipment” has fallen from 4998 in 1988 to 227 in 2008 to just 80 now. For the same £100, you can get 60 times as much of that processing as in 1998, and almost three times as much as in 2008. Unfortunately, this whole Audiovisual category takes up just 1.5%-2.5% of the consumption basket (that is why it it is a small blob). We get a lot more of it, but it ain’t much. More on that later.

Finally, there are the really bad news items – the commodities that have gotten way more expensive, and the services that appear to offer less for more. Here they are in red.

The obvious worst item – our energy bills – take almost 5% of the overall consumption basket (up from 3.3% a few years ago). Their price index is up from 62 in January 2008 to 235 in January 2023. Ouch.

Enough with the charts. What does this all tell us? I have some reflections: on technological progress, its relationship with economic growth, the importance of trade, and the importance of not forgetting demand.

Rapid digital technological advance does not generate huge prosperity directly via the consumer basket. The size of that “Audiovisual” dot is a reflection of what all these videos, music streaming and photo sharing mean, according to the statisticians. They haven’t ignored gigantic improvements – they are in the price indices. But we have responded by spending about as much of our wallet on them, and getting way more. Nice for us. But it is a 2% thing.

Technological advance has not shown up enormously in other goods and services. I find it striking how few other services have shown a big improvement – apart from financial! You may doubt the latter but think about it – online banking, pay by tap, all have improved a lot. But “Cultural services”, Restaurants, transport – these are much more about the price of fuel and of labour than digital tech.

Inelastic demand is a total downer. Gas is up 250% in price since 2008, but the ability to switch from it is limited. Hence its increase in the consumption basket from 1.5% to 2.0%. Ditto electricity. When you speculate about its role in the consumption of everything else, the problem of expensive energy looms larger and larger. A thesis of this book, while wacky at times, cannot be ignored: look out how energy improvements stopped.

The biggest story is a dog that didn’t bark. For the industrial era, prosperity has been driven by the constant improvement in price of big, important physical items. Cars got invented, and became a combination of cheaper and better, for decade after decade. We spent more on them (unlike “Audiovisual”), but we got much more back. Lots of physical goods were like this. Clothes. Mod-cons. Computers. The whole of modernity got created and cheaper.

But not so much, since 2008. Look at this ugly table. It compares the cash price improvement in a bunch of items for the years 1992-2008, and then the 15 years after.

They make up around a fifth of the consumption basket. Every item here stopped improving at the same pace (apart from “Other Financial Services”)- including the really incredible smartphone-era technologies at the top. Clothing, which fell in half in cash terms over the previous 16 years, started rising in price again. New cars just stopped improving. Look at air travel! The years up to 2008 were wonderful. Afterwards, just like anything else.

Why did this happen (or not happen)? There will be a lot of answers. The one that strikes me mostis a reflection on how we trade a lot of these items. For a long time, Western Consuming countries passively enjoyed the benefit of falling prices that stemmed from the incorporation of the East into our trading networks, and the constant improvement that their factories achieved. That came to an end. Maybe it had a natural limit. The Financial Crisis will not have helped. Rising Chinese wages likewise. The collapse in the pound from $2.00 to $1.20.

In particular, I think it is a real and important mystery that the explosion of network technology, the incredible GPT that is the smartphone, has not seemingly improved the productivity of other industries. Our ability to gain knowledge and promulgate it has skyrocketted. Why hasn’t that had real, physical consequences? This unbarking dog is one reason I remain sceptical, for now, about artificial intelligence transforming real growth. We still need to demonstrate how to make the last technological marvel do that.

For all that this post is already overlong, it just scratches the surface of the topic, and hides a lot. It doesn’t solve the problem of UK productivity, or even characterise it. Had the UK been a ‘better’ economy, selling for high prices a lot of valuable goods and services that the world really wants, our incomes would be higher, the pound stronger, and all these numbers would look different. What we choose to consume would not have constrained us.

But I find in all this data further confirmation that in a big, connected world full of mostly exogenous technological trends, our future prosperity is, unavoidably, to a large extent out of our hands. Each generation has tended to be more prosperous than the one before because of phenomena like factory managers organising production better, somewhere a long way away. Hairdressers, lawyers, politicians and teachers are better off because of exogenous changes they are not directly responsible for. Economic progress is largely a game of free-riding. It is humbling.

*Overall, I pulled in about 90% of the consumption basket for this

Featured

Ted Lasso versus the Triangle of Crapness

About six months ago, we passed the point at which bad news for the economy was good news for Labour.  Thanks to Liz Truss, the Conservatives have lost their reputation for economic competence. High mortgage rates will be associated with this government, come what may. Labour are now around 90% likely to be in power in 2025. They don’t want a basket case.

And let’s be clear about it – Labour governments need times to be good. Parties that believe in the power of the state to improve things have a much harder time when funds are tight; look at the stress caused by the two-child benefits policy. We can all celebrate the achievements of the Attlee government but it wasn’t an easy time for the country, and it left Labour exhausted. Not having a financial crisis would have been good.

If better times are needed, it is difficult after the last 15 years to believe they are around the corner.  As well as being a master at producing endless growth charts pointing down and to the right, I read and follow the wrong people: Tim and the OBR on the fiscal situation, Peter Foster and Rafael Behr on Brexit, Dieter Vollrath and Tim on the prospects for growth, Bagehot and Tim on the prospects for cost-free public sector reform. You know: pessimists. Together they generate what I might poetically call the Triangle of Crapness:

Hence a slew of articles setting out Labour’s crappy inheritance.  As you might expect, Chris Giles’s is the most comprehensive, covering all three points of the triangle: no more room for spending (according to the fiscal rules); much less low-hanging fruit to improve growth; and public services start from a perilous position.

Also, remember that the OBR is if anything a little optimistic. Including its forecasts out to 2027, the period from 2010 has seen real growth average at 1.6% a year, whereas the OBR thinks (as of March) that we will manage 1.8, 2.5, 2.1 and 1.9 in the years ahead. In nominal GDP terms, the trend has been terrible for three decades:

That shift from 5.5% in the years up to 2010 to 3.5% ever since is why I still think the Financial Crisis is the most significant event of the millennium so far, more than Brexit, Trump, Covid or Ukraine. It changed everything. By the power of compounding, this is what those shrinking forecasts did to our expected nominal GDP in 2027

We have an economy some £800bn smaller in cash terms than you might have forecast 15 years ago. Compared to late 2015, before Brexit gut-punched the recovering economy, we still have £200bn less. And though these are cash figures, remember that inflation has turned out higher than forecast.  Cash isn’t going any further. Think about this the next time someone tells you GDP isn’t the point. Only if you clearly have enough of it. We don’t.

What makes it worse is that the points of the Triangle interrelate, in a bad way. Bad public services undermine the economy – through poor health outcomes, sclerotic planning procedures, etc.  The weak economy damages the fiscal situation, obviously, and then the services get worse again … Put a “circling the drain” gif into that Triangle.

Objectively, if that is a thing, this gloom is justified.  Given the ageing economy, the shortage of workers, the threat of energy shortages, higher interest rates and deglobalization, it would be irresponsible for forecasting bodies like the OBR and BOE simply to assume things will pick up. Their independence is designed around avoiding just that kind of bias. And while I am no political strategist, I fully understand why Reeves and Starmer (and Hunt and Sunak, for that matter) are going with the pessimism in devising their pre-election strategies. Memories of Truss are too vivid. I suspect the British public associate boosterish optimism with recklessness and insincerity, to a greater degree than ever before, thanks to three years of Johnson and six weeks of his successor. And raising growth is hard work. There isn’t one simple trick (read my Nesta blog). Growth isn’t just “unleashed” any more: see my other blog, and read everything by Dieter Vollrath. There is just too much already there: £4.5tn of capital, 33m workers, a vast amount of inertia, a gradual shift towards more services, Baumol’s cost disease. Your policy ideas are small in comparison.  You need frankly amazing estimates for how much a tax cut or capital increase can raise production to believe otherwise.

The risk is that this level of sensible conservativism leads to fatalism – if every government has to confront this Triangle of Crapness then what is the point of voting? But to escape it you need something better than a vacuous Ted Lasso theory of change, in which you can take over an establishment, no matter how rubbish, and transform its performance simply through a change in the management and some positive thinking.

So here are a few reasons I think the Labour inheritance might end up being better than currently feared. In no particular order:

  • That there is definitely a negative feedback loop within the Triangle points unavoidably to there being a positive one as well. Improve the economy, make public services more efficient, sort out the public finances and you can get a virtuous circle going too.
  • The miracle of compounding.  Too many people look at this chart and treat it as our future:

But what I see is how relatively small starting conditions build over time, if nothing at all is done about them. It suggests that we might end up with a debt/GDP ratio of 150% in 2050, in about 25 Budgets’ time. But that many Budgets ago, the world economy was beginning to do so well that Alan Greenspan fretted before Congress about the prospect of endless fiscal surpluses, oh woe. Small improvements now – or avoiding mistakes like those Greenspan-era tax cuts – make a huge difference.  Focus on now, not 2073.

  • The inflation problem is going to resolve itself, and not necessarily in a bad way.  As Tim points out, sometimes it serves to boost revenues and lighten the deficit.
  • And one of the reasons that inflation has proven stubborn is that the widely predicted UK recession has still not arrived.  For the next few months we may enjoy something of a Goldilocks period – falling producer prices, the beginning of some real wage increases, a renewed sense that interest rates are near or at their peak
  • Furthermore the shift, finally, out of a zero interest rate world isn’t all bad, either. Sure, it is worse for the indebted government, but negative real rates were a miserable signal for the economy. Pension schemes will be more solvent now.  Above all …
  • … it may be easier to eke out productivity gains in an economy closer to running “hot” than one bumping along in deflationary conditions.  Trying to raise productivity in a cold economy is much harder, like trying to float a boat off the rocks when the tide is low. For individuals and businesses, the incentive to do it isn’t there as much when conditions are slack. What motivates investment, training, innovation and all those productivity-boosting good things is the press of business, the actual experience of not having enough capacity to serve what is coming through your door. We have finally stumbled upon how to run the economy hot-ish
  • The pessimism about public sector reform is a bit overdone.  I can see why the Economist’s Bagehot columnist goes after the “reform fairy”: in politician-speak, it has supplanted “efficiencies” as the magic balancing item. There is no doubt that some key reforms need upfront investment, such as spending more on the planning system and NHS capital.  And some injustices just demand money – like the two child benefits limit. But, having reviewed a nice book about public sector reforms a couple of years ago – How Should a Government Be? The New Levers of State Power by Jaideep Prabhu – I refuse to believe we have exhausted all possibilities. The excellent Dutch “Buurtzorg” social care system, for example, is simply a better way of arranging care. It does not have to cost more.  Countries like Vietnam manage to improve their education system without oodles of money.  So has the UK!
  • It is also too glib to conclude that just because Reeves is trying to sound as close to Hunt as possible, there are going to be no fiscal recourses available. There are tax-breaks and allowances for business riddled through our fiscal system – look at the OECD examination – that amount to quite a few billions. And the business bungs are small compared to those aimed at individuals – see these figures:

On this topic, I also subscribe to a little Ted Lasso-style thinking. Simply removing the pressure of the Conservative backbenchers with their constant clamour for unfunded tax cuts is a fiscal plus. It hasn’t generated extra growth or more sustainable public finances.

  • Fundamentally, there is an optimistic way of responding to how badly the UK has done this last fifteen years. We have fallen ever further away from the productivity frontier. That is a huge pity, but it also means growing is less about performing achingly high-tech, best-in-class actions. You just need to catch up to what is possible elsewhere. Don’t have such a centralized government, don’t have such a sclerotic planning system, stick to the same investment incentives for more than a year at a time, improve your deal with Europe. You don’t need to host the world’s first quantum computer or fusion reactor (though by all means go for it)
  • And significant chunks of the UK are pretty close to the frontier already (see Tyler Cowen on south England). So there is nothing fundamentally prosperity-repelling about the UK’s laws and customs. We just need the whole country to be closer to that level.  

I feel weird projecting any kind of optimism about this discombobulated country of ours. Brexit in particular still has the capacity to depress me – read Peter Foster on the negative ratchet it has put between us and the EU. I never stop worrying about Ukraine. But if we have learned anything about the last 15 years it is that the future course is never set. Sometimes things can get better.

Growth – some less edited thoughts

After too long a gestation today I finally put out my report for the Institute for Government about what is needed to raise growth rates. Finally.

I am rather an old dog in this fight. My goodness, it is five years since I wrote that growth cannot just be “unleashed”, a ridiculously obvious point that nevertheless upsets some people who think “more houses” does just that. The year after I set out how the challenge is mis-conceptualised, in this picture:

and how I saw it instead:

Getting growth “right” is about a splatter of many, many policies, and hoping that their median somehow survives the law of large numbers and is shifted marginally rightwards. There are hundreds of growth-relevant policies ongoing in government at any one time, and in the centre some political leader occasionally barking “be pro growth!”. If you are lucky, their overall effect will be marginally good. But what is your systematic reason for ensuring that they are? What is your strategy?

Read some strategic literature (well, Good Strategy/Bad Strategy by Rumelt) and there is a useful framework. Have a diagnosis of what is wrong, a set of policies for going about addressing this, actions and governance for managing that. The diagnosis is the easy bit: there is no shortage of reasons for why the UK is weak. Just don’t be a one-trick pony. All of this was discussed here, after inspiration from a brilliant piece from Ben Ansell on “does Labour have a growth theory?“.

But if you think the diagnosis is easy, and there are policies simply bursting out of think tanks for how to improve growth, why has it not happened? And the answer is politics – again, something sort-of obvious that I must have first blogged on a looong while ago (well, 2024). Providing certainty and stability, allowing disruption, shifting from consumption to investment, permitting the loss of control that comes with openness, all of these come at a political cost. If it is easy, it probably isn’t pro-growth. Privatisation was not easy. Nor was making the BOE independent, entering the European Common Market, freeing up capital controls, or diverting money into the science budget.

So I arrive at my point. Labour knows growth is important. I do not doubt that the PM, Chancellor and others actually mean it. But sitting there, banging their fists on tables in Downing Street, what does it mean to make that determination meaningful? It is not just a matter of rhetorical vehemence. It is surely not their belief that until now the rest of the Whitehall Machine just didn’t get how important it was, would not put in the hours. And I repeat – the problem isn’t a lack of a theory: they know the issue is on the supply side, that investment (private sector in particular) is weak, that macro stability has been poor and we will need a few years’ of steadiness to restore our reputation, that our second tier cities underperform, and a few growth sectors could do with extra support, that trade links need to be restored.

All of that may sound thuddingly obvious, but it beats most of what passed for a theory for why growth would return during my time. What was the dominant theory during the Coalition for how growth would be restored ? Mostly that it would just come back once there was no reason to worry about the deficit and the state of the banking system. Sorry if that sounds derogatory, but I was in there for four years. There was relatively little deeper structural thinking than that. (To be fair, “the UK will bounce back to 2%+ GDP growth once this macro storm has passed” was not the most idiotic theory, given history. I believed it too). And at times the only theory emanating from No10 itself was “isn’t tech incredible”.

Where I found this government to have come up short, is in having a strategy that combines their solid economic sense of what needs doing, with a political strategy for the problems with doing it. Name any of the big pillars of decent growth plan and there are serious political challenges to how to survive it. In my imagination, in an ideal government, around the first week of the parliament there would be a PM chaired meeting where these sorts of realities were teased out:

It took 5 minutes to make such a table. Imagine what one produced by a big, well staffed, raucous bunch of experienced political economists might be, how much more detail and nuance there might be with the right departments involved. I am not saying any of the question marks or blanks would be easily filled in. But it would be a start, and it would confront the government’s leadership with a sense of what it meant, when it said it wanted to achieve growth. What risks it would take, what practical difficulties it felt it could take a risk on solving – and where, crucially, the input of the powerful Centre of Government might make a meaningful difference.

These frustrated thoughts are what ultimately motivated my report. I obviously haven’t solved them, and bring no good news here: the nature of the politics of growth is that doing so might bring no political dividend whatsoever. But I do think we do not approach this incredibly important topic with anything like the systemic, well-resourced approach it merits.

so now we’re pretending we don’t know what causes inflation??

The mark of a stupid person is not their inability to understand things. It is their thinking they understand something that much smarter people do not.

Which means I myself must be extremely stupid, because I think I understand, roughly, what causes inflation and yet Lord Mervyn King implies he does not, or at least the central bankers of the world don’t. King is so much brighter and more accomplished than I am in this field of study that there is not a metric to capture it. Moreover, Gillian Tett, a quite terrifyingly accomplished FT writer who has been on this kind of beat for twenty years, appears to have sympathy for his non-view.

Here is my stupid view: inflation is a reflection of aggregate demand and supply in the economy. When, through whatever means, an economy is allowed to have far more purchasing power chasing the same real capacity to produce goods and services, the effect will be rising prices. Another way of putting this is MV=PY – money in circulation multiplied by the velocity at which it circulates, will be equal to the price level multiplied by the real quantity of output. Actually, by definition. So P will rise a lot if MV/Y does.

Lord King knows this so he must mean something else when telling a Harvard seminary “Central banks no longer have a theory of inflation”. What is the gap? I think he cannot mean “central banks have no idea about the supply side”. The economic capacity of our economy is impossible, like so many things, to discern directly but we all roughly understand how the supply side works – a combination of the labour, capital, technology and range of techniques, market conditions, norms, rules and abilities in an economy. It is hard to nail down in real time, but we know it is a slow-moving thing, and what tends to move it around positively or negatively. Drive a lot of people overseas and your supply side potential will fall, for example. Obliterate a lot of capital and likewise.

So perhaps he means “we have no idea what causes aggregate demand to rise and fall”? Again, though, I am a bit confused. Of course, central banks through history have shown remarkable clumsiness in doing it very well. Compare it to steering a giant oil tanker with its rudder – it is quite possible to get the tides and currents wrong, fail to appreciate the momentum of the tanker going one way or another … one can easily imagine a captain veering wildly off course, missing his berth. But does no one have a theory for how the rudder should work? Pushing it one way veers us starboard, another way to port. Some monetary operations – printing money to buy short term debt to drive up prices, drive down yields – surely raises NGDP ceteris paribus, and others – like offering to pay a gigantic interest rate on reserves – does the opposite. And we know that a government increasing its deficit to spend on goods and services will add to demand, don’t we? We know roughly what the state’s levers do.

Dive into other thoughts of Mervyn King and you really do not emerge with the impression that he thinks there is no accepted theory for how inflation happens. He tells Martin Wolf that

what the academic world did was to persuade people that inflation really depended only on expectations. And that led to a mindset in which people abandoned the Friedmanite view that inflation is always and everywhere a monetary phenomenon.

Too much money, too few goods, inflation. In other words he accused central banks of acting like their control over people’s expectations was SO good that they could control the money demand function, and keep NGDP expectations and NGDP absolutely nailed down, no matter what the circumstances. A bit like MK himself sort of implied twenty years ago, comparing himself naturally enough to Maradona (honestly):

“Because inflation expectations matter to the behaviour of households and firms, the critical aspect of monetary policy is how the decisions of the central bank influence those expectations”.

And I think later MK is right to criticize Maradona-era MK, because it is apparent that if the circumstances are special enough – post pandemic households stuffed with money, an energy shock, interest rates not appearing to rise enough – the sheer fact of the money just outweighed people’s hazy expectation that eventually the Central Banks will come in and rein demand growth back to where it should be. Things can get out of hand. This caused the Great-ish inflation.

But I personally, as a stupid person, felt that the 2021-24 period only made it all the more obvious what causes inflation. It was not some mysterious moment where the central banks and economists were suddenly flummoxed, but its very opposite! We REALLY understand inflation now! (I think they were much MORE flummoxed in the twenty years before. )

To make a serious point, at a time when ordinary people are apparently distrustful of experts, economic ones in particular, it does not do any of them any good to pretend, even slightly, that they do not know the basics like this. I am absolutely sure they do. We know what causes inflation. The economy is a big complex thing, with mutliple half-hidden variables playing upon one another, it is hard to ‘see’ in real time, and it is easy for policy to misfire. But something being complicated is not the same as it being mysterious.

what, the fiscal rules, again?

The conventional wisdom, at least of the sort of crowd I hang out with, is that there is nothing wrong with the fiscal rules, nor with the Office for Budget Responsibility (OBR) that measures policy against them. You can’t blame them for the state we’re in: not low growth, nor strained public services, and not even the high public debt that they were in theory set up to help control.

The Centre for Policy Studies has written a piece all about this, that I think disagrees. I think. Parts of it are excellent. They are right to point out that Chancellors appear to have no incentive to pay down debt when times are good, and this is revealed in their behaviour (linking to an excellent piece of work from the IFS on just this). When times are better than expected, the revenues are spent; when worse, the debt takes the strain. They make an interesting point that Chancellors are not punished when a previous forecast is subsequently shown to be too optimistic. No one, apart from a band of determined geeks, looks back 5 years, reminds the Chancellor what he said he would do, and berates him for it. Chancellors get fired quite often, but never for that.

The result is that people in the Treasury have a strong incentive to pencil in wildly ambitious (for which read: low) targets for future spending, but when the year in question rolls in, what it spent is not longer binding. At least, not by the fiscal rules. Cue a few dozen boring columnists quoting St Augustine.

But other parts of the piece confuse me, on second reading as much as the first. The CPS complains about policy being made to meet these forward-facing fiscal rules, and the fuss made by all and sundry about future headroom. Like everyone, they criticise the way Reeves tried to adjust welfare policy midyear to find savings, and fell flat on her face. You could argue, as the Institute for Government has, that we should only look at policy once a year. And as everyone suggests, have more headroom, then you won’t be jiggered around by random, exogenous shocks! But what should the rules be, if not binding and demanding policy responses at some point?

The standard complaint, which the CPS magnifies with some brilliant charts, is that forecasting is well-nigh impossible and therefore a terrible basis for policy.

Here I think the CPS are just a tad disingenuous. For all the multiplicity of blue dots, there have been four or five giant macro uncontrollables that have knocked the UK economy and its fiscal forecasts sideways. The recovery from 2010 was too deflationary; Covid happened; there was a big post-Covid inflationary surge that both raised NGDP and also introduced a massive, energy supply shock; and Brexit looks to have half murdered future productivity growth. Unless you are the kind of wally who thinks this can be blamed on Resolution Foundation, these are largely not the fault of the fiscal rules nor the OBR’s forecasting capability.

Yes, they show that forecasting is hard, but not that you should never make any. I don’t really understand what other basis you can suggest for budgeting. Spending and tax policy have to be sticky over the medium term or you wreck the certainty of the economy and public services. Do this without a revenue forecast and the bond market will go bananas. Budgets need forecasts.

The more controllable reason the forecasts are reliably wrong is the point the CPS makes so well earlier: a persistent inability of governments to be honest – with themselves or the electorate – about the spending they need to make for public services. As the CPS says, “hard decisions are put off”. But another way of putting this is that everyone – politicians, voters, and many right wing think tanks – have conspired in a fiction that a future government can run public services on far lower resources than they in fact need. I have been complaining about this for a dozen years now. I am not going to be so petty as to go back over everything the CPS has said on spending, but I would be amazed if they have been urging realism on this topic. Realism means preparing the voters for higher taxes, or drastically curtailed services. It feels unfair, but everyone has the right to play one Truss card, and I remember very clearly their enthusiasm for that “let’s cut taxes like crazy I am sure we can find the spending cuts later” moment.

In a much more hawkish mood, now the CPS nobly suggests that governments should adopt a Charter that includes strategy for “addressing long-term spending pressures identified in the OBR’s fiscal risks reports”. Well, bravo! But they immediately notice the contradiction they have been caught on, in this glorious acknowledgement:

Of course, any long-term models of spending and debt should be treated with caution, and not used to replace today’s arbitrary targets with even hazier ones decades hence. Their usefulness lies in that they show broad trends and can indicate whether current tax levels are adequate for projected levels of spending, and force politicians to confront those choices.

So this is why I am confused. If you want to show whether “current tax levels are adequate for projected levels of spending” and force a confrontation, you have to forecast the state of the economy for a good few years! Those forecasts will keep changing, and you will have to respond, or it is meaningless. So how does that leave us substantially in a different place to where we are now?

I am also confused that they want Chancellors held accountable for current year outcomes (i.e. be responsible for failing to hit past forecasts), without spelling out how this would actually change behaviour. Suppose a Chancellor learned, half way through the year, that rates were rising, revenues falling, and current year deficit going to be blown right through. Is the CPS idea that the Chancellor just looks ashamed, or that they adjust policy? If the former, nothing has changed. If the latter, this would trigger the kind of in-year tax rises and spending cuts that are supposedly a fault of the current fiscal rules. Or, to quote their own eloquent complaint, “in response to extremely fine-grained changes in projected spending or tax revenues, the Chancellor announces policy designed purely to meet these fiscal objectives.”

Just replace “projected” with “realised”. It is still policy instability. Realised near term outcomes are just as big a driver of volatility as changing future forecasts, and muleishly refusing to use the highly convenient device of “borrowing cheaply” because of some promise your predecessor made 3-4 years ago is a bit crazy. I am glad Chancellors do not have to perform this way.

The final bit of the report contains some useful comparisons with more virtuous or fortunate countries. I am not sure everyone would agree the German debt brake has been the ideal policy – it may explain why they have been such a growth laggard – but like they say it is political. They add an interesting discussion of using Public Sector Net Worth as a target, though noting in an ironic aside quite how it moves with interest rates and can therefore be somewhat unstable … well quite.

All in all this is a good short read that encourages people to think about the rules. But I think it inadvertently reveals that the volatility, uncertainty and asymmetry in the fiscal system is fairly intrinsic, and can’t be designed away. And you can’t change what Chancellors get fired for, even if they have to endure the horror of presenting an account to parliament on what went wrong. Politicians inherently have near-term incentives that outweigh longer-term considerations, and it takes acts of statesmanship to get beyond it. Maybe some day in the future, one of them will stand up and speak this truth straightforwardly. Either a left wing think tank accepting that lots of spending needs to be cut, or a right-wing one setting out how taxes have to rise. I actually have more money on the latter. It may even be the CPS.

Is this really a BOE “whatever it takes” moment?

There is a striking column in the FT from Adam Tooze, the incredibly prolific Chartbook author , which as I see it boils down to this: prolonged stagnation has thrown the UK into a desperate position; the 2022 Truss FacePlant has magnified an already strong tendency to overreact to the bond market; past such overreactions like those of 2010-15 led to some terrible policymaking; we need to emulate the QE-enacting, demand-boosting heroics of Carney, Draghi et al from a decade ago and “affirm the priority of reviving investment-led growth”.

Somewhat coded, it is nevertheless bracing stuff, including such sentences as “one could follow Donald Trump in demanding interest rate cuts” (really?). He hedges himself with a warning not to ignore inflationary pressures or long run debt. The most concrete suggestion is for an immediate end to quantitative tightening (QT), which he says would “help to lift the fear of bond market crisis”, which is apparently what standing in the way of democratically-elected politiciants delivering all that investment.

There is a fair bit to agree with from Tooze, and a large proportion of BlueSky might swallow the whole package. Longstanding readers of this blog will know that I have called for the Bank to pursue NGDP growth rather than stable inflation for over a decade*. Five years ago I set out what you need to believe if you are to call for this. Top of the list, more important than all the rest, is a strong conviction that the economy is demand-constrained. More cash spending will produce more real output! Otherwise, all you are doing is creating that inflationary pressure that Tooze admits we should not ignore.

Anyway, is he right? Well, I have questions.

First, I want to protest my demand-side bona fides. For years I felt, strongly, that weak nominal growth – demand in other words – was why the economy was underperforming. So what if inflation was on target! It was too much of a coincidence that it should have happened all at once. I produced slides like this for fellow government insiders:

and

I was particularly exercised by the idea that what may have been a positive labour supply shock was being seen as a negative productivity shock (because it just lowered wages). I wasn’t sure, I just thought it was under-explored, because it was a heresy.

This is my roundabout way of saying that I think Adam Tooze is right about the failures of 2011-15, partiularly with regard to the Eurozone, when Trichet raised rates in the face of a weak economy. This probably brought about the crisis that Draghi had to do “whatever it takes” to solve.

But now? Here is how I see things.

  • Demand is the problem when NGDP growth is too low, and resources are not fully mobilized.
  • Supply is a problem when a lot of NGDP growth generates inflation, and not real returns.

And here is the chart showing how these have both behaved. It compares the post Great Financial Crisis recovery (2010-17, say), nominal and real, with the one that began in October 2021, up to the most recent moment.

The blue lines go up at 3.7% and 2.05% respectively. The gap between, inflation (actually the GDP deflator), was clearly not the problem. I personally think that if we had yanked up the thick blue line, the dotted one would have risen too: we would have had more real growth.

Now look at the red lines. Our nominal growth has been far higher since 2021: about 6% per year. The dotted one has been much lower – about 1%. This means most of that nominal growth has been inflationary, with significant consequences: for inflationary expectations, bond yields, living standards and more. It is not that mysterious why. We have enacted a really bad Brexit deal, suffered a terrible energy price shock that is only half dissipated, and the hangover of covid, which has enduring labour market effects. You can argue about government (present and former) culpability in some of these, but the mode of their effect is clear: it is on the supply side. They are not causing their effect through insufficient spending.

To be very clear: I am worried about a great many things. Weak technology diffusion. Stubborn energy costs. Low levels of dynamism, the need for tax reform, crappy regional transport networks. But right now, unlike from 2010-20, I am not worried that the Bank is doing something that is holding down spending and investment in the UK economy.

My second criticism is about Tooze’s apparent unconcern about how his suggestions would “lift the fear of a bond market crisis”. What he seems to be calling for is fiscal dominance – for growth-concerned policymakers to be allowed to assert that investment should be allowed to take place without incurring unduly high interest rates. The implication of the call to end QT is that it is central bank selling that is driving down bond prices/driving up yields, and so the reverse will apply too. But Friedman wrote about this in 1968, where he argued that monetary policy cannot peg interest rates away from their natural level through putting out extra money. Doing this raises prices, inflation expectations and the equilibrium interest rate the Bank needs to be targeting to keep it all under control. The result is that inflation and rates end up being higher, because of the attempt to make them lower.** The whole section is brilliant – read it. The conclusion to take is that it is very dangerous to try to lower future borrowing costs through interference in what the Bank is doing.

I would also argue that if your objective is higher business investment, the obsession with interest rates is overdone. Companies do not chose whether to invest on the back of whether rates are 4 or 5% (see my business investment piece). The hurdle rate is remarkably invariant. High business investment has tended to coincide with higher rates. Never reason from an interest rate change …

Concluding: having come of age, economically speaking, in the deflationary 2010s, I am temperamentally very disinclined to take the supply side view. I also ought to bow to a far more qualified economic writer than I am. But on the evidence of what nominal GDP has been doing, and prices, and the rest of the economy, this piece in the FT is at best missing the point in calling for some interference with the Bank . It may deflect politicians from much harder choices than what to do with QT. And at worst, there is a risk it sends them down the wrong path.

*it goes back to a 2009 pamphlet from Centre Forum, called Credit where it’s Due, about QE, and now hard to find online.

**the same happened in reverse when Trichet et al tried to raise rates above where they should be in 2011, which depressed the economy, drove the equilibrium rate down, and led to rates being lower than they would have needed to be had they never blundered.

There really is no getting out of this fiscal corner

It is something of a cliche to argue that Britain is running out of money, living beyond its means, wandering through a fiscal fool’s paradise – but no less true for that. The trend of old-age payments will make it even worse (read The Economist). It was the great unspoken theme of the last election – well, unspoken except for every damned think tanker with a spreadsheet, who could in half a minute explain that Jeremy Hunt’s departing NICs cuts were unaffordable, and Rachel Reeves’ incoming promise not to raise the major taxes just as unrealistic. And things have gotten worse since then.

I was a bit surprised therefore, when mildly calling for some leftish think tank to do proper work on welfare reform, to come across quite so many reply-people questioning the premise. I leave it to experts at the Resolution Foundation and elsewhere to set out how there is a problem in welfare itself. But there are two other popular diversions I keep reading: that the problem is the fiscal rules, which just need to be changed (or abolished); and that we can always just tax the rich a bit more.

The fiscal rules are not perfect, and the government (over)reaction mid-year to events framed by those rules is pretty suboptimal. But they are also quite irrelevant. The government’s financial position is objectively bad. Just make a silly little model, with real growth, inflation, taxes as a share of the economy, spending similarly, and interest costs, and you can easily see how quickly things go from dicey to terrible. Here, I have had a rudimentary go.

In an easy Blair-Brown world, with debt 35% of GDP, you can have interest rates of 4.5-5.0%, spending rising every year about 2% above inflation, and with taxes rising gently from 35 to 37% of GDP over a 10-15 year period, debt is going to trend up gently to 45% of GDP. A situation easy to bring under control, because growth is 2.4% which is enough for everything. And you can do lots of good things.

It is likewise easy to make things work under deflationary Coalition era times, even with a high starting deficit: when your refinancing rate is 2%, and nominal growth 3.6% (half real, half inflation), all you need is to trend spending down ever so slightly and things again remain under control:

Debt peaks a few years out, debt interest is never the huge burden.

Things get dicier when rates are higher and growth lower, which is what the Treasury and OBR have to concede now. Here I have lowered real growth from 1.8 to 1.5%, and raised the borrowing costs to 4.5%. I also include a highly optimistic assumption of spending rising just 0.5% faster than inflation. Now the only way to get debt to peak somewhere in the knowable future is to raise taxes every year by 0.2% of GDP, or £6bn. Every year.

In this world, in spite of that achievement keeping spending growth low, and taxes going up, you end up with over 10% of those taxes going on interest.

And then what if something goes wrong? What if interest rates go up 1%, growth drops to 1.2%, and it turns out the backbenchers can’t stomach that kind of spending restraint, adding 0.5% a year? Now it suddenly looks like this:

In this world, the only way to bring things back under control is to have taxes rise by 0.5% of GDP every year – a £15bn fight every year.

I am labouring the point, and both the model and figures within are sketchy, late-afternoon toy quality. But the point should be clear: when your starting debt is high, interest rates rising and growth falling (r-g is growing!), wicked fiscal maths is never far away. And it does not need the interposition of a *rule* to bring this to bear. It would take only a couple of adverse, geopolitical moments to drive forecasts of future interest spending into deeply uncomfortable territory.

So: why not just tax the rich, then? Well, you can try, but I think it is first worth looking at some figures and trends. There is a lovely dataset called “Effects of Taxes and Benefits on Household Income” which you can (ab)use to do this. The first fact I pull from this monster is: the total income of the top decile of households (who have an average gross income of £180k) was £540bn in 2023, and after taxes it was £329bn. That is the pool in which you are fishing – though note the emphasis on households, and the average at £180k. These are senior managers, doctors, heads of department and solicitors, not all globetrotting plutocrats and snotty investment bankers.

This is the trend of how much direct tax (income and NICS) has been taken from that decile in the last 20 years.

Has it been higher? A bit – but a squint at that graph suggests raising the line by 1-2% would be quite something. That is £5-11bn perhaps. You solve one year of the fiscal problems set out above.

Meanwhile, to think about the politics for a moment, this is not a set of people that are getting much in the way of cash directly back from the state:

The top 10% get more in the sense of “benefits in kind” – but much less as a share of their income.

So maybe one can go after this top 10% – but there has to be a limit beyond which there is not much left to get. As far as I can see, all of these charts are quite progressive in shape- and have mostly been getting more progressive with time.*

I tend to be sympathetic to people who think we have missed some fiscal opportunities in the last 15 years. Taxes were held down unnecessarily at times, and investments missed. You can play fantasy hindsight-Chancellor, imagine that a bigger splurge 15 years ago might have produced more investment when rates were low, and brought today’s Chancellor the growth to make it all better today.

But now we are where we are. Interest rates are high, interest costs are an unavoidable fact, the rules are not even needed to constrain the chancellor, and there is probably only one or two tens of billions to squeeze out of the richest. This is not a dilemma you can evade. Tim is right: Reeves’ prudence is needed to prevent something even worse and more chaotic, and the Left should appreciate her more. There are plenty of puzzles in public policy right now, but it is far from mysterious why the Treasury wants to control spending.

*the only exception I saw is how the top decile started in covid getting a much larger share of NHS services.

You have no idea if the Spending Review boosted growth

Imagine that, having committed some unspeakable acts in a former life, you were asked in this one to deliver a verdict on whether the Spending Review was good or bad for UK Growth. What would be your answer?

The most honest one would be shrug, followed by a rant about the slipperiness of Treasury communications. The second of these is not some cosmetic point: the way numbers are presented at fiscal moments appears designed to impress the foolish and exasperated the better-informed. As The Economist put it,

on June 11th the House of Commons felt like a bingo hall, or perhaps an auction house. Rachel Reeves reeled off a dizzying list of wildly varying numbers and time horizons….To hear the chancellor tell it, almost every corner of the British state was to be showered with cash and attention. 

This is not a dig at Reeves in particular: every Chancellor does it. Sit through a Budget day speech from the Despatch Box, and you’ll emerge with the impression of an endless flow of goodies, a Santa-sack full of investments and tax bungs spreading over the country. As Chris Giles recalls, it was a feature of Gordon Brown’s style, and last week

some were presented in cash terms, others adjusted for inflation, one or two expressed as a proportion of GDP, a few compared payments over the next three years, some over five and some cumulated over many to arrive at a single enormous number.

I ran the speech through an LLM , and was indeed befuddled by this constant mixture of units.

  • total spending rising 2.3% in real terms a year (rate of change, cumulative over SR, real terms)
  • £190bn more allocated to day-to-day spending (total amount, cumulative over SR, cash terms)
  • £15.6bn in total by 2031-32 for Transport for City Regions (total amount, cumulative over a different period, cash terms)
  • £39bn for a new 10-year Affordable Homes Programme (total amount, cumulative over yet another period, cash terms)
  • NHS spending up 3.0% in real terms, leading to £29bn more a year. (a baffling combination of a real-terms top with a cash-terms bottom).
  • “A £30bn commitment to our nuclear-powered future“. This one is a doozy. AFAIK it includes: a big financial investment to the Sizewell C project (equity? debt? Timescale unknowable?); £13.9bn for the Nuclear Decommissioning Authority (surely a relatively non-negotiable commitment to stop some really bad things happening); £2.5bn for Small Modular Reactors; £2.5bn for Nuclear Fusion (both more industrial strategy, though each at VERY different stages of technological development. Grants, Loans, payments for an actual reactor? Not sure yet).

Perhaps a team of trained, caffeinated IFS researchers can break all the tables into numbers that can be used in an comparable way. But even then, it is impossible to derive from an examination of such numbers any solid sense of whether the economy will thereby be better, stronger, healthier, fairer and so on. The main reasons: opportunity costs in the government and in the economy, inertia and a skew to the visible:

  • You don’t know what was cut, to pay for it. Take, for example, that £15.6bn for Transport for City Regions. I really like that! We have been told a great many times that a. our second-tier cities underperform and b. more agglomeration might help, maybe if they got denser and their Centres were more accessible. £15.6bn sounds like a lot, compared to the £2bn Transforming Cities Fund we got going in 2018. But then I read in the FT that there will nevertheless be a large (17%!) cut in the roads budget. Net-net, is an implicit diversion from one to the other good for growth? you don’t know! The Chancellor is only Santa Claus if Santa went around stealing presents as well as giving them out.
  • You don’t know about crowding out. Britain has a supply-constrained economy. Our limits are not just the ones expressed in the fiscal rules, but the knowledge that any policy action that brings about extra activity will come at the expense of other activity. Only if the new activity is “better” than the old will you score positive for growth. Ironically, a relevant example can be seen in one of the government’s big policy successes, planning reform. Your mental image of what this achieves is: Government reforms planning; fewer obstructions to housebuilding mean more houses; diggers, workers, GDP! But in the Spring Statement, the OBR actually pours a little cold water on that particular view, describing how given we are supply constrained, other effects will weigh against this. In the end, you get that small 0.2% bump in GDP just because of better construction sector productivity. The diggers weren’t idle, you see. Look at this chart.
  • You don’t really know about what is already there. Just as there is a great deal of ruin in a nation, there is a great deal of inertia in the economy. This can be a good thing – they are harder to wreck than you may fear! But it means that even when the government is really unleashing a tidal-wave of new investment, say, you have to compare it with the literal trillions already invested. A Chancellor that unveiled an extra £100bn of capex – really, truly, guaranteed by the IFS to be new – is still only raising the total stock by a 2-3 percentage points

The same goes for your skills idea. Transform the skills of a couple of hundred thousand people, and you still need to reflect that there are 33m workers.

  • Finally, and my absolute favourite, Treasury Fiscal Days exhibit the most commonplace feature of government comms: the obsession with the visible over the invisible. The above are examples of this: the government is asking you to look at what they announced, over what they cut, and the new activity they inspire, not the activity it displaces. When it has a thing for industrial strategy, it will want you to think about the growth sectors it is prioritising- the technological wonders it hopes to promote (graphene! AI! Nuclear Fusion!), the future champion businesses. But it struggles with the humdrum buzz of ordinary economic activity, even if it is in this ‘everyday economy’ that most of our prosperity is founded, and most of our failures occur. We have gotten poorer in the recent past, not just because we have failed to launch our own Nvidia or build a million more houses or anything else so easily visualised, but because the ordinary work of economic progress has stalled. People starting companies, shifting jobs, bad businesses going bust, good ones expanding, the search for new markets, better processes, different products: all those near-invisible forces of economic progress just slowing down a bit.

Growth normally feels mysterious not because it is inherently hard. We know plenty about what causes growth! We find it mysterious because it happens through a countless number of small experiments and ventures, failures and successes alike unplanned by any higher authority and invisible to the eye. Its failure is more like an ennervating sickness than a series of spectacular injuries.

And did the Spending Review do anything to fix it? Well, you don’t know.

The hunt for the £45bn

A month ago I whiled away a lunch break asking BlueSky for the origin of a massive number. The figure £45bn had acquired a kind of solidity-by-repetition in what we pretentious types call “the political discourse”. £45bn was meant to be how much the government might save if it were to replace “manual, paper-based and poor-quality interactions with the State [that] are sucking up time and resource that could be allocated elsewhere” (quote source). The thread details an amusing and frustrating chase through the citations and footnotes often seeming to end back where I started. Yes, this is how I amuse myself.

But somehow this drew the attention of the DSIT committee, as well as Lord Theodore Agnew, and last week DSIT published its response explaining how the number is arrived at. All of this reflects well on everyone, in my view: nobody is hiding. When ministers, think tanks and government reports go out claiming something extraordinary, they are subject to visible public scrutiny, and letters are published, politely. This is not how the whole world operates.

Nevertheless, nothing in the response diminishes my disquiet at this number being taken so seriously. Hold it a mo, “diminishes my disquiet”, why am I trying to put it so decorously? No: I think this number and numbers like it (TBI analysis) are usually garbage, and the scant detail we have here gives me no reason for reassurance.

A number this large (enough to fix all of Rachel Reeves’ problems) is like the proverbial elephant being explored blindly by touch: it must be examined from a number of angles. Here are a few.

Always be sceptical of massive numbers and look for analogs. £45bn is a vast, vast amount – something like three times all MOD service and personnel costs, or in the same area as the cost base of a globe-spanning bank. When such a bank embarks on a cost reduction programme, it is hard yards – maybe 1% of the cost base taken out in a year, five times that at the end of the programme (source of guesswork), difficult decisions the whole way. (These are, moreover, information economy entities par excellence – the very sorts of organisation ideally suited to the implementation of digital cost saving ideas. Why would it be easier for a government?)

In part this is because, as Matt Clifford put it nicely, “There are no AI-shaped holes lying around”. There is a huge amount of business transformation to do before your AI thing sits where your human-process thing was. Another way of saying it: if your contention is that AI is going to tranform activity XX, then you need to be an expert not just in AI but very much in XX too. And XX will be different depending on whether it is running a prison, teaching pre-schoolers, triaging health services, administering welfare claims or procuring weapons. The method for deriving AI savings simply cannot take a portion of public services and extrapolate.

Where there ARE AI shaped holes, they are most likely in administrative, word-play jobs. It is unavoidable that many of the optimists about the impact of AI can be found in the word business; read superb wordsmith Ian Leslie’s informative post. Words in, words out is what LLMs literally do. I have no doubt that Governments could make more use of them. But the admin budget of the Government is a very small part of the whole – less than 2%.

Moreover, most of the problems impeding productivity are not “if only I could get better words faster without paying people as much”. They mostly involve harder problems, of energy and human services in particular. This point has never been put better than by Tyler Cowen in his endlessly patient discussion with an extreme AI optimist, as he tries to explain the logic of thinking at the margin: as the supply of one factor gets cheaper (intelligent words), the ones that DON’T get cheaper increase in significance (look up Baumol’s Cost Disease). In the end, in his words, “the bottleneck is humans”. This is why it mattered much more for human flourishing when light began getting cheaper, than the last tiny leap to LEDs.

Why is there not more curiosity about how technological transformations have worked in the past? The past eighty years have not exactly been short of administrative innovations, as typewriters were replaced by wordprocessors, paper legers by online databases, secretaries by desktop PCs and expensive snail mail by maddening volumes of email. (The most tedious part of any minister’s technology speech is always that bit when he wonders at the pace of change around us all, as if the audience hadn’t spotted that they can get live football on their phones.) Yet throughout this period of transformation, admin spending has not shifted down:

And hours have not reduced, either. This chart shows Labour Volume (all KLEMs data)

Note, by the way, that the £45bn number has a new context: it is about half of the entire GVA of the whole admin sector of the UK economy.

Nobody can deny that there have been astonishing efficiencies in office work: we don’t need pocket calculators for calculation, rooms full of books for basic facts, phone calls to communicate or a giant printing press to get thoughts out to a wider audience. But whatever savings these generate appear to dissipate through new uses of the resource (a sort of rebound effect), some consumer surplus, and the way technology creates new demands as well as supply solutions. Email has given us a quicker way of communicating but also more to plough through. And there is also David Edgerton’s insight – that old technologies hang around for far longer than you expect – as managers and consultants slowly generate the technology-shaped hole for the new one to fit into.

A priori, it is hard to accept confidently any predictions on a technology’s impact, and squinting at history feels more reliable than detailed micro-examinations of tasks. Our economies, when they DO respond, do so to new technologies in ways that are not as straightforward as the optimistic analyses suggest. The tasks that economies ask are constantly changing, AI or not AI, and new demands are constantly created. The more than analysts claim to be using detailed, granular methods for assessing exactly what AI is meant to do (as the TBI seem to), the more you suspect some kind of GosPlan fallacy, where they think they can analyse in detail what a gigantic complex system with billions of separate incentives is going to do in response to a change.

It is time to conclude. Over a decade ago I was asked to review a book that predicted the professions (law, medicine, accountacy etc) would be savagely gutted by AI. The authors’ view was

that what once hit cloth weavers and miners, and is now happening to cashiers and travel agents, will eventually sweep up the advanced professions. The traditional ways of working currently enjoyed by lawyers and doctors will be broken and revolutionised. This will happen through the encroachment of open IT systems and ever more capable artificial intelligence, able to make the sort of fine judgements—including those with a moral angle—that currently rely on experienced human beings.

I thought the book made some good points, and it was prescient in forecasting how AI could soon beat humans at cognitive tasks. But I didn’t see a future of lawyers on the dole, because their job is not just to compute, but to decide and take responsibility, and they will ultimately contest ownership of the economic rents inherent in what they do. Gifted a new tool, they will find more uses of their labour. I don’t see it being very different in the public sector.

Against vibes-based economic prognosticating

Here is how it goes.

Let’s say it starts with the Government doing something bad, like raise a tax by £20bn, to fund a bunch of stuff.

People don’t like tax, according to science, and so those affected complain. There are plenty of ways that they might complain: to the journalists ringing around asking for views on the Budget, on social media, in response to surveys, and so on. They report it to the Treasury officials tasked with calling them up to find out how the Budget went down, who then say things like “badly” to the anxious ministers and spads. The vibes are bad.

The thing appears to snowball. Those surveys come back breaking down all the negative ways business is going to react to this egregious tax. Since everyone only ever had just enough money to start with, the tax is going to have to come from somewhere virtuous. It will hit investment! It will hit hiring! It will hit wage growth! It will raise prices! The £20bn intervention appears to metastize into something attacking all the vital organs of enterprise. No one wants to hire, invest and spend, and everything is going to be really expensive!

This is then promulgated through surveys into the media and back into politics. Journalists calling spads hear what spads read in the media about what businesses who read newspapers say in response to surveys, and opinion pieces are written about how bad it is. Business groups report widespread depression. Well-crafted notes from investment banks land in the inboxes of well-connected Great or Good people with charts and paragraphs reporting how bad things are. The vibes are really bad! Very senior well connected people call Downing Street and report that sentiment is really bad, and hear back from No10 advisers that they too have heard it is bad. Ad hoc roundtables convened by Whitehall hear from serious besuited people who have read some well-crafted notes and excoriating Sunday Times pieces that the vibes are bad, and they worry that the Government literally doesn’t understand the following stunning insight: businesses much prefer lower taxes to higher. Call this a growth plan!?

At this stage, some economic adviser, tasked with finding out how things are going, collects all the strings of this web and can only report back to the Chancellor: they are going badly! the vibes are really bad! Not only do businesses hate the tax rise, but now we have lower hiring to contend with, price rises, wage cuts and cancelled investment. And they hated it at our roundtable in the State Dining Room! And that guy on the flight who sat near the PM was horrible! Why on earth would anyone want to do anything in this economy now, huh?

Now type in your guestimate for UK growth this year. What is it? Zero? Probably. Why? Terrible vibes, and no plan to deal with them!

Meanwhile, in the non-vibes based world of OBR forecasts , the UK economy was seen growing by 3.8% in cash terms this year. To put it in concrete terms: an economy with £2882bn of production in the year to 2025 will somehow turn into one with £3,006bn in the following year (yes there will be inflation too). Incredible! How can the OBR not have anticipated the bad vibes? Why on earth would incomes rise when everyone is so devastatingly depressed? Dumb technocrats!

OK, enough of the caffeinated hyperbole. What is the point I am making?

The vibes based way of assessing how things are going is horribly prone to double-counting. I am not denying for a second that the Tax Thing is bad – I have written so myself. It has an income effect (less money for business) and an incentive effect (relative cost of hiring gone up). Neither are welcome, ceteris paribis. But the OBR took that into account when assessing the effect. The vibes are not something extra. “I will have less money and behave accordingly” is not extra information. The OBR’s model did not anticipate no behavioural response to a tax rise!

And the way everyone reads and repeats back what everyone else has said creates a misleading amplifying effect. All of these are echoes of the one, original bad thing, the £20bn rise in a £3trn economy. But because Jeremy repeats what Rafael heard from Emma who put it in a report to Tim who spoke to Jessica who put it in a note that Jeremy read and passed back to Morgan, the whole thing just becomes an echoing din. There was still only one original thing.

It gives far too much weight to what people say. Talk is cheap. I have no doubt about the sincerity of people saying they are going to have to make up for having less money. But survey and journalist ring-round responses are also a way to express your view on what happened. If sentiment now improves, all because people generally liked the cut of Reeves’ jib when she did that Heathrow Third Runway speech, just after defenestrating a regulator, I will think my point is proven. How many businesses expect this year or next to be affected by whoever is chair of the CMA, or the restart of the Third Runway? This is a very flimsy variable!

The vibes analysis is partial and one-sided. In the case of Reeves’ budget, the extra funds raised (and also borrowed) will go into investment and higher public spending. Very normal macro-economists will agree that the net impulse from a Budget can only be understood when you take all the effects into account. The increase in the deficit is a positive fiscal impulse – hence higher rates and inflation in the short run! This is all about the extra money in workers’ pockets, the extra investment which is some company’s future sales … But the survey method will invariably ignore macro – it won’t ask companies what they expect to get from second order or distant effects that they are not expecting to experience directly. (Nor does the analysis think about what that not-hired worker goes off to do. )

The vibes way of looking at the world is ignoring the Bank reaction function. Let us all concede that an Emplyer NICs rise is a bad way of raising money, and let us even pretend that the other positive fiscal impulses just don’t work/are too late/etc. Animal spirits are down. Come on class, what does that mean? It means the Budget has damaged future spending, more than maybe realised. And that will affect inflation, growth and NGDP in general, and if NGDP is going to be much lower than hitherto expected, the Bank is going to act to rebuild it.

I need to reiterate this point: the Bank is still responsible for keeping that escalating NGDP pathway on track (and if the Bank makes a mistake, things are bad*). And that NGDP level is easily the most important variable in the economy. You may have doubted this during the period of near-zero rates, but you cannot any more. If you really, honestly think that the £20bn NICs rise is going to hit actual spending and investment in the economy, then it falls to the Bank – automatically – and not the Treasury, to address it. They have to. So even if you think 2025 is going to be shittier than you thought before, you should NOT think the size of the economy in 2026, 2027, 2028 is going to be much different from before.

I am not denying that government actions affect the economy, nor that business sentiment is a “thing”. Of coure they do, of course it is. My model, though, is pretty simple. The level of spending in the economy is ultimately under the control of the Bank. This is not going to deviate permanently from what we thought it would be, no matter what Vibes are being expressed in Downing Street. And what really matters is our supply side**. The NICS rise was egregious insofar as it made the economy less efficient, and tax wedges decrease efficiency. Against that, the Budget also raised investment, and people do not congratulate this or the last government enough for raising investment incentives through Full Capital Expensing.

If the UK economy now grows pretty much as it was expected to, I will want to ask: how real were all these vibes? Let’s see,.

I hate vibes-based reasoning, because of the kind of thinking that it elevates. It elevates the comms spad over the macroeconomist, the reader-of-headlines over the modeller, the use of a finger in the air over a solid think about the vast, hard-to-move economy. It encourages people to grossly misuse Keynes’ term “animal spirits”, and encourages politicians to act like what they say, the winning of favourable quotes and approving letters, matters more than the solid fact of cashflow, incentives, real factors of production. It takes us further from a proper understanding of things.

Anyway, here endeth the rant.

*this is my alibi

** which will ultimately determine how much of that NGDP is real and how much inflation

POSTSCRIPT (which I forgot to include). “Vibes”-based thinking elevates what people think and say about a policy over what it actually is. If everyone feels down then they act like things are bad, and it becomes self-fulfilling, right? But there have been plenty of times when the economy was actually growing, but the vibes were all “we are in recession”. I recall the commentary after Black Wednesday being really bad, for example – but we were at the beginning of a spell of great growth. And in 2012, all the talk was about how we were in a double-dip recession – how could we not be, the fiscal policies were really contractionary! – and yet it turned out were were actually growing.

What really matters in the end is not how things felt, but how they actually were.

The Government needs its growth *explanation*

In Downing Street, I was once lobbied to support a £200m per annum cut to beer duty, because it was “the best growth policy I could ask for”. You see, that £200m would go into drinkers’ pockets, generate some 50m more pints, and with each barman serving 50 pints a day, call it 10,000 a year, that’s a 5000-job creation scheme right there.

I forget the exact numbers. The lobbyist was convinced: if you are too, probably best not to read on. Here is an article about the cost of the Death Star instead.

There are countless, variously questionable methods you might propose for boosting the size of the UK economy. Here are some, free of charge, divided into two types:

Better allocations of economic assets

  • Reallocate 5% of the workforce from inactivity towards decent-quality employment. Ceteris paribus about 2m people generating £40k each for the economy is worth £80bn or 3% of GDP
  • Reallocate 1m workers from low value administrative sectors(£26/hour) to higher value Scientific or IT roles (£70/hour). Result: £44bn more GDP.
  • Reallocate 2m people from low-productivity regions (£25,000/head) to the Greater South East (£40,000). Result: £30bn more GDP.
  • Reallocate 1m people from the median business in terms of GVA per head, to businesses at the 90th percentile, where it is £90,000 higher. Result: £90bn more GDP.
  • Reallocate 1% of GDP annually from consumption to investment. According to the OBR, this would raise GDP by 0.5% in five years, and 2.5% in 25 years, or £80bn.

Better attributes of existing assets

  • Perform some magical technology adoption that raises productivity by 10% in all Administrative jobs (public and private) totally £100bn GVA. Result: £10bn more
  • Somehow double the gross-value added in Transport Manufacturing: raising it from around £30bn to £60bn. Result: £30bn more.
  • Somehow execute energy policy so well that we spend 20% less on it. My guess is that the total UK energy bill is £150bn-ish, so this is worth £30bn.
  • Raise the highest education level of 1m workers from A level to Graduate which increases salaries by £10,000 each (squinted source) but GVA by a multiple of that – call it double? So that is worth £20bn more a year.

I accept immediately that any such decompositions are far too crude for properly dissecting an economy. I list them merely to illustrate a point: you can decompose something into what we have, and how it is configured, and that might get you closer to an answer. Compared to the path we were on before 2008, what combination of allocations and attributes led to us being less productive than expected? Or, alternatively, what combination of allocations and attributes see us so far below the United States?

None of these bullets are actual ideas. To qualify as an idea, you also need a theory for why all this beneficial change ought to happen: a theory for why factors of production should shift from lower- to higher-value uses, or for why workers will get more education, or the managers will improve productivity, or what will shift sales towards the better-managed companies. If your ‘idea’ is that the government should arrange for millions of £20-an-hour repetitive task workers to move into £100-an-hour high value occupations, it would be good to explain how.*

The best theory for why this should all happen is: markets! Markets are what put the right stuff on shop shelves, make available the inputs you need for your outputs, and encourage self-interested agents to pursue the best, sales-boosting, cost-reducing methods. I was earlier asked by a colleague “what will generate this growth we need”, and my honest answer was free markets: when they work, they just constantly create better configuation of the economy, like some kind of reverse entropy.

But if “markets” is your answer, what is it about markets that started failing 15 or so years ago (chart stolen from earlier post)?

The other theory is “brilliant industrial/regional strategy” – policies through which the Government raises productivity in the sectors it favours, or reallocates resources of labour or capital towards those sectors. This is clearly what the Government intends with its Industrial Strategy, called Invest 2035, which points at eight sectors that might be more growth-generating, matter more in their connection to the rest of the economy, and where effort can bring a disproportionate reward.

There have been a slew of pieces discussing whether Labour has a theory of growth, stemming from Ben Ansell’s excellent piece. I have no problem with his taxonomy, which ranges from neoclassical Osbornism, neoKeynesian, institutionalism, developmentalism, to Schumpeterian and even Trussism. What matters is his core contention: that without picking a side, the government risks incoherence. They may come unstuck on policy questions like our relationship with Europe, how welcoming we should be to foreign investment, or the balance between job security and dynamism (you can see some of the tensions in my Political Choices in Choosing Growth).

Aveek on the other hand says on the SMF website** that the issue isn’t the theory, it is Labour’s view on where the real binding constraint on growth lies that matters. What is holding us back?

I mostly pick Aveek’s side. I have strong sympathies with Ansell’s desire for the Government to have some solid theoretical understanding of what drives an economy – what he calls “a deep understanding of the British economy and its options”. In particular, it would be good to know that they appreciate the importance of market dynamism – that restless reallocation of resources towards better uses, which has failed according to work from the Resolution Foundation, building on impressive analysis at the ONS. But I am not so fussed about the incoherence point. Essentially, industrial strategy means taking a different lens towards some parts of the economy, making judgements such as “markets are working fine here, less so there, and over in THIS place there really needs to be a government-shaped strategy”.

It is never about just one thing

Where I am less sympathetic to Aveek is his demand for us to learn “the strongest binding constraint on growth”. Single issue fanatics are the bane of growth analysis. The laws of diminishing returns mean that it is never, ever about just one thing. Does physical capital matter? Not if you have enough! but a lot if you have none at all! Even in the wake of the Financial Crisis, weak growth was not just about a lack of bank finance. In the 1950s, we suffered a dearth of labour, but it was not just about this. We thought macro-instability the single biggest problem from 1950 to 1997, but fixing that with central bank independence didn’t cause business investment to leap. (Nor has full expensing.) Labour’s go-to “single biggest” is the planning system but as Arthur argues at length, planning reform is not the answer to or explanatation for everything growth-negative.

And William Hague’s ferocious demands that everything be sacrificed for AI production – including sickness benefits, energy for new towns, and the very idea of cost-benefit analysis – suffers the same fault. The provision of “intelligence” is undoubtedly a constraint on growth, but not the only one. As one factor of production becomes more abundant, the constraints on the others begin to matter more. If you want to make statements like “AI is going to transform the BoonDoggle industry” it is not enough to have views on AI, you need to understand everything else that goes into BoonDoggle production. As Jones, Aghion and Jones put it,

“Economic growth may be constrained not by what we do well but rather by what is essential and yet hard to improve

Tyler Cowen spends many patient minutes explaining this counterintuitive point – it doesn’t matter if you believe in an infinitude of AI helpers, if there are other bottlenecks in the economy. AI is an opportunity, not the only one.

So what I want to see from the Government, as it embarks on a Growth Strategy, is a wide-ranging statement of where it feels the UK has fallen short of its potential – even with some numbers on it. I am not too bothered by a capital T theory – so long as they exhibit some pragmatic appreciation for how it will be about market function in most places, and factor endowments and government strategy in others. Planning will definitely be in there, and AI too. Then we can move onto some policy ideas for getting back to growth. Surely not too much to ask?

*I once heard a prominent government thinker suggest we set up an agency to shift people out of declining sectors and into the growing ones, and I purpled with vicarious embarrassment; an agency manifesting the infarmous ballerina-to-cyber ad.

**Am privileged to sit on their advisory board.

Quick note on the US beating the UK at growth

I wrote hurriedly last week about how US growth outperformance cannot all be explained by tech. Here is an even more hurried analysis using KLEMS data to dive into some of the decompositions of growth between UK and US.

[A decomposition, in very crude terms: we know that output can be expressed as a function of how much labour; the quality (education) of that labour; the capital stock (tangible, intangible, ICT and not) used to produce the output, and finally the “magic residual”, Total Factor Productivity, which is by definition whatever variable you need to make the inputs achieve the outputs. It can be anything, is often associated with technology but better management, access to larger markets, better incentives might equally explain it].

Anyway, with a considerable lag, data on all of these bits can be gathered and worked with so as to explain why the US has had a better 30 years than the UK. And this is what the story looks like, up to the pandemic:

and the US

What does this tell us? Up to 2019, the US grew a few percentage points better than the UK: but in “per hour” terms, considerably more, as the UK put in more and more hours – it is the only variable at which we beat the US.

If you break down that large (>11pts) outperformance, it comes in a few chunks. Half of it is TFP, and most of this TFP performance appeares to have happened during the long expansion of 1996-2007. When the dotcom boom arrived, the US did really well from it.

But the rest is largely down to Tangible Non-ICT Capital Services. It wasn’t in having an improvement in the quality of their labour force, any more than the UK. And it wasn’t just “ideas”, but things: machines and plant. And while some of that happened in the go-go years of the late 1990s, the biggest gap yawned in the 2010s:

Here you can see the series in terms of an index. At the end of 25 years, you see the US has in terms of tangible, non-ICT capital, about 20% more invested (of 1995 amounts) than the UK. That is going to make a difference.

There is plenty more of diving in that can be done, sectorally for example. I would love to know how much is state-spending dependent: we know that state investment budgets were slaughtered in the UK in the late 1990s, and cut a lot in the 2010s. But as I am reading a (rather good) book that argues against the importance of physical investment, I think this is an important statistical observation to note. America put down more physical stuff for a while, and the numbers guys think it made a difference. The Labour government’s emphasis on investment is not wrong.