The question of public or private ownership has been given a new prominence by recent commitments by the Labour Party to renationalise water, the railways and energy if  they are re-elected. To do so raises issues that have scarcely been discussed since the massive privatisations of public assets undertaken by Mrs Thatcher and subsequent Tory governments since the 1980s. These policies were based largely on the writings of Friedrich Hayek who, in ‘The Road to Serfdom’, argued for a minimalist role for the state in economic activity. This has been the mantra of Tory governments ever since – aided and abetted by Labour when in office under Blair and Brown.

Most countries have polices that restrict foreign ownership on the grounds that there are strategic sectors that need to be kept in domestic ownership. For example, the US refused to allow the Chinese to take over one of their key ports and a small oil company, and has restrictions on foreign ownership of airlines and TV stations as well. This is supposedly the country that is most enthusiastic about free trade and deregulation. Similarly, Germany has passed legislation that protects key areas of technology from takeovers by foreigner firms. This is again aimed at the Chinese who see company acquisitions as a way of acquiring  advanced technologies and market opportunities.

In the UK, not only public utilities but also a significant share of manufacturing is in the hands of foreign companies – most obviously in cars where there is no locally owned producer of any scale. The market for domestic and overseas vehicle sales is dominated by Japanese companies. Alex Brummer in ‘Britain for Sale: British Companies in Foreign Hands’ estimated that no less than half of British companies had been sold to foreigners – uniquely among other countries. The UK witnessed the sale of its premier chemical company, ICI, to Holland without a murmur. After Cadburys was sold off to Kraft, its capacity was closed and production moved elsewhere despite original promises by the new owners that it would continue local production and employment.

ARM Holdings, one the key British companies for research and innovation in electronics, was sold off in 2017 for £24bn to the Japanese company Softbank. The clear aim of the Japanese purchase was to get access to the intellectual property of ARM which is a leading player in mobile technology.

One might have thought that the lessons of an earlier privatisation in 2001 of defence technology contractor Qinetiq, a former British Government agency, would have been learned. A third of the shares in Qinetiq were acquired at knock-down prices by the US private equity group Carlyle and subsequently sold off in 2006 with enormous profits.  Carlyle was established by a former US Secretary of State, James Baker, and has a former British Prime Minister as a member in the form of Sir John Major.

But the British seem to see things differently, despite the clear social, economic and political costs of foreign ownership. Here are just some examples:

• Amazon, a US corporation, now dominates retail in the UK. Through cost cutting and other non-competitive activities, Amazon has caused significant reductions in retail capacity in all town centres. It pays no taxes in the UK despite billions in sales, and working conditions for staff are deplorable. It is worth noting that the former Director of John Lewis spoke of the impossibility of competing with companies that do not pay tax.
• Rupert Murdoch, an Australian/American, was permitted by Mrs Thatcher to take over the Times illegally despite owning the Sun and Sky, further increasing levels of media concentration with all of the costs that this has entailed . Other formerly British owned newspapers have been acquired including the Financial Times (bought by Nikkei Corp) and the Evening Standard (bought by a Russian oligarch). It is worth noting also that Waterstones, the only surviving national book chain in UK, is also Russian owned.
• Google dominates the browser market and pays derisory UK taxes, and Facebook is now the main source of news for most British people despite its biases and its inadequate constraints on the dissemination of fake news. Both of these companies are effectively unregulated despite their critical social media roles, and both make enormous sums of money from advertising that goes untaxed.
• Starbucks has effectively out-sourced their UK tax liabilities through various off-shore arrangements and scandalous high internal charges for management fees and inputs (purchases of coffee from subsidiaries overseas). These tax avoidance mechanisms make it difficult for independent companies to compete and survive.
• Apple has shifted its tax liability in the UK to Ireland. The EU has rejected Irish claims that corporate taxation is a national matter and have instructed Ireland to impose some 13bn euros of unpaid taxes on Apple – so far uncollected.
• The key national airports in the UK – Heathrow and Gatwick – are both in foreign ownership despite their strategic role in the national and international transport system Similarly, UK ports are now more or less all in foreign ownership having been privatised. Liverpool, Glasgow and Great Yarmouth ports are owned by Deutsche Bank and a family trust, Whitiker, registered offshore in the Isle of Man who according to the Public Accounts Committee ‘do not pay their fair share of tax’.  Britain’s busiest port, Felixstowe, is owned by one of Asia’s richest men and incorporated in the Cayman Islands. Even Associated British Ports, which manages many UK ports, is owned by the Singapore foreign reserve fund and Kuwait’s sovereign wealth fund and registered offshore in Jersey.
• The BBC estimates that there are currently no less than 97,000 properties owned by foreign firms in England and Wales. Of this total about half are in London (of which 10% are in Westminster) with a total value of £33.9bn. A quarter of all foreign owned property in England and Wales is registered to companies in a British tax haven, the British Virgin Islands, and the rest in other off-shore tax havens such as the Isle of Man and the Channel Island].
• Until April 2017 non-residents owning property in UK through offshore companies were exempt from inheritance tax – a nice arrangement for avoiding UK taxation and further concentrating inherited wealth. Foreign demand for property simply bids up the costs to residents in a housing market where prices are among the highest globally, and helps to increase already high levels of rents.
• The NHS, which is thought of as the great British innovation, is also increasingly being infiltrated by American health providers. Indeed, the government seems to welcome the possibility of further growth of US health providers as part of any free trade arrangements with the US post Brexit. This is something that most commentators see as highly undesirable given the generally poor performance of the US health care system, with its unjustifiably high administrative and other costs. Fee for service is not a route the UK should pursue and is alien to the whole concept of the NHS.
• Blackstone, a US company, purchased social care provider Southern Cross and then loaded it up with debt and made large payments to the parent company. This is a common strategy with foreign buyers of UK companies – to engage in asset stripping and then leave the company saddled with debt at interest rates that drive the company into insolvency with losses of employment. Along the way the company pension fund will also have been raided. Another example of this strategy is Boots, which has 2,500 shops in the UK. Boots was acquired by private equity in 2007, asset stripped and saw its HQ moved to Switzerland to avoid UK taxes. It is now wholly owned by the giant US pharmacy chain Walgreens – another key part of the health infrastructure in foreign ownership.
• The major public utilities – energy, railways and water – are all to a significant degree foreign owned and have been exceptionally poorly managed, while at the same time making large distributions of dividends to their owners. Their prices as well as inflated salaries have in all cases increased much faster than the general rate of inflation, and they have clearly abused their quasi-monopoly power to fleece consumers. In all cases the regulatory systems have proven to be totally ineffective. It is remarkable that nuclear power stations are owned and managed by the French company EDF (something the French would never allow in their own country) and that Hinckley Point C is a joint French/Chinese project.

What are the common elements in the above? The regulatory regime post Thatcher in the 1980s seems not to have had any interest in questions of ownership despite the mounting evidence of the costs of foreign acquisitions. It is clear that some at least of the purchasers of domestic assets have used the opportunity to launder illegally acquired money, and Britain has become the global centre of such transactions. This is most evident in foreign purchases of property, especially in London, where the scale of purchases has massively raised prices but without generating any sizeable tax revenues for the British Government.

What seems to have driven UK policy are the interests of the banking and financial sector including all the companies, estate agents and law firms that have benefited from the massive growth of the City. There have been some direct employment gains and government has been a beneficiary through increased tax revenues. But there have also been negative consequences and losses of employment and taxation elsewhere in the economy caused by what is called ‘the Dutch disease’ – the negative effects of a rising exchange rate.

The bidding up of the exchange rate caused by capital inflows associated with the increase in the size of the City to something like 10% of GDP has dramatically reduced the competitiveness of other producing sectors – especially of manufacturing. Hence the collapse of employment, exports and output in manufacturing post 1980 which have had strong regional impacts. It is precisely these regions that voted to leave in the EU referendum and which it is predicted will suffer most of the adverse impacts of Brexit.

Because of weak regulatory systems, especially in respect of privatised utilities, there has been price gouging at the expense of consumers in the UK. This has in many cases led also to the transfer to foreign owners of capital through the medium of excessive dividend distributions. Thus UK consumers have indirectly supported France and Germany, amongst others,  both of whom are major owners of UK energy and rail and where British prices have increased enormously.

Key to much of the overseas acquisitions has been a tax system that is not fit for purpose. It is evident from the Paradise and Panama papers that avoidance of UK taxation has been systematic and that accountancy companies such as PWC and others have been complicit in facilitating tax avoidance. Thus the shifts in ownership plus unnecessary cuts in UK corporation tax under the Tories have been contributory to the underlying structural fiscal deficit of government. This is the real reason for Tory imposed austerity.

Shifts in patterns of ownership and production have been causal in generating changes in working practices and the development of the so-called gig economy. It was an objective of the Thatcher de-regulation both of the City and elsewhere in the economy to undermine trade unions and in this they have been very successful. The result is only too obvious with unstable work, often poorly paid, and increasingly inadequate to support a family. It is unsurprising therefore that there has been a sharp increase in poverty much of it in families in full-time work. Government subsidies to wages that are too low (in the form of rent support and child benefits etc)  have added further to the structural fiscal deficit of government.

Thus the current structure of output and employment in Britain, the problems of inadequate tax revenues to finance public services, and the vast gap in living standards between the precariat and the executive class are all to some extent the result of increased foreign ownership of almost everything we continue to call ‘British’.

The post Who owns Britain? appeared first on New thinking for the British economy.

During his time as Chancellor of the Exchequer George Osborne liked to say “we are all in this together”. But until now it has been difficult to assess the distributional effects of the tax and welfare policies of the 2010-15 coalition government and the current Conservative government. The government has refused to do the calculations, for obvious reasons.

But in November the Equalities and Human Rights Commission (EHRC) published a distributional assessment of the impact of tax and welfare reforms between 2010 and 2017, modelled in 2021/22 tax year. It did not receive much attention, and does not include any discussion or set of recommendations. But the analysis in the paper is damning. It highlights just how regressive the tax and welfare changes have been, with the greatest burden falling on the poorest, ethnic minorities, women, children and the disabled.

The researchers modelled the effects of changes in taxes and benefits – specifically income taxes, national insurance contributions, VAT and excises, benefits and social security transfers, tax credits and the national minimum wage/living wage. These are then analysed in terms of household income distribution by decile, from the poorest to the richest. The results are initially expressed in terms of effects on cash flows for each decile:

Average net cash losses are greatest for the bottom 40% of households, at around £1,500 per year. This compares to just £200 for households in the second top decile. The largest losses are due to changes in benefits and tax credits, which amount to more than £2,000 per household for the lower deciles.

These cash estimates are then converted into shares of net household income. The results are shown to be highly regressive, with the poorest suffering the greatest proportional loss:

Households in the lowest decile have seen net incomes fall by 10%. In contrast, households in the second top decile have only seen net incomes fall by 0.4%.                     

The report then looks at the impact of the tax and benefit changes on households with different characteristics. Here the results are even more striking.

Ethnic minority households have suffered more than white households, with the average loss for African, Caribbean and Black British households amounting to 5% of net income – more than double the equivalent loss for white households.

Households with one or more disabled member have seen net incomes fall by £2,500 a year. For households with a disabled child, losses amount to more than £5,500 a year on average. This compares with a reduction of about £1,000 a year for households without any disabled members.

Lone parents have seen net incomes fall by 15% of net income on average, compared to between 0% to 8% for other family groups. Women have been effected more than men at every income level, with losses averaging £940 compared with £460 for men.

By age group, the biggest average losses are for those aged 65-74 who have seen net incomes fall by £1,450 per year, primarily due to the increase in the pension age to 66 in 2021 as a result of the Pensions Act of 2011. Those in the age range 35-44 are losing £1,250 per year on average.

Households with three or more children have been particularly hard hit, with cash losses amounting to £5,400 per year. In contrast, losses for households with no children have only amounted to £500 a year.

There are currently four million children living in poverty – 30% of all children in 2015/16. Between 1998-2011 public policy took 800,000 children out of poverty, but this achievement has been reversed by governments since 2010. Some two-thirds of children living in poverty live in families where at least one person is working. 36% of all children in poverty live in families where there are three or more children, so size of family is a significant determinant of child deprivation.

It is hard to believe that a government would target its cuts on children, and especially children in large families. Inevitably the government’s policies will add to the numbers of children living in poverty, and have major consequences for the lives that children lead.

How is it possible to pursue tax and expenditure policies that have such a skewed set of outcomes? One might like to think it is simply incompetence. But despite the impact of the changes now being clear, the government has continued down the same track – irrespective of the effects on the living standards of the poorest in our society.

There have been also huge cuts in local authority funding affecting services for children, the disabled, the elderly, and targeted services such as Sure Start centres. Funding has also been cut for breakfast clubs in schools, sports and recreation facilities, libraries and education.

All of these policies cumulatively add to the pressures on those households least able to manage. At the same time, investment in social housing has more or less ceased, while taxes on corporations and the rich have been reduced.

The Government can and should be held to account for their policies. Going forward, Parliament should require a full distributional analysis to be produced for all tax and expenditure changes at the time of a Budget. The government should also have to demonstrate that all proposed changes are consistent with existing human rights and other equalities legislation. The tax and welfare changes since 2010 clearly contravene rights and obligations in areas such as child poverty and the rights of children, ethnicity and gender, and trample on the rights of the disabled.

The strategy of hammering the poorest in society in pursuit of some chimera of a reduced level of national debt has failed. Surely, we have had enough. It is time to use fiscal policy in the interests of everyone.

The post Not in it together: the distributional impact of austerity appeared first on New thinking for the British economy.

Eighteen months on from the Brexit referendum, the story that the ‘people have spoken’ is only one version of the truth. There was only a very small majority for leaving the EU: more than 16 million people were on the electoral register but did not vote, and a further 2 million were not even registered. It is now evident that many of those who voted to leave had no idea what this entailed, or the likely costs. Surveys confirm that enough people have now changed their position that, if there was a second referendum, a majority would now vote to remain in the EU.

But both the Government and the Labour opposition seem determined not to have a second referendum, despite the mounting evidence of the massive destruction Brexit will cause to the British economy. There is a daily record of companies preparing to leave the UK and establish themselves elsewhere in the EU. Cumulatively, the impact on GDP, employment and the public finances are going to be extremely large and yet these costs are simply shrugged off as if they were obviously worth enduring.

To take the most obvious example, let us consider banking and financial services, the only sector where the UK has established a global position. Many banks and associated enterprises have already begun the process of moving to Paris, Dublin, Frankfurt and elsewhere. These are highly paid jobs in firms that are very profitable and which account for a very significant proportion of GDP and government revenues. The CEOs of banks have been perfectly open about their planned shift to other locations, and have called on Government to re-evaluate their policies but to no avail. The consultancy and auditing firm EY has estimated that on day one of Brexit some 10,500 jobs would be lost in the City, and they had previously estimated that a total of 83,000 jobs would disappear.

Two EU agencies have already announced they will be moving to other locations in the EU – the European Medicines Agency and the European Banking Agency, with a loss of skilled jobs. In the case of the EMA, the transfer of jobs to Amsterdam will be 900 – all highly skilled and professional. More worrying is that the move of the EMA will lead to disinvestment in the UK by pharmaceutical companies as they shift their clinical research activities elsewhere.

Other sectors have pointed to the impact on their ability to function if EU residents leave. In the higher education sector, around a third of academic posts are filled by EU citizens – with many of them in scientific areas – and many university leaders have warned of the effects on system capacity. The impact on construction, health and social services, on transport, on agriculture, on tourist and related services have been enumerated and yet are shrugged aside as if they were manageable and unimportant. How the UK will source the 40% of food that is currently imported and which sustains national food production, given the massive dependence on EU labour, remains a mystery.

Then there is the economic and social impact on EU residents, and the effects on UK residents living and working in the EU. Not least of the predictive costs are those on Ireland where 80% of exports are sent to the UK, and where there is a possibility that these will subsequently face import tariffs. The impact on Ireland is more or less ignored in the UK and instead the focus is on the issue of the border between the North and the Republic. While this issue is important, it is clearly unresolvable unless the UK remains within the single market and the existing customs union. To believe that there is any other practical solution is like believing the moon is made of cheese.

Employment will contract, incomes will fall, tax revenues will decline, prices will rise and the balance of payments will worsen. The sterling exchange rate has already fallen against all of the major currencies with a decline of more than 15% against the euro. The LSE has estimated that the impact of Brexit has already been significant and that the average household has experienced an increased shopping bill by £400, largely due to the fall in the value of sterling. The effects will not be confined to the UK; residents from the EU will be directly and indirectly impacted by the resulting shifts in demand and supply.

Brexit has already diverted the resources of Government and of Parliament at considerable cost. Governance has more or less come to a standstill as the Tories battle it out amongst themselves about what kind of relationship the UK will have with the EU. It has always been clear to anyone who knows anything substantively about the EU what would be on offer, and this really should not have been a surprise to the British Government. There was never any chance that a deal would be negotiated which threatened the stability of the EU, and this would be paramount in any discussions with the UK.

Key basic principles such as freedom of movement of labour, goods and capital were sacrosanct and would be retained at all cost. So would be the demand that the UK meet all of its financial obligations. It has also been made clear that no trade deal would be possible after Brexit except under conditions in which the UK accepted and applied the existing regulatory regime. This means that the UK could not be in a trading relationship with the EU if it deregulated existing labour, health and environmental standards – and would be expected to apply future changes as well.

A deal would have to be struck for EU citizens in the UK, and for UK citizens living in Europe, that protected all of their existing rights. These and other key elements of the ongoing relationship between the UK and the EU would need to be subject to the European Court of Justice. Finally, a deal had to be agreed that was legally binding on both parties to any agreement to prevent any hard border between Northern Ireland and the Republic. In effect, this last requirement means that the UK has to remain a member of the single market and customs union.

Given these conditions, why would any rational government pursue Brexit at such immense financial and non-financial cost?  On the face of it none of this makes any sense given the easily predicted consequences of Brexit and the uncertainty created both in the UK and with our partners in the EU. Everyone has wasted resources over the past 18 months on negotiations and posturing that have led to an outcome that was always inevitable. One of the less evident consequences, but a cost nevertheless, has been a breakdown in national social cohesion and a release of ethnic tension. Putting this genie back in the bottle will not be an easy thing to achieve, with or without Brexit.

What are the forces driving Brexit given the above analysis? We now have more information on the funding of the leave side of the referendum, and after a good deal of pressure the Electoral Commission is finally doing some real analysis of the sources of funding. There can be no doubt that this funding was illegal and largely from overseas sources. In a series of articles Carole Cadwallader has documented the role that a very right wing American billionaire had in providing financial and non-financial support to a UK company called Cambridge Analytica. The purpose of this structure was to infiltrate social media with fake news so as to influence voting behaviour in the referendum. This process acted as support for the lies being told by Farage, Gove and Johnson and others who bombarded the electorate with falsehoods about extra funding for the NHS, swarms of Turkish Muslim migrants, and the threat from EU nationals to British livelihoods.

Also worrying is where most of the money for the leave campaign came from. It was supposedly provided by a millionaire called Arron Banks, but an analysis of his finances by openDemocracy suggests that he was in no position to make very large donations. So where did this money come from? This is presently under investigation by the Commission, but it is evident that it does not have the resources for such an investigation. Some of the funding was routed to the leave campaign via the DUP in Northern Ireland where the is no legal requirement to disclose the sources of funding.

This leaves it unclear where Banks’ money came from, except that we now have evidence of the role that Russia played in the US presidential elections and elsewhere. What is driving Farage, Mercer, Banks and their supporters? It is only too evident. They want to see the collapse of the post -war settlement in which the state actively intervenes in economic and social life in the interests of social stability and fairness in accessing social goods. They want to roll this back in the interests of the rich and the wealthy, and have managed to get Trump elected to pursue their objectives.

Brexit might yet do the same, and in the meantime, it has managed to divert the attention of policymakers in the UK from important issues such as how to reduce wealth and income inequality and associated issues of housing, jobs and pay. Brexit in their eyes is simply a source of instability that in the short and longer runs will enable them to bring about their ultimate right wing agenda. This includes a determination to deregulate the UK economy and remove regulations covering the environment, food safety, animal welfare and labour conditions.

But what of Putin: why would he be prepared to finance the leave campaign?  He has clearly been trying to undermine the EU for many years, hence his opposition to Ukraine joining the EU and to the EU sanctions after the annexation of the Crimea. Weakening the EU as was hoped would suit Russia just fine since this would further enhance Russia’s power in Europe. Furthermore, anything that weakened Europe’s military capacity would be highly desirable, as would anything that caused greater economic weakness.

Brexit is a failed process and will cause untold and unnecessary damage to the UK, the EU and elsewhere. The sooner it is dumped the better for everyone, including for those who voted for it given that most of the negative effects of Brexit will fall mainly on those living in the less favoured areas of the UK.

The question is: do we have political leadership capable of doing the obvious? The influence of big money is everywhere in politics – not least in the UK – and politicians are both too close to the rich and too isolated from the electorate. But it could all change. The Rand Corporation – a respected US think tank – recently published an assessment of the impact of Brexit on the UK . It has concluded that “a no deal Brexit will cost Britons £1,585 each. Even the softest Brexit of the customs union would damage the economy and any gains from leaving would take at least 12 years”.

Why would any Government, Tory or Labour, go down this route if it had the interests of the population, and of Europe, at heart?

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A recent post on Social Europe made some interesting points about the comparative process of policy development within the EU and bilateral trade negotiations. It stressed the benefits of the former in that national governments are integral to the development of trade and other regulations along with their partners whereas in bilateral trade negotiations. For example, between the US and the UK following Brexit the British would be junior partners and have limited options to determine the outcome. Undoubtedly true but the analysis even within the limited structure discussed simply did not go far enough. While lobbyists have a happy hunting ground in Brussels (and nationally) they are weak in comparison with their counterparts in the USA.

Thus in any trade negotiations with the US inevitably the UK would have to accept regulations relating to production and trade that are largely the outcome of corporate pressures which embody their interests at the expense of consumers. One has only to look at the funding mechanisms for the US Food and Drug Administration i.e. it is funded by the industry, and its failures to regulate effectively to be extremely concerned about probable outcomes of any bilateral trade agreement between the US and the UK. It is worth noting that at EU level the UK has been less interested in effective regulation than most other countries preferring less control by the EU vis a vis US multinationals.

But the issues are much broader than those discussed by Professor Crouch in Social Europe and it is worth looking in some detail at the whole issue of economic sovereignty since supposedly one of the aims of Brexit is to restore this in the United Kingdom. Even the following brief analysis of the economic structure of the UK shows that it is unachievable and is simply pie in the sky.

It has been Tory policy since Mrs Thatcher to reduce the size of the state in pursuit of some golden age where private ownership and management of more or less everything would dominate. For a review of this policy strategy and its outcomes everyone should read James Meek’s ‘Private Island: Why Britain Belongs to Someone Else’. The scale of the dismantling of the state and the destruction of what Meek calls ‘universal networks’ – the social and technological system deemed essential to all citizens independently of their ability to pay yet able to draw down – has been extraordinary. As Meek concludes:

“The most absurd paradox of Britain’s privatisation is that it has actually led to the nationalisation of British infrastructure by foreign governments with parts of former British state firms becoming the property of the governments of France, the Netherlands, Sweden, China, Singapore and Abu Dhabi”

Even the most basic services such as water, electricity, gas and public transport have been transferred into private ownership, and since in most cases these are natural monopolies and/or behave as collusive oligopolists they have been able to function as tax farmers. They have in fact substituted for Government and their pricing activities are analogous to levying taxes on consumers who have little or no alternative.

The most egregious example of this is water and sanitation where the privatised owners, who are mostly foreign, have fully exploited their economic power through their pricing policies. They are moreover in many cases now privately-owned companies – they are no longer quoted on the stock exchange but owned by pension funds in Canada, Australia and the Netherlands. These are managed through subsidiaries located in tax havens where they pay themselves huge management fees. Whereas supposedly a major aim of all of these privatisations was said to be to maximise individual share ownership in the UK, in practice the level of this fell from 40% before Thatcher came to office in 1979 to under 12% now.

British Governments since Thatcher have been totally disinterested in who owns what unlike most other countries which have had strategic objectives concerning the importance of ownership and control. The result is that most of the major industries are partially or wholly owned by foreign enterprises – including automobiles, pharmaceuticals, ports and airports, banking and finance and electronics. It is not that foreign ownership is in itself a bad thing but to argue that Brexit will permit the UK to re-establish economic sovereignty is simply a chimera. It is simply not going to happen.

Indeed it is totally unclear what economic sovereignty means in a globalised world. UK is a very open economy with a ratio of Imports and exports to GDP of 61% and rising, while it was 51% in 2003. This is one of the highest ratios of any of the G8 countries. How is it possible for an economy so dependent on trade in goods and services to recover its economic sovereignty given this extremely high dependence on imports both for consumption and for production? One of the results of joining the EU has been greater specialisation in production and further integration in industry with obvious benefits in terms of efficiency, prices and quality. It is worth noting that the import content of UK exports is extremely high at 23%, which is a further indicator of dependence on trade for both output and employment. Membership of the EU gives the UK greater control in these circumstances over imports since the UK participates in all bodies involved in regulation.

It is only recently that the impact of Brexit on food security in the UK has been identified and been the subject of discussion (see for example A Food Brexit: Time to get real). In part as a result of membership of the EU and in part due to rising incomes and population the UK is now much more dependent on food imports. Some 40 % of total food needs is presently imported and it is totally unclear how this dependence on trade could or should be reduced. There is little capacity in the UK for the substitution of local supplies for imported food and anything that threatened imports would have severe consequences for food security and health. The range of foods consumed has expanded dramatically since joining the EU and it is difficult to envisage returning to a diet of carrots, parsnips and peas.

It goes without saying that it is not only food supplies that are potentially threatened by Brexit but other aspects of security as well. The UK has been dependent on NATO for its post-war security and will presumably continue to be so. With the caveat that recent statements by the US imply that Europe will have to provide more resources for defence and inevitably this will involve the UK.  Thus security underlies economic sovereignty and UK is dependent on allies for this including imports of essential equipment, especially from the US. One of the least noted effects of the fall in the sterling exchange rate after the Brexit referendum has been a rise in the cost of imported military equipment and a sharp rise in defence costs both now and in the near future.

As noted above the UK is a highly open economy and yet the price at which trade takes place is only tenuously in the control of the British monetary authorities. The exchange rate of sterling against both the $ and the Euro has tumbled since the referendum and there is more or less nothing the Government can do about it.  The collapse of the exchange rate by this magnitude has caused a sharp decline in National Income since exports are sold at a lower price and imports cost more. The resulting fall in National Income is of the order of 10% – exports plus imports are 60% of GDP and this now costs 20% more than previously. It is not surprising that people feel much worse off than before the exchange rate collapsed. Notionally the Bank of England could raise domestic interest rates in an attempt to reverse the fall in the level of sterling but this would have adverse effects on the domestic economy which is now severely leveraged with debt once again.

The Bank itself admitted recently that unsecured debt is now at the highest level since 2008 and that it needs to be reined back. Any attempt to raise interest rates would thus have drastically adverse effects on domestic incomes and thus on employment and output. Inflation is above the Bank’s target of 2% in large part caused by the fall in the value of sterling. The Bank faces a dilemma and clearly doesn’t know what to do. Yet surely economic sovereignty means having the instruments of policy available so as to be able to establish an exchange rate that secures both internal and external balance?  The current account of the balance of payments remains in large deficit as it has been over many years and is largely out of policy control.

At the core of the case for economic sovereignty and Brexit is the claim that it is possible to control immigration. But this is another chimera since cutting immigration would mean immense damage across the board to the output of economic and social goods and services. The scale of dependence on skills and experience is such that there is no way that the UK could dispense with EU and other sources of immigrant labour. There is simply not the capacity to train those needed to substitute for the labour that would be lost through any set of autarchic labour control policies, and it would take decades to create this capacity and train British workers.

The scale of dependence on immigrant labour is immense – in higher education and research, in agriculture, in construction, in tourism, in transport, in health and social care. The levels have recently been documented by ONS and in some sectors the levels are well above 20%. In the case of food manufacturing, the largest manufacturing sector in the UK, no less than one-third is migrant labour. It should also be noted that in general immigrants are much better educated than local workers.

What can be concluded from the foregoing? In the kind of integrated world that we live in it is a chimera to believe that one can establish some presumed long-lost economic sovereignty. Economic and other systems have become too integrated to believe that one could dismantle existing structures without immense costs – social, economic and political. Any attempt to try and do so would inevitably fail and the UK is deluding itself if it believes that economic sovereignty can be re-established.

It would be more realistic to re-examine areas of domestic economic and social policy and to seek solutions to problems of under-performance and economic exploitation which are largely the result of previous policies such as privatisation of essential public services. Alternative, better, structures for the delivery of goods and services are feasible and worth pursuing. These would include taking key sectors such as water, energy and railways back into public ownership together with much more effective systems of regulation

It was announced at the end of July that Worldpay, the largest UK payment processing company, has been acquired in a takeover of £9.3bn by Vantiv, the US payment processing giant. No one in Government seems concerned with the change in ownership and control of yet another key national activity. It is worth also noting that the purchase is especially advantageous for Vantiv given the large fall in the sterling/dollar exchange rate since the Brexirt referendum.

It is also worth noting that in July the Germans announced a tightening of their company takeover laws to protect important areas of scientific and technical knowledge and together with France and Italy have proposed changes in EU policy with a similar intention. Nevertheless the UK continues to remain unconcerned about who owns what despite the loss of national sovereignty that is entailed.

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When the Guardian reported that the former Chancellor of the Exchequer George Osborne had been appointed Professor of Economics at the University of Manchester, it seemed like an April fools joke or perhaps some fake news. But it turns out to be true, despite the objections from many of the economics students at the university who have for many years railed against the neoclassical teaching they have to endure. Luckily Professor Osborne is not being paid for his endeavours, whatever these may be.

George Osborne is the person responsible for the appalling state of the public finances as a result of policy decisions taken when in office during the period 2010-2016. Of course his policies were also those of the coalition government between 2010 and 2015 and thus the Liberal Democrats bear part of the responsibility for what happened during those years.

But the core responsibility for economic policy in the period since 2010 lies with the Tories, and they are now faced by a storm of problems which have their origins in their doctrinaire and misguided strategies for Britain. What they have done over the past 7 years has resembled Thatcherism on steroids, and the rest of us have had to bear the costs. These have been huge, and focused on the poorest and most vulnerable members of society. As always it is worth recalling what Thatcher said – “there is no such thing as society” – so who cares whether social and economic policies create further divisions, add to income and wealth inequality, and make the poor poorer.

Indeed, a basic mantra of the Tory government continues to be that inequality is good for economic growth and for the health of society, despite the clear evidence that this is untrue. This has been demonstrated by the experience of the Nordic countries and is fully documented in ‘The Spirit Level: Why Equality is Better for Everyone’ by Richard Wilkinson and Kate Pickett.  They concluded that, “there is a strong tendency for ill-health and social problems to occur less frequently in the more equal countries….Health and social problems are indeed more common in countries with bigger income inequalities, The two are extraordinarily closely related”.

But then whose interests are the Tories representing? Not the disabled, the sick, the single parents, the unemployed, the homeless, the increasing numbers in low paid and insecure employment, the poorly educated and inadequately trained. There was a time when the Tory party reflected the interests of British business, of those firms and industries that were productive. But as their importance has declined, the hedge fund managers, asset strippers, bankers and property developers have taken their place. The fiscal policies that have been followed have favoured the extractive and destructive activities of the unproductive rich.

Privatisation and deregulation

One of the core principles of Thatcherism is that the public sector is bad and the private sector is good. Hence the raft of privatisations of more or less everything that could be sold so that neoliberalism could be advanced. The results could have been predicted – and were – but no one in Government was listening. There is no evidence that the privatised industries have performed better than when they were in public ownership. Indeed, rather the opposite – with results that have been catastrophic.

Anyone interested in the effects of privatisation should look at the recent book by James Meek, ‘Private Island: Why Britain Now Belongs to Someone Else’. It is evident that market power has been used by former public utilities to engage in ‘tax farming’ – a process whereby prices are raised to enhance profits and with nothing consumers can do to escape extreme exploitation. Instead of creating a share owning class as promised by Thatcher we have instead industries with monopoly and oligopolistic power, often foreign owned, which are in many cases no longer public companies but privately owned and managed. The case of water privatisation speaks for the general effects of these policies, which are worse than anyone could have imagined.

In the case of housing, not only has little new social housing been built despite the huge rise in household formation, but low cost housing has been forcibly taken out of public ownership and almost all of it ended up in the private rental sector. So the supposed objective of creating a property owning class has ended up with a huge increase in the number of households who are privately renting – often at rents that take 50 to 60% of family income. Often these are properties that are poor quality and poorly maintained.

Not only do we have exploitation by private landlords (encouraged by tax concessions from the Tory Government) but to a significant degree the rents are being funded by rent support provided by the government. Thus we have a totally inadequate housing stock which is poor in quality and in quantity and increasingly in the hands of private landlords, where rents are both excessive and in part funded through the public purse. What kind of social policy is this?

All that seems to have been important for Tory Governments is that the public sector be shrunk and the private sector take its place. Indeed, the former Deputy Prime Minister, Nick Clegg, reported during the coalition years that the only concern that Osborne had when there were discussions of tax and social policy was ‘how would supporters of the Tory party react and whether they would benefit’. What kind of calculus is this for a Minister supposedly concerned about national interests?

But the costs of privatisation are not confined to the appalling consequences of the government’s failure to meet housing needs. It is everywhere that there has been privatisation – railways, energy, water and sewage, telecommunications, bus services, airport management and so on. We are only too aware of the failures of many of the private companies that now own and manage these services and of the price gouging that has happened over many years.

Regulation of former public enterprises where it exists has been nothing more than window dressing, for how else could these companies have got away with levels of service that are often poor together with high and rising profits, massive management fees and executive pay and bonuses. For the high profits to be possible, prices had to increase exorbitantly with much of the profits transferred to overseas companies often themselves in public ownership. In many cases we have swapped British public ownership for foreign public ownership. Is there any logic in this? If there is then it is hard to see how consumers have benefited by the changes in ownership and de-regulation that simply increases the profits of companies.

The banking group Santander carried out research on their customers pay and expenditure on utilities and other core outlays, and concluded that over the past decade:

“Basic household bills have increased by an average of 43 per cent in the last decade – more than double the rate of wage growth… Gas and electricity are the biggest drivers of price increases, rising 73 per cent and 72 per cent respectively in the last decade, while water bills have increased by 41 per cent – all significantly higher than inflation at 32 per cent. Council Tax has risen by 27 per cent and TV, phone and broadband prices have all risen by 24 per cent, albeit slower than inflation but still faster than wage growth (19 per cent).”

The findings are summarised in the following Table:

Source: Santander, 2017

Transport is not included, but anyone who travels frequently on trains will confirm how outrageous the fares are, and how much faster these have risen since privatisation. Railway fares in UK are much higher than elsewhere in the EU and it seems that government subsidies in practice simply bolster the profits of the train operators. Standards of service are also lamentable compared with railways in Europe, which are still largely in public ownership. Investment in the railway infrastructure has also been totally inadequate, as the 300,000 commuters who have suffered now for several years from disrupted Southern Rail services can attest. Costs of other public transport are also high – the London underground is extremely expensive – and buses similarly are also costly for regular users who are not pensioners.

That wages and prices have behaved in the way detailed in the above table is scarcely accidental, but in significant part reflects government policy. It reflects the privatisations undertaken by the Tories, together with a belief that deregulation produces the best results. For years the Tories have followed a programme of dismantling regulations, and have followed a policy of two regulations abolished for any one new regulation – irrespective of the consequences. Public resources have flowed into an organisation established by David Cameron called the Red Tape Initiative, the intention of which is to dismantle regulations as part of their neoliberal programme. This did not appear in any manifesto.

The collapse of effective fire regulations has in part been the direct consequence of this policy, together with the underfunding of local government (including the fire service). Unfortunately, it is not surprising that the disaster at Grenfell Tower happened given the general dismantling of local government responsibilities and the subcontracting of housing development and management to private companies. Where private profit dominates and regulation is weak, standards will decline. This is only too evident in relation to social housing.

Cutting Public Sector Employment and Pay

As a direct consequence of Treasury policy under Osborne and now under Phillip Hammond, there have been enormous cutbacks in employment across huge area of the public sector. The fire service and the police have lost thousands of jobs, with consequences for the effective response to emergences and a reduced ability to monitor terrorists and to be able to respond to attacks. Similarly, in education and health there have been budgetary cutbacks and reductions in staff which have had knock on effects on the quality of teaching in schools and colleges and health care in the NHS.

But the government seems largely uninterested in the effects of its policies, and despite the evidence continues to ignore the pressure to reverse their policies on the funding of public services – including those for the disabled and the mentally ill. There is a pressing crisis in social care, as demographics increase the pressure on services that are increasingly inadequate.

Years of pay restraint have been key to the Treasury’s policy of reducing the funding of the public sector. The public services are big employers, much of it highly educated with professional skills and experience that have taken years of training to acquire.  This last point is important: it is not sensible to simply compare wage trends between the public and private sectors since former as a whole has a more educated and better trained labour force.

So the argument often trotted out by Government and others that public sector pay should not increase faster than that in the private sector has no merit given the differing composition of the two sectors and quite different needs with respect to recruitment and retention of labour.  At the present time key public services such as the NHS are losing skilled and experienced workers at all levels, and are facing a crisis in recruitment both as a result of underfunding and of Brexit. Both of these factors are reversible by government through increasing funding in real terms and issuing guarantees to EU staff with respect to their rights to remain in the UK.

There has been a freeze on public sector pay for many years, and this has reduced the real value of pay for employees across the public sector. The scale of this has recently been documented by a report from UCL and the NIESR for the Office of Manpower Economics which advises Government on pay. That there is now a crisis in recruitment in the public sector is unsurprising given the erosion of the real pay of workers since 2010 which is directly as a result of government policy.

The following table gives a picture of what has happened over the period 2005 to 2015 for a selection of occupations.

It is worth emphasising that these changes in real earnings are annual rates and the cumulative fall in the period since 2010 has been substantial across all of the occupations listed in the table. Thus, in the case of doctors the loss in real earnings per hour 2010-2015 is 22% ,for nurses 7.5% and for police officers some 10%. In practice the decline has been greater than estimated in the table since it does not take account of the losses of real earnings since 2015 – in part caused by the fall in the value of sterling which itself is largely a result of the policies of Government together with the continuation of the pay freeze.

Fiscal austerity – a veil for neoliberal policies

Osborne was responsible for the conduct of fiscal policy from 2010 until he was removed from office by Mrs May in 2016. During this period fiscal policy was lamentable both in its detail and in its effects on the aggregate performance of the economy. In the period immediately before the financial crash in 2008 fiscal policy under the Labour government was in reasonable balance, with the deficit close to that which had prevailed during the post war years. Even the IMF subsequently confirmed that the destabilisation of the budget was due to the cost of bailing out the financial system which was facing collapse in 2008, and was not caused by financial recklessness on the part of the Labour government.

The mantra of the Coalition and subsequent governments from 2010 onwards that the problems with the deficit were caused by the Labour Government is simply untrue. The destabilisation of the budget was the inevitable cost of rescuing the banking system, but the subsequent fiscal policy choices were exactly that – choices by the Coalition and subsequent governments under the economic leadership of Osborne and now Philip Hammond. The current Chancellor has pushed the achievement of the Government’s fiscal targets into the future, and public expenditure is expected to be more or less flat for the next few years rather than continuing to fall as forecast by Osborne. But Hammond is as determined as Osborne to establish a balanced budget in the near future independently of the state of the economy.

While public sector debt as a share of GDP rose sharply between 2008 and 2017 this was largely caused by bailing out the banks, plus the subsequent contraction of GDP which in large part was caused by the tightening of fiscal policy. Even with a much higher level of public sector debt as a share of GDP, now approx 90% compared with 30-35% prior to the financial crisis of 2008, there was still capacity for additional borrowing in order to finance government expenditure, and thus avoid the unnecessary losses of output that ultimately occurred.

Osborne chose to set targets for the fiscal balance which had no foundation in the needs of the economy, but reflected a preference for a smaller state – a level of state activity that reflected neoliberal objectives irrespective of the consequences for public services and the performance of the economy overall. There was a sharp fall in GDP after the financial crisis and subsequently GDP growth has been weak and well below trend. The fact that there has been such a weak recovery is in part the direct result of the fiscal policies pursued by Osborne.

VAT was raised in 2011, which is highly regressive, and while an expansionary fiscal policy was needed to re-establish economic growth Osborne chose to follow the opposite in pursuit of the chimera of a small state and a balanced budget. One of the obvious results of the fiscal contraction was economic growth that was well below trend and tax receipts that lagged.

Not even Milton Friedman, the economic guru of the right, would have applauded this policy stance, and he well recognised the need for fiscal and monetary policy to behave counter-cyclically. This is precisely the opposite of what Osborne did and, not surprisingly, the target for fiscal balance moved further and further into the future as the economy limped along with extremely low growth rates. Aiming for fiscal balance irrespective of the state of the economy is something Friedman would never have supported, and neither would Keynes or most other macroeconomists of note.

The other key aspects of Osborne’s fiscal strategy were also counter-productive, both individually and in the aggregate. It is worth quoting the Resolution Foundation in their overall assessment of tax policy:

Such tax cuts have obviously helped to support living standards for different parts of society, but they have also come at a cost to the Exchequer. Using OBR estimates of the costs of income tax, corporation tax and fuel duty giveaways at the time they were made,…..the total cost is set to add up to £45 billion by 2021-22, which is almost three times the expected size of the deficit in that year. Indeed, in the absence of this suite of tax cuts, public sector net borrowing would be in surplus by 2018-19.

It is worth noting the Foundation’s estimates of the cumulative costs of the various tax changes between 2010-2021/22. The cuts in corporation tax are estimated at £72bn, changes to the personal tax threshold at £132bn and the freezing of fuel duty at £62bn. There are specific arguments that can be marshalled against all of these tax changes plus the cut in the top rate of income tax from 50% to 45%, but it is essential to note that the changes were in all cases discretionary, and were made by Osborne irrespective of the general state of the economy.

Corporation tax has been reduced from 28% in 2010 to 20%, with the aim of reducing it to 17% by 2020. By then the UK will have the lowest rate of any major country and will be well below the OECD average of 25%. It is hard to see the economic case for reducing the rate of corporate taxation other than a determination to undercut our competitors. The result is simply to add to the fiscal deficit while at the same time doing more or less nothing to increase the level of private investment which has remained weak over the whole period since 2008. Cutting corporation tax is not an effective way to increase the rate of investment – there are more strategic tax incentives that are less costly in terms of revenue lost. A considerable share of the cuts in tax will have accrued to foreign owned enterprises.

There is clearly no economic case, quite the opposite, for the fuel duty changes. From Spring 2017 a litre of petrol is 28 pence less than it otherwise would have been under the previous tax regime. Clearly the primary aim of fuel duty taxation was to raise revenue and this has partly been reversed. As a secondary objective increases in the rate would have achieved something towards reducing the impact of carbon emissions and thus contributed to targets relating to air quality and climate change. Policy has therefore made the achievement of these targets even more difficult despite the evidence that transport is a major source of CO2 emissions. Clearly policy was driven by purely political objectives, since cuts in the real level of fuel duties will have been popular with corporations and with those voting for the Tory Party.

The uprating of tax allowances seems in principle to have been a sensible strategy and it was certainly popular – not least with the Lib Dems who pressed hard for the changes. The target is to take the level to £12,500 by 2020, which would be some £4,000 higher than if just uprated with inflation. As we can see from the data above, the changes are extremely costly for the Exchequer and although some of the gains will have been received by those on low incomes in practice most of the benefits go to those in the higher rate bands since the tax free sum would have been taxed at a higher rate. In effect this is a very expensive way to help those with low incomes, and more targeted tax and expenditure changes would have achieved better outcome at much lower cost for the Treasury.

The losses to the public revenue due to the discretionary changes in tax rates, together with a fiscal policy that was deliberately contractionary in its impact, became essential to the case being made by Government for austerity. But there really was no case for austerity, and the setting of arbitrary targets for the deficit together with tax cuts had no merit. Indeed, austerity was and is a veil for other economic and social objectives – to roll back the state to a target level of 30% of GDP irrespective of the effects of such policies on what makes the UK a civilised and caring society.

Assessing the Costs of Austerity

Discretionary tax increases and spending cuts by Government since April 2008 are around 10.6 % of national income – some £200 billion at 2017 prices. Of this fiscal tightening, 16% were net tax changes and 84% reductions in public spending, with some two-thirds of the fiscal contraction achieved by 2016-2017. Policy decisions were taken which loaded the fiscal adjustment on expenditure cuts with a much smaller role for tax changes in the conduct of fiscal adjustment. Most of the tax changes benefitted the rich, especially the cut in the top rate of income tax. During this period the share in total government receipts rose sharply for council tax, VAT and NICs, and fell for Business Rates and Corporation Tax.

The increase in VAT and council tax were highly regressive with the impact much greater on those with lower incomes. One of the most egregious changes was the imposition of the so called ‘bedroom tax’ on households with a ‘spare room’, despite the fact that there existed no alternative social housing for those affected.

It is also clear that in the early stages of the coalition government that the impact of fiscal adjustment on the real economy was much greater than the Treasury had assumed. It has been estimated that the loss of GDP between 2008 and 2016 was £5,700 per head. This represents a permanent loss in part due to the collapse of the economy after the 2008 financial crash, and in part due to the weak recovery afterwards which had superimposed on it the contractionary fiscal policy of the coalition government. This loss of per capita income was much greater than in previous economic downturns in the 1970s and 1990s when management of the economy was much better aligned with economic needs.

It is worth detailing how drastic the changes in government policy have been since 2010, changes which reflected policy choices and a determination to reduce the size of the public sector irrespective of its impact on the social, economic and political system. It is evident that many people in government do not understand the critical role that that state plays in a modern economic system. Not least the fact that much of public current expenditure has a significant investment element both directly and indirectly. This is most evident in the case of education and training, but the same is true of investment in housing and in health, in the legal system, and social services as well as in infrastructure. Much technical innovation originates in state supported research programmes, often undertaken by universities.

The swingeing cuts we have seen in recent years in public expenditure have nothing to commend them. In the period between the 1950s and 2010 government spending increased in real terms at an annual rate of 2.9% and the UK had a level of public expenditure relative to GDP comparable to most other OECD countries. Since 2010 the increase in government spending has fallen to an annual rate of 0.3% with the result that per person real spending per head has been flat. By 2020/21 per person real government spending per person will have fallen by 4% compared to 2010 when the coalition took office.

Within government there have been catastrophic cutbacks in departmental spending (17% overall) with cuts to education (14%), defence (18%) and Communities and Local Government (25%). The NHS has had an increased level of funding (5%) but this is totally inadequate to meet demographic growth and the needs of an ageing population. Welfare spending per person (excluding pensioners) has fallen 10% in real terms since 2010. All of the increases in child benefit made between 1999 and 2009 have been reversed, and job seekers allowance is now lower than at any time since 1992.

It should also be noted that public investment has fallen to levels not seen in the post-war period, with results that are everywhere apparent in terms of a crumbling infrastructure. The gap between needs and performance is most evident in the case of housing where investment by government has more or less ceased despite the recommendation of the Barker Commission that we needed an annual investment of 250,000 houses to keep pace with demand.

Government rejected the advice of many economists who said it should expand its investment programme during the post 2008 downturn so as to expand demand at a time when borrowing costs were extremely low. The enormous shortage of affordable housing in the UK has its origins in the failure of government to undertake the required public investment.

One of the consequences of the cutbacks in Government spending has been an enormous loss of jobs in the public sector. In Local Government the cuts have been about one-third, with a loss of critical services for which there is no private sector provision such as libraries, parks, children’s and youth services etc. Overall General Government (including Local Government) now has total employment below 5million for the first time this century, with an estimated loss of jobs of about 500,000 since 2010. The biggest workforce cuts are health and social services (35%), armed forces (25%) and police (22%). How could anyone defend such an erosion of public sector employment and the associated services?

Along with the losses in employment have gone cuts in the real pay of employees. Public sector pay was frozen in 2011 until 2013 and then was subject to a 1% cap thereafter. As we have seen above this has massively eroded the pay of employees and it is unsurprising that many key sectors face major problems of retaining and attracting labour. It has been reported that since 2011 25% of newly qualified teachers have left the profession on account of low pay together with excessive working hours. Average public sector pay was £26,780 in 2009 and is projected to be £25,430 in 2020 – a fall of £1,300 which can be compared with a rise of £1000 for average private sector pay over the same period.

The Tories have tried to create an ideological shift against the public sector by diminishing public employees as ‘bureaucrats’ or ‘penpushers’. The denigration of experts that has taken place is part of a longer trend in under-valuing technical expertise and paying those with engineering and other technical skills much less than in competitor countries such as Germany. We are now witnessing the consequences of these attitudes and policies as the quality and quantity of public administration has fallen dramatically. Not least in the capacity of central government to deal with the complexity of Brexit and all the activities that are affected by the ‘planned’ withdrawal from the EU.

A final summary statistic that strikingly portrays the failure of Osborne’s strategy is that real household per capita income was a mere 1% higher in 2017 than it was a decade ago. In the years before 2007 the average annual increase in household real per capita income was 2.6%, however since then it has fallen to a mere 0.3%. This has to be the worst performance by any post-war government in the UK.

The economic consequences of Mr Osborne

In 1925 Keynes wrote a very powerful analysis of the failures of government economic policy which he published in a book entitled ‘The Economic Consequences of Mr Churchill’. The decision that Churchill took at that stage to return to the gold standard at an over-valued parity directly led to massive unemployment which contributed to the Great Depression of the 1930s.

It is evident that when Chancellor Mr Osborne knew nothing about the effective conduct of economic policy. As a result the UK looks set to experience a decade or more of insecure employment and stagnant real incomes within a society that is deeply fractured.  At the same time, the rich will get richer.

The UK is a deeply unequal country and one that is getting more unequal by the day. There was a remarkable rise in inequality from the 1980s, with the Gini coefficient increasing from 25% in 1979 to almost 40% in 2010. It is remarkable that the Gini in 2016/17 was higher than in all the years since 1961 except for the short period of 2007-2010.

The Resolution Foundation in ‘The Living Standards Audit 2017’ concluded that:

“In 2015-16 the share of income going to the top one per cent reached 8.5 per cent, broadly returning to pre-crisis levels although below 2009-10’s record peak of 8.7 per cent. Both these years of high income shares reflect, in part, income being shifted between years in response to tax changes.”

So the rich not surprisingly managed to protect themselves from austerity while incomes for the other 99% at best stagnated after the 2008 financial crisis, with a further widening of regional income inequality. And how successful has the Osborne strategy been in reducing the risks faced by the economy? A report from the OBR in July concluded as follows:

“A decade after the outbreak of the financial crisis and recession, net borrowing is well down from its peak. But the budget is still in deficit by 2 to 3 per cent of GDP – as it was on the eve of the crisis – and net debt is more than double its pre-crisis share of GDP and not yet falling. As a result, the public finances are much more sensitive to interest rate and inflation surprises than they were.”

This doesn’t sound like much of a success story, and its unsurprising that the population have had enough of austerity and the government and political party responsible. One could add that the public finances are also subject to a wide range of other risks including the economic meltdown caused by Brexit and the high probability of another financial crisis. The UK is now in a much worse state to deal with imminent risks than it was before 2008, not least because of a decade of failed economic and social policies.

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A great deal has been written in recent years on the topic of inequality. The books of Thomas Piketty and the late Tony Atkinson are just two recent examples. It is hard to believe that anyone can be unaware of the issues and the possible explanations of why there has been such a massive shift in income and wealth distribution in both rich and poor countries. And yet it is still possible to be surprised at what is going on at the highest echelons of business. Here is just one example, as reported in the Guardian earlier this month:

Burberry is to hand Christopher Bailey shares worth £10.5m next month when day-to-day management of the luxury goods retailer switches to a newly recruited chief executive. Bailey is to receive 600,000 of the 1m shares he was awarded in 2013, at a time when the company was concerned he might be poached by a rival. Bailey will receive the rest of the 1m shares at a later date and at the current share price of £17.65 the 600,000 that he will receive are worth about £10.5m.

 

The annual report published on Tuesday shows that Bailey was paid £3.5m last year – up from the £1.9m the previous year. While he waived his entitlement to any annual bonus for the year, his total was boosted by a £1.4m payout from a further award of shares in 2014. ….In 2014 the company had endured a bruising annual meeting with its shareholders, who voted against its remuneration report to protest about Bailey’s pay. His pay deals also include a £440,000 allowance to cover clothes and other items.

 

Bailey’s salary will remain at £1.1m when he becomes president next month, following a year in which underlying profits fell by 21%.

Burberry isn’t exactly at the forefront of technical innovation and nor is it a company supplying a product that most of us would consider essential to life and limb. It caters of course to the global rich and its success until recently in expanding sales has depended on precisely the shift in income and wealth that has been measured by Piketty and others. But relative to average wages in the same company and to median household income in the UK, the scale of the payments to Bailey seem unreasonable. This is someone who has presided over a 21% fall in profits, and yet is still rewarded by a huge set of payments. What does this say about corporate governance and any supposed relationship between payment and performance?

It is perhaps unsurprising that in the land of Thatcherism the UK comes out very unfavourably in international comparisons of income and wealth distribution. In the UK the top 10% of households have disposable income 9 times that of the bottom 10%. But the level of inequality is much higher for original pre-tax incomes where the top 10% is 24 times higher than the bottom 10%. It is even worse than this within the top 10% where the level of inequality is greater; the top 1% of households on average had an income of £253,927 and the top 0.1% had an average income of £919,882 in 2012. The UK is the 7th most unequal country in the OECD, and the 4th most unequal country in Europe.

In the case of wealth, inequality is even greater. The richest 10% of households hold 45% of all wealth and the poorest 50% have 8.7%. Within the OECD countries the UK has a gini coefficient for wealth inequality a little higher than the rest of the members [73.2 compared to 72.8].

In an interesting paper in 2012 the Bank of England argues that more or less every citizen gained to some degree from the fact that monetary expansion after the 2008 crisis generated additional demand and growth in GDP of 1.5 to 2.0%. Perhaps, but more importantly quantitative easing (QE) both directly and indirectly increases asset prices, and since ownership of financial assets is skewed most of the capital gain accrues to those with the largest holdings. Thus it is the top 5% of households in the UK hold 40% of financial assets who gained the most.

This is equivalent to the top 5% each receiving £128,000 as a result of QE in the years prior to 2012. Since QE has continued to be central to monetary policy in the UK since then, the richest have continued to be the main beneficiaries. It is reasonable to assume that in the 5 years since the Bank made its estimates that another £130,000 or so has been added to the wealth of each of the top 5%.

It is also worth noting that the UK has had massive property price inflation in part as a result of the liquidity generated by QE. Again, the greatest benefit will have accrued to the richest segment of the population. This gain is an additional transfer to the top 5% since real gains on property were excluded from the Bank’s estimates. The scale of the rise in house prices both has been enormous. Nominal house prices on average increased between 1975 to 2016 by more than 800%, while real house price growth (after inflation is considered) was 333%. The following chart from Nationwide the biggest UK lender for housing finance maps the trend over the whole period since 1975.

What we face in the UK and elsewhere in the EU is a situation of deep and growing income and wealth inequality which in part has its origins in globalised trade but also in trends in technological development that substituted precarious work for previously well paid and secure employment. But we also witness governments both in the UK and across the EU following tax policies that are increasingly regressive in their impact, with greater dependence on indirect taxes and reductions in the degree of tax progressivism in income taxes.

In practice corporate taxes are increasingly easily to avoid, which also raises the returns to owners of capital. Meanwhile, the power of labour organisations has weakened which has enabled capital to grab a larger share of net product and hence a higher share of national income and wealth. To these forces we have also identified the actions of central banks who through their activities have directly and indirectly caused further income and wealth inequality.

Present levels of inequality threaten social, economic and political stability. It is now generally agreed as to what to do, but the problem is that years of increasing inequality have embedded the interests of the rich and powerful such that governments more or less everywhere have been captured and are no longer representative of their populations. But the structural forces at work will make it difficult for governments to continue with present policies, and they will have little option but to change direction. Populism and the rise of extreme parties of the left and right will inevitably lead to change, but why wait for this to happen?

The broad outlines of policy reform are clear:

1. Monetary policy needs to revert to its more traditional role with a much reduced level of dependence on QE. Savers need to be offered higher real rates of interest and credit needs to be brought under more effective control. Banks and other financial intermediaries need to be effectively regulated and their stability should be the focus of the monetary authorities. Where QE is continued it should be used to serve the interests of the country and not the rich few, and this would mean using monetary expansion for financing public investment in a sustainable way – both social and economic investment.
2. Fiscal policy needs to be given a much greater weight and needs to become much more progressive in terms of tax structure. The current regressive nature of the tax system needs to be reversed with much greater reliance on income taxes and much less on indirect taxes. Corporate taxes need to be increased and loopholes closed so that the effective tax rate is moved closer to historical levels. In particular corporate taxes should be based on where revenue is received rather than on profits so as to make it much more difficult for companies to avoid taxation. Wealth taxes need to be made more effective and loopholes closed especially in relation to the passing of wealth between generations which is presently a major avenue for processes of inequality to persist and deepen over time.
3. Political reform is essential so that the role of money and corporate power is removed from the political process. This has become even more critical now that it is evident that social media such as Facebook have been infiltrated by organisations that manipulate data and information in the interests of the rich and powerful. Political systems have become corrupted and urgently need reform.
4. Wages are too low and this threatens economic stability. It is critical that real wages be increased in part through changes in wage policy in respect of public sector employees where there has been wage restraint, and in part through policies to strengthen organisations representing the interests of labour. The insecurity of work especially in the so called ‘gig’ economy needs to be addressed via regulations which require workers to be treated as employees and not as self-employed. The weakening of the bargaining power of unions should be reversed through public policy since this is an effective way to raise wages and reduce the dependence of workers on debt and fiscal transfers from government. The shift in the shares of national income to capital has to be reversed so that employment incomes can be raised and with it increased consumer expenditure. Economic growth nearer to long term trends is essential if employment and income levels are to be restored.

Will the above reforms happen? Time will tell, but the clock is ticking. If structural reforms are not undertaken by government then we will all reap the consequences – and these will not be pleasant.

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Brexit raises fundamental questions not only for the UK but also for the EU and it is far from obvious that either the British or the leaders of the EU have grasped this fact. The government of the UK has demonstrated a total incapacity to understand the threat that Brexit poses for the economy and seems to think that it can muddle through despite the risk of the economy unravelling and with it the political union. The government says that it will not only withdraw from the EU but also from the single market despite opposition from almost all of the business sector in the UK.

Mrs May seems to believe that developing closer relationships with the USA – in the guise of a closer alliance with President Trump – is the best option for the UK. This is despite the evidence that the US is entirely ruthless in pursuit of its own objectives. Mr Trump has already announced that NAFTA is a dead treaty and that production by US companies in Mexico should be relocated back to the US irrespective of the effects on employment in Mexico, or the higher cost of imported as well as domestically produced goods in the US.

It is worth also recalling that when Britain desperately needed economic assistance in the Second World War that the US insisted that it sell all of its external assets which were then acquired by the US at knock-down prices. Not surprisingly in the years after 1945 the UK experienced extreme economic adjustment precisely because of the forced liquidation of overseas investments during the war. In the famous book by Servan-Schreiber [1967] the US was described as ‘le defi americain’, and the European Economic Community was seen then as a necessary counterweight to US economic imperialism.

By the 1960s the UK had run out of all its trade options – the Commonwealth no longer offered market growth for UK exports and indeed those goods that the Commonwealth imported were no longer products for which global markets were growing rapidly. The attempt to find markets through the European Free Trade Area proved illusory and by the time Macmillan was in office [the early 1960s] it was clear that Britain’s trading future lay with the EEC [precursor of the EU]. So the UK has been a member of the EEC/EU since 1973 and has gained enormously from access to a large and growing market such that today over40% of its exports go to Europe. The contribution to GDP from membership of the EU is hard to measure but is estimated to be of the order of 10%. due to economies of scale in production, greater competition and access to markets with higher levels of demand growth.

Any review of recent trade developments provides two important conclusions. Firstly, leaving the EU and the single market which is the policy of the May government would entail enormous and avoidable costs. The presumption that there are accessible markets out there for UK exporters to tap – and alternative sources of imports – is simply unfounded. Secondly, after almost 50 years as members of the EU the UK has developed patterns of production (and of consumption) that will take many years – and be extremely costly – to adjust. Systems of production have developed which depend on linkeages between countries such that the UK will need to find alternative non-EU suppliers for many inputs, and will also face the common external EU tariff in respect of its exports. There are also bound to be very negative impacts on both direct and portfolio investment by foreigners in the UK.

In an internal memo of JP Morgan their chief economist stated that, ‘much of the plumbing that affects trade in goods and services on a day to day basis would be left without defined administrative process and legal foundations. The importance of tariffs is almost a sideshow relative to these issues’ (November 2016). He also concluded that Brexit was extremely dangerous for UK jobs and that any treaty with the EU was unlikely before 2019.

Britain is of course still a member of the EU and is likely to be so for at least a couple of years – and probably considerably longer (the previous UK ambassador to the EU estimated it would take 10 years to complete the negotiations). This being the case the UK does not have the legal authority to negotiate new trade treaties with third countries although clearly it can hold informal discussions with potential partners. What is clear is that the UK does not have the experienced professionals to engage in the process of trade negotiations and it’s unclear where this expertise is to come from.

What we do know from experience of past negotiations is that the US is extremely tough and pursues its domestic interests relentlessly. So any negotiations on trade with the US will have to face extremely difficult issues such as those relating to animal welfare, GM commodities and products, access to US markets for agricultural products (and the heavy subsidisation of US production) and legal and other protections for US corporations. Concerns about the latter have figured heavily in recent trade discussions between the US and the EU where there is general dismay about the rights that have been demanded for US corporations with potential to sue for financial damages where US companies have been supposedly affected by national policies, eg on health, GM products and so on.

Reducing immigration is primary ?

But irrespective of the evidence the British government still says that all that matters is reducing immigration and everything else is secondary. That this is best achieved through withdrawing from the EU and the single market despite the impact on society and the economy. It is as if the government cannot understand that the British economy has over many years become dependent on the human capital embodied in the flows of labour from the EU and elsewhere in the world. This high level of dependence on immigrant labour across all sectors reflects the dismal failure of all governments who were not prepared to invest in education and skills so as to meet labour needs.

At the present time around 15% of the active labour force is composed of immigrants and key economic sectors such as health, education, construction, transport, social care, agriculture,  banking and finance and tourism could not function without their contribution. Overall their contribution to net output and to fiscal receipts are such that both the Office of Budget Responsibility and the Institute of Fiscal Studies have warned of significant effects on the fiscal balance and on economic growth were there to be any major reduction in the contribution of immigrants to national output.

But let’s assume that the British government is determined to leave the EU and the single market primarily in order to be able to control immigration, despite its importance to the economy and to the fiscal position of the country. How it will replace the labour that is currently provided by immigrants is unclear given that the capacity to generate from domestic sources the necessary skilled and highly educated labour does not exist. For many years the British economy has depended on drawing down the investment in skills etc of other countries because it has not been prepared to develop the domestic capacity, ie. it has not been willing to find the resources to invest in training and education.

Developing that capacity will itself take years to achieve given that the capacity would have to be established or at least greatly expanded before there was any flow of trained and educated workers. This is a long term project and would be costly and there would be ongoing dependence on immigrant labour for many years to come. Among the many steps that the government could take now if it seriously wanted to reduce dependence on immigrant labour are to stop cutting education budgets, restore the funding of Further Education Colleges and bring back the Education Maintenance Allowance – all of which assist nationals in acquiring the education and skills that are desperately needed.

What is surprising is that not only does the May government not understand these issues but that the leadership of the EU made such feeble efforts to address the looming crisis prior to the in/out referendum in June 2016. It was not helpful then and not now to reiterate the mantra that free movement of labour is central to the functioning of the single market and that UK cannot be permitted a derogation from it. Whereas it would be much more sensible to accept that countries facing unstable labour markets characterised by precarious employment conditions and falling real wages should have the ability to manage labour flows whether from within the EU or globally.

These labour market conditions are not confined to the UK and other countries are interested in greater control over flows of labour, and in particular the abolition of the posted workers directive which permits employers to undercut locally negotiated wages including minimum wage laws. There is nothing to prevent the UK now from developing policies and programmes that re-structure labour markets with the objective of raising wages and ensuring that employment opportunities in low wage sectors are largely confined to UK nationals. Administrative action is possible through the system of national insurance numbers to restrict the flows of migrant labour into low wage jobs. This does not mean that the existing 3.2 million EU citizens currently in the UK would lose their employment and the government needs to state clearly that their employment rights are protected.

Reforms for all EU members

Here we come to the crux of the problems facing the EU. It is surely of relatively minor importance to allow members the freedom to manage labour flows than to risk the further destabilisation of the Union and possible exits by other countries. Not only will the UK experience social and economic costs as a result of Brexit but so also will other members of the EU. These avoidable costs arise from loss of market access for goods and services, reduced contributions from the UK to the EU budget, greater costs in accessing the financial markets located in London and restrictions on access to the UK labour market for EU citizens.

What Brexit brings to the fore are the real issues confronting the EU which are the relevance of the original principles in its establishment and subsequent policy developments, especially the Euro, for its ability to function and survive in a rapidly changing world.

It may be useful to list some of the EU’s achievements:

• It has established a single market for goods and services and although there are still uncompetitive practices, especially in services, the opening of national markets has raised output and incomes across the Union.
• It has during the past several decades successfully expanded to a membership of 28 countries (as against the original 6) and integrated many of the countries formerly part of the Soviet system with great success.
• It has through the linking of economic and social systems across many countries strengthened the forces of internationalism in many ways, and established mechanisms for conflict avoidance/resolution such that the countries of Western Europe have had 70 years of peace. Aided and assisted of course by NATO.
• It has supported rapid transitions to higher levels of output and employment in many countries through infrastructure investment, technology transfer, and institutional development, not only in countries that have recently joined but in Spain, Portugal, and Italy among others.

These are important achievements and it is important not to sacrifice them through ill thought out reforms. There are of course negatives as well. These include the establishment of the Euro as a monetary arrangement without a fiscal union such that in recent years rather than economic stability and competitive convergence countries have diverged in terms of output and income, and many have as a consequence experienced severe social and economic distress. This was and still is avoidable through reform of the Euro provided there is leadership especially from Germany as the strongest country in the Union.

What seems evident is that the EU is lacking in any strategic leadership. The Commission President seems to see his role as ensuring that nothing is effectively done on tax havens and on the taxation of large multi-national companies. This is a role which he developed when in office in Luxembourg and it seems only too clear that the Commission as a whole has been largely captured by lobbyists. There is no strategic leadership from Germany (and France) and nothing useful can be expected from the European Parliament. That the EU suffers from a democratic deficit is recognised by everyone, and this is another area for urgent reform.

So the key objectives of the EU have largely been achieved and many countries have benefited from the freedom of trade between member countries. The euro as a monetary arrangement needs urgent reform as also does the system of support for agriculture. Not least, the EU needs to do something effective about tax havens and ensure that global companies such as Google and Apple pay appropriate taxes. The role of the European Parliament needs to be revisited with the aim of building effective democratic institutions. Common policies need to be strengthened especially in the areas of climate change and the environment.

The Union has proved more or less totally unable to deal with the problem of refugees fleeing conflict in the Middle East and yet this problem is only going to intensify. Many countries in Africa have growing and youthful populations, high levels of unemployment, often tyrannical regimes and are already experiencing the impact of climate change such that large numbers of people are going to try to migrate into Europe. There is no evidence that the EU understands this threat nor that it has policies in place to meet the challenge. This despite the fact that refugees are already a major issue in some countries, such as Hungary and Poland, contributing to the rise of right wing parties in many EU countries.

The role of lobbyists needs to be addressed and systems developed to ensure a much wider representation of citizen interests and concerns. In part the achievement of these reforms depends on new and committed leadership in the Commission and this will not be achieved under those currently leading the organisation. The existing relationship between the Commission and the Council of Ministers, where the real decisions are taken, needs to be re-visited such that the Commission is strengthened and made more effective.

What is not essential to the functioning of the EU is the total freedom of movement of labour, and systems need to be created that permit members to manage labour flows in collaboration with the Commission. If this reform is introduced with speed then perhaps the current problems created by Brexit will disappear or at least be sufficiently ameliorated that the UK would be able to continue as part of the Union in some form. A possibility – even if not a certainty but preferable to continuing on the present disastrous trajectory.

The last thing the EU needs is a low tax offshore haven on its doorstep which also undercuts working conditions in the EU through derogation from established standards by a British government facing uncontrollable problems caused by Brexit. Yet this is something that the UK has threatened if a productive trade deal is not negotiated. The British government seems prepared to further destabilise its own fiscal situation by cutting corporate taxes and thus adding to the budgetary problems generated by falling output, rising unemployment and any reduction in migrants.

Who would lose most from such behaviour is fairly obvious, and making unrealistic threats does not seem a sensible basis on which to negotiate with our partners in the EU.

The threat by the British government that it will turn the UK into an offshore tax haven – as if in practice it wasn’t already – is similar. Some of the most egregious tax havens such as the British Virgin Islands and the Turcs and Caicos Islands, and Jersey and the Isle of Man…and so on and so on…. are already providing tax saving opportunities for the global rich and for international companies such as Apple and Amazon.

It is also no secret that the largest centre globally for money laundering is the City of London so it’s hard to see what extra the British government could do to make things worse for everyone else including countries in the EU. It is also evident of course that the UK itself would benefit from tackling tax havens and setting up effective systems for reducing money laundering.

There is a fundamental misunderstanding in government of the role of the City which has become a major source of employment and taxation in recent decades. It is precisely because London is interconnected with a large and generally prosperous market that it has been able to thrive and ending our economic and political relationship with the EU threatens this inter-dependence, in the same way Singapore and Hong Kong have thrived precisely because of their connexions with dynamic economies in Asia. Leaving the EU and the single market as May proposes threatens the business of the City and it’s unsurprising that HSBC and UBS both announced after the May speech on November 17^th that they were moving thousands of highly paid jobs out of London and to Paris, Frankfurt and elsewhere in the EU. Not in the distant future but more or less immediately.

Both Britain and the EU can prosper – if opportunities are grasped

What is essential are reforms both in the UK and the EU so that both can be a force for good in a very unstable and uncertain world. With Mr Trump in the White House and Mr Putin in the Kremlin we sorely need the stabilising influence of the EU – preferably with the UK as a continuing member. It can scarcely be a serious objective of British policy to both undermine its own prosperity and set in motion developments that add to regional and national instability.

Even preserving the unity of the Tory party can’t be worth these risks and yet this seems to be all that the present government is concerned with. The story that it is implementing ‘the will of the people’ is not much more than a fable. More than 13 million of those on the electoral register didn’t even bother to vote, and of those who voted to leave it is entirely unclear what they were voting for. Did they really vote for UK to become an offshore tax haven with falling real incomes and high levels of unemployment or did they vote for the oft-repeated promise of more resources for the National Health Service? And did they realise that going forward with the current policies of the government would probably lead Scotland to exit the Union? For what? – to keep the Tories in power and leave UKIP stranded having lost its main political message.

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It’s déjà vu all over again.

This malapropism is usually attributed to Yogi Berra, a famous baseball player in the early 1960s. It also seems to be appropriate now when thinking about international economic policy in the UK. I could have written ‘analysing’ rather than ‘thinking’ but that would suggest that current policy is the outcome of a serious discussion of options and estimates of the costs and benefits of alternative possibilities. Unfortunately policy makers seem not to have any understanding of the history of Britain’s recent relations with Europe and seem intent on unravelling what has been put together in recent decades irrespective of the impact on both the UK and our partners in Europe. The following will hopefully throw some light on the how and why of where we are presently but is in no sense intended to be other than a personal account of past events that ought to have some weight in current policy development.

I joined the Treasury in the mid 1960s during Harold Wilson’s first government and had a remit that focused on international economic policy. At that time the Government Economic Service was truly professional and was headed by professor Alec Cairncross who was highly experienced in government and very insightful about economic policy. Other economists on the staff included Wynne Godley who subsequently became professor at Cambridge and his close collaborator James Shepherd. There was a depth to economic analysis and policy discussion across Whitehall that has subsequently been eroded in part through the appointment of special advisors who are essentially political aides rather than economists. This weakening of the policy making process is unfortunately only too evident and in part explains the cumulative failures of recent years – not least the deadweight-losses and distributional costs of Osborne’s austerity policies.

The Labour government had a majority of 4 when it took office in 1964 and had inherited a balance of payments in significant deficit. The previous Tory Chancellor (Maudling) had been advised to reduce domestic demand in the 1964 budget but had chosen to ignore this advice and instead cut taxes in advance of the autumn election. But preparatory work went ahead in the Treasury so as to have a range of measures in place to deal with the expected sterling crisis which would inevitably occur given the forecast balance of payments deficit. Wilson chose not to devalue the exchange rate and chose instead a temporary import charge which reduced over time the level of imports. But the underlying position of an overvalued exchange rate continued until the UK was forced to devalue in late 1967 under conditions that were extremely costly for the Treasury and the country.

This background is relevant in that by the 1960s the UK had reached the end of the line in respect of international trading relationships. The Commonwealth which in the 1930s had sustained the British economy had ceased to provide growing and dynamic markets for UK exports in the post war period and indeed had to a degree held back the industrial regeneration that was needed. Thus Tibor Barna demonstrated in an influential paper that dependence on slow growing Commonwealth markets was part of the problem and that shifting exports to faster growing markets would generate more competitive production. The UK had grown slowly during the 1950s in part because of the constraints of the balance of payments (a stop/go economic cycle) and had lagged behind our European competitors. New trading relationships were thus seen as essential if the UK was to break free of the constraints of the balance of payments but there was disagreement about what to do.

On the one hand there were those who wanted to maintain the Commonwealth relationship of essentially protected trade dependent on a set of defence and other preferred relations. This despite the fact that such markets did not display the patterns of demand that were essential if the UK was to develop new and growing industrial capacity. Hence the dispute that went on for ever within the Tory party about sustaining the Commonwealth ties despite the fact that the latter were themselves developing new markets for their output/exports. As we shall see below some of these arguments reverberate today given the belief of some of those supporting Brexit that there exist alternative markets which could easily replace access to the EU single market. The question becomes whether such markets exist and whether the UK would be competitive in the face of for example Chinese, Indian, and Vietnamese products.

In 1957 the six European countries signed the Treaty of Rome establishing the European Economic Community. At that time the UK would have been welcomed as a member but chose not to join and instead formed a rival bloc of seven small countries (EFTA – the European Free Trade Area). It was hoped that EFTA would provide some of the trade growth that UK so desperately sought without the various obligations involved in the EEC whilst allowing the UK to sustain the Commonwealth relationship. EFTA was never a realistic alternative to the EEC and this soon became apparent even to the Tory party that was in office throughout the 1950s and until 1964 when Wilson won the election. Macmillan had by the early 1960s decided that Britain should join the EEC but faced problems within his own party and also from the French. De Gaulle had decided that the UK was simply a ‘trojan horse’ for the USA and after the Nassau agreement on nuclear weapons essentially an American colony.

Charles de Gaulle, by fr.politique.wikia.com/

By the mid 1960s, the UK had run out of options. The Commonwealth couldn’t provide the market growth that British industry needed; EFTA was too small a market to generate the industrial economies of scale needed if the UK was to compete with the Germans, and the French were not prepared to let the UK join the EEC. Wilson when he took office realised that the future of the UK lay with the EEC and he took up the UK application to join in the later 1960s but continued to be rebuffed by the French. Internal economic assessments in Whitehall showed quite clearly the costs and benefits of membership of the EEC with overwhelming support for the gains from membership. Opponents of membership of the EEC within the Cabinet still persisted in supporting the Commonwealth option and some Labour ministers even proposed setting up a free trade arrangement with the USA. As we shall see below the UK tried to address the concerns of the French and these were to a degree easier after the changes in UK defence policies when Wilson abandoned its East of Suez commitments.

But it was left to Edward Heath when he took office in 1970 to actually engage with our European neighbours and he signed the Treaty of Accession in 1973. So finally the UK, having tried all of the various options, had concluded that the EEC was the best and it signed on the bottom line. Of course one of the consequences of joining the club was that the table had been set in the interests of the original members, and the UK had more or less no option but to accept arrangements some of which were definitely not in the British interest such as the Common Agricultural Policy. Herein lies part of the problem with the EEC since its structure wasn’t ever set in the interests of the UK but of the founding members. Mrs Thatcher managed to get the famous fiscal rebate to reflect that fact that the UK was contributing excessively to the EU budget, and has increasingly sought opt-outs from policies that supposedly do not meet British needs. This increasingly semi-detached relationship has not endeared the UK to its EU partners and one would not expect them to be falling over to please Brexiteers in any negotiations as and when these begin in 2017.

A digression – or is it: Concorde

There was great secrecy surrounding the development of Concorde and although public funds were used to support the project from the early 1950s it was not until December 1962 that parliament was allowed to have a debate. Attempts had been made to try and get the USA to share the costs of development but they turned down the opportunity having a totally different view about market opportunities for aviation growth. Proponents of supersonic aircraft made sure that the project was kept as far as possible away from Treasury oversight even though development costs had already vastly exceeded the estimates originally produced. In the end the development costs were no less than 15 times the original estimates.

Tory governments during the 1950s were keen to take forward Concorde in part so as to support the British aviation industry which was reeling from the failure of the Comet aircraft. In part the problem was an engineering one – how to design a plane which could carry enough paying passengers and not make operational losses in the process. This was never resolved and the plane often flew with only half of the seats occupied. There were also the severe environmental issues – of noise and pollution – which were never solved and exercised the minds of many of those affected by the plane in urban settings. While back of the envelope projections were made in the Ministry of Aviation of a market for the aircraft of between 150 and 500 planes only 16 were ever produced. These were acquired by British Airways and Air France which were both national carriers at that time either at discounted prices or for free. Both airlines were also given guarantees by their respective governments against operational losses.

The Macmillan government having been rebuffed by the Americans turned to the French and discussions started about a joint venture in 1959 and finally in 1962 an agreement was reached on funding and development of Concorde. What is remarkable about this agreement is that no market assessment was ever made and no one ever approached the main airlines to ask whether they would buy a supersonic aircraft. Furthermore it was agreed that if either partner pulled out of the project then they would have to fully compensate financially all of the costs incurred by the other country.

Why was the British Government so committed to Concorde? Well the answer to a degree relates to the discussion above that UK had by the early 1960s decided that its trading future lay with the EEC. The joint development of Concorde with the French as a full partner was supposed to demonstrate two things. Firstly, that UK would bring to the EEC a viable and high tech aviation industry to rival the dominance of the USA, and secondly that it was now committed to a European market as represented by the Economic Community. Macmillan was not of course committed to the vision of Europe of Monnet and Schuman who saw economic arrangements as a stepping stone to broader political integration. Rather, Macmillan’s decision in 1962 to apply to join was essentially economic and herein in part lies the genesis of the problem in the longer term.

Unfortunately for Macmillan the French were not convinced that the UK was ready to join the EEC and De Gaulle rejected the application in January 1963. When the Wilson Government came into office in the autumn of 1964 it looked at the agreement with France and at the costs of developing Concorde and tried to cancel the project. They were appalled at the fact that no commercial assessment had been made of the market for the plane and that cancellation by either partner would lead to compensating the other for all of the costs incurred. Labour decided it was simply easier to continue with the project rather than cancel it. Furthermore, as noted above, Wilson became convinced that joining the EEC was the only viable strategy so he took up the application that was still on the table and engaged the French government in further discussions. Concorde was part of the background to the discussions but in itself proved insufficient to get the French to change their opposition and Pompidou again rejected membership.

The best and easiest accessible analysis of the tangled web of events relating to the development of Concorde is to be found in the Atlantic Monthly, Jan 1977 (Supersonic Bust by Robert Gillmann). It’s a sorry story and an example of the far too many appallingly bad public investment decisions made by British governments over the past 50 years. The project was hugely expensive – estimated by David Henderson who was chief economist at one stage at the Ministry of Aviation at £4.26billion in 1975 prices. The Concorde project furthermore tied up the scarce engineering and design capacity of the British aviation industry for decades at a time when the global market was expanding rapidly. Allowing this hugely profitable market to be captured by the Americans who had rightly seen no future in supersonic flight.

And then there is Hinkley Point C

Hinkley Point nuclear power stations, by Richard Baker.

The parallels between  Concorde and the decision made in September by the May government to go ahead with the building of the first nuclear power station for many years is truly amazing. It is as if the British have a preference for investments that are white elephants, and are determined to go ahead with immensely expensive projects despite the evidence that they are not the best solution to national needs. The French, Chinese and British governments have agreed jointly on the building of Hinkley Point C at an estimated cost of £18billion. This is despite the fact that the technology is untried and that the 2 plants presently under construction in Finland and France are years behind schedule and well over budget. The Finnish plant was due to come on stream in 2009 and is now 5.2 billion euros over budget while the French plant is 6 years late.

As with Concorde, the government has chosen a technology that is risky when other alternatives are available. The government has itself confirmed a report from the National Audit Office (July 2016) that by the mid 2020s that large scale solar and onshore wind power would generate electricity more cheaply than that produced by Hinkley Point. Indeed, the government estimates are that sustainable sources of energy would be half the price of nuclear. Furthermore there would not be any need for the price guarantees given to the Chinese and French developers in the contract (the latter are expected to add very significantly to the electricity bills of consumers over several decades and have been estimated by the National Audit Office as up to £30billion). There also remains the complex issue of responsibility for decommissioning the nuclear plant and who bears the cost of this huge and unpredictable expenditure. Notionally this will fall on the developers but the contracted costs look as if they will be far below the actual cost and the huge excess will fall on UK taxpayers.

So why would the British government choose nuclear over the available alternatives? The technology is untried, the costs of construction are inevitably going to be billions more than estimated and the project delayed by many years, and the costs of operation greater than competing sustainable energy alternatives. There will be ongoing subsidies to operators and the clean-up costs impossible to predict but inevitably huge (the present estimate is up to £7.2 billion but they will be many times that figure). There are so many elements here that parallel the case of Concorde and in the final analysis the costs will again fall on the UK tax payer.

Where are the benefits?  Well these seem to lie in the nebulous and unlikely possibility of access to the Chinese market for British exports, and an ability to draw down Chinese direct and financial investment in the UK. In the case of exports of goods and services to the Chinese these are already possible under WTO rules so what would be gained by the Hinckley contract? Similarly in the case of Chinese investment where the Chinese will make rational decisions on where to put their savings and this will depend on the usual assessments of financial return and profitability. Of course the investment in Hinkley Point may generate further opportunities for Chinese nuclear contractors in the UK but this is highly uncertain given that nuclear will be a high cost option relative to other sustainable energy.

In large part the British are going ahead with Hinkley because of the market disruption caused by Brexit. The loss of privileged access to the EU market for goods and services will mean finding alternative markets – and the Chinese market is huge and is growing. But as noted above, for most products, the Chinese are a much lower cost producer than the UK. So where would the market opportunities lie? The British current account is already in large deficit and has been for many years and has been financed by capital inflows – some of it from China. The hope presumably in government is that it will continue to be possible to draw-down Chinese savings to finance the ongoing deficit – a deficit that will probably widen after Brexit. But this is a highly uncertain strategy and one that no sensible government would find attractive given the political structure of China and instability in Chinese/Western relations.

Where to now?

Membership of the EEC and subsequently the EU has been immensely beneficial to the UK. There have been large and ongoing economic benefits as was predicted in the early assessments undertaken in Whitehall in the 1960s and subsequently confirmed by innumerable economists. The recent Treasury assessment of the cost of Brexit of a reduction in British GDP of between 5.4% and 9.5% looks only too realistic, and represents an estimate of the gains to GDP that the UK has had from membership of the Community.

There have, of course, been non-quantifiable benefits which have been just as important not least the opportunity to draw on highly skilled and professional labour from across the EU over many years. Not least of the benefits has been an awareness over time that the future of the UK lies in cultural and social integration with our partners in Europe – recognised most fully by the youth of Britain who overwhelmingly voted to remain in the EU in the June referendum.

There is no realistic alternative to the EU available to the UK out there – a world of supposed ‘free trade’ which has been always a fiction in the minds of a few classical economists and naive Tory politicians. As we have seen above in the brief history of our accession to the EEC and subsequently the EU there is no alternative, as even Mrs Thatcher finally realised as she signed the Treaty of Maastricht.

What we now have is a world of managed trade where membership of a large trading bloc such as the EU is essential for access to global markets on reasonably fair terms. There is no way the UK could freely compete with the low wage economies of East and South Asia in most manufacturing products. Rather the future of the UK has to lie with products and services that embody high levels of education and technology. These are precisely the capacities that are developed and sustained by ongoing membership of the EU.

Brexit, if it ever happens will cause deep economic and social costs and is totally avoidable. It would be yet another example of policy decisions of which there have been far too many examples in recent British history and which have been disastrous in their impact on the population. If Brexit is persisted with by the present government, not only will it reduce GDP, cause high and unnecessary unemployment, and social distress but it will probably also lead to the breakup of the UK.

Why would any government choose to go down this path?

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The collapse of the foreign exchange rate since the BREXIT referendum is on a scale we have not seen in many years and yet the government seems totally unconcerned. Indeed in large part the fall in the rate of exchange is directly the result of statements and actions taken by the government. Some decline in the rate was predicted following the referendum, but it seems now to be in free-fall as a result of recent declarations by a government that it is intent on what it calls a ‘hard BREXIT’. No one, least of all the government, has a clue what sort of trading arrangements are feasible and attainable in a world of managed trade and within the WTO framework. At the present time at least 44% of all UK trade is with the EU and it seems highly unlikely that access to this market can be retained unless the UK accepts free movement of labour.

So it is unsurprising that, in these conditions of uncertainty, the exchange rate has collapsed. But the scale of the decline in the exchange rate has been greater than anyone had predicted. Sterling has fallen sharply against the US dollar to a rate not seen since the 1980s and there have been similarly sharp falls against the euro. In the case of the dollar and the euro there are now predictions that the rates may fall to parity within the next few months with huge implications for the British economy and for general living standards.

The overall effect of exchange depreciation on this scale is to reduce real national income – the cost of imports is increased and export prices are lowered. In the short run also the current account will worsen since the cost of imports rises and any growth in export volumes will depend on conditions in foreign markets and on the ability to increase UK productive capacity. But the government seems unperturbed both by the scale of the exchange rate decline and by the potential economic costs that will inevitably follow. It is worth noting that the Treasury assessment of the costs of BREXIT made prior to the referendum predicted a decline of between 5.4% and 9.5% of GDP over 15 years, and losses of revenue per annum of between £38b and £66b over the same period of time because the tax base would be much smaller.

Government having largely created the conditions under which the exchange rate has collapsed now has more or less no instruments of economic policy available with which to reverse the decline and seems totally fazed about what to do. Since the end of the Bretton Woods system of fixed exchange rates in the early 1970s the world has operated under conditions of variable rates which have fluctuated in accordance with market conditions – the latter have in general reflected fundamental economic conditions in different countries. Countries with dynamic and competitive conditions have experienced strong balance of payments positions and other less successful countries the opposite with associated high levels of international debt. Germany is a good example of a country with a strong balance of payments and while one might have expected the exchange rate of Germany to appreciate this in fact has not happened because the Eurozone is a system of fixed exchange rates. Exchange rates have thus been prevented from playing their appropriate role within the Eurozone with very undesirable effects.

The UK very sensibly refused under Blair/Brown to join the Eurozone and sterling has floated against all other countries globally with the exchange rate being permitted to play more or less its appropriate role in the conduct of economic policy. Of course what we have experienced globally, including the UK, has been a system not of freely floating rates but one of managed rates where countries have used instruments of monetary policy to influence the level of their exchange rate so as to achieve competitive advantages. Thus countries could use exchange controls so as to influence capital movements or levels of domestic interest rates as ways of attracting capital. In recent years, for example, Switzerland has levied negative interest rates on bank deposits as a way of deterring capital inflow and thus damping to some degree the appreciation of the Swiss currency. Japan has similarly set domestic interest rates at levels to reduce appreciation of the yen. One of the costs of the Eurozone for members is that individual countries do not have control of the level of interest rates which are set by the European Central Bank and these may be totally inappropriate for individual countries such as Greece or also Italy which have large fiscal deficits.

The UK has for many years been running a deficit on its current account of the balance of payments. In other words there has been a large excess of imports of goods and services over what is exported. In the second quarter of 2016 the current account deficit was no less than 5.9% of GDP and deficits of this sort of scale have been common for many years. Of course a country can only continue to run a large current account deficit if it either has large foreign exchange reserves which the UK does not have [indeed it has been engaged in reducing their level as a means of financing domestic fiscal deficits under the previous Chancellor Osborne] or else it borrows extensively overseas.

And herein lies the first of the problems facing the government. How to generate the conditions favourable to continued foreign capital inflow so as to finance the huge current account deficit and at the same time have low domestic interest rates, with the value of sterling in free fall. The Bank of England in August reduced its key short term interest rate to 0.25% in an attempt to sustain domestic demand in response to the uncertainty released by the Brexit referendum. But low interest rates act as a deterrent to foreign capital inflow and are unlikely to do much to sustain domestic demand. Foreign capital will of course see opportunities to buy British financial and non-financial assets since the sterling cost has fallen as a result of the exchange rate depreciation but similarly their foreign exchange value will be lessened as and when they attempt to liquidate these investments. For any investor it would pay to hold off buying sterling assets until the exchange rate has stopped falling, and it looks as if it will not do so until later in 2017 when it may be clearer what BREXIT means for the British economy.

The Bank (and Government) could reverse its current interest rate strategy (low rates to sustain domestic demand) but any significant rise would create chaos given the level of secured (mortgage) and unsecured debt much of it unfinaceable if rates were to rise. To finance the current account deficit through encouraging capital inflows through higher interest rates would add to the domestic deflationary pressures already caused by the threat of Brexit and thus causing higher levels of unemployment and widening the fiscal deficit as automatic fiscal stabilisers kick in. As output contracts tax receipts fall and higher levels of unemployment generate more government expenditure on welfare and other payments. It would also create chaos in the housing market because it would generate widespread negative equity.

What to do in situations of policy conflict such as this? Well the government story repeated ad nauseam by ministers who seem to understand nothing about economics is that the fall in the exchange rate will boost demand through encouraging exports. Now to a degree this may indeed happen – but with long lags and the scale of any general increase in demand is highly uncertain and probably not very large. Exports currently account for some 28% of GDP and since manufacturing output in the UK is now less than 15% of GDP the leverage that is possible through an expansion of the component of demand that is considered sensitive to a falling exchange rate is relatively small. Plus, and this is very important, there is a very significant import content of exports – estimated by OECD as 23%. A large part of both UK manufacturing output and especially of exports is through chains of inputs that are highly specialised and not easily substitutable from other suppliers. So as the exchange rate depreciates so also does the cost of inputs rise for both domestic markets and for exports – as we have seen for the latter by almost a quarter. So a significant part of the competitive gain to exporters from the fall in the exchange rate of sterling is offset directly by the rising cost of imports that are key inputs in production.

There will also be indirect effects on the cost of exports which derive from domestic cost adjustments as the impact of the decline in the exchange rate feed through into the economy. Imports are 30% of GDP and a fall of, say, 15% in the sterling exchange rate will add something like 5% to domestic costs of all food and other commodities, including fuel where increases in petrol and diesel prices have already been announced by suppliers. Oil prices are set internationally in US$ so the fall in sterling against the $ immediately causes an increase in the price of fuel in sterling terms.

The UK is now as a result of globalisation very dependent on foreign supply of many industrial products with few alternative domestic sources and their costs will inevitably increase. The exchange depreciation that has already occurred will raise domestic costs of production and add directly to prices of more or less everything. There will thus be an impact on domestic cost and price levels and a fall in domestic disposable incomes. This will have multiplier effects on domestic demand and lead to further rounds of output contraction. How wages and incomes will react is uncertain but pressure on disposable incomes and rising unemployment is bound to be resisted across all sectors of the economy.

There are other features of the situation that are worth noting in part because they are longer term in their origin and undermine the government’s strategy [if one can call it that]. If there is to be a rise in net exports (a fall in imports and an increase in exports caused by the fall in the sterling exchange rate) then UK output has to become more competitive. But as we have seen the current account of the balance of payments has been in large deficit for many years and this reflects the general uncompetitiveness of the economy. The exception to this statement is the financial services sector (more on this below) but otherwise the UK has displayed low levels of international competitiveness. This reflects the low level of productive investment and a total disregard by government and private industry of the skills of the domestic workforce.

The ONS has just published data on comparative labour productivity which makes only too clear the gap between UK and its main competitors. In 2014 output per hour worked in Italy was 10% more, in the USA and France 30% more, in Germany 36% more than in the UK. For the G7 countries the average productivity level was 18% more than the UK. This gap reflects low levels of investment per worker in the UK, low levels of investment in skills and especially low levels of Research and Development expenditure. In the case of the latter the UK spends 1.7% of GDP whereas Germany spends 2.9% and the US 2.7% (for the EU of 28 countries the average level is 1.95%). The UK for example trails the USA in productivity per worker in all sectors according to the ONS and especially in manufacturing. So how is the UK supposed to take advantage of a change in the financial exchange rate given these underlying factors which ultimately determine international competiveness?

Of course one of the factors that has made it possible for the economy to function more or less effectively has been the ability to draw on the international market for skills. This reflects the abject failure of governments over many years to invest in education and training. There are key sectors which are totally dependent on recruitment of overseas labour including health and social care, financial services, higher education and basic scientific research, construction and transport. It takes many years to train people and ensure their appropriate experience and yet government has said that it will restrict immigration irrespective of the needs of different productive sectors as part of its hard Brexit policies. It is unsurprising in these conditions and also facing the uncertainty of levels and instability of exchange rates that businesses have declared their opposition to the government’s stand on Brexit.

The UK has become since it joined the EU in the 1970s an important destination for direct investment less because of the opportunities opened in the UK market and more because it was a base for exporting to the rest of the EU. The EU is now the largest market worldwide and yet the hard BREXIT stance of Government threatens access to the single market. British producers will, if BREXIT is implemented as planned by the Government, face the common external tariff which will make it more expensive to sell against competitors inside the EU. The tariff is substantial – intended to be protective – and will further erode any advantage a fall in the sterling exchange rate gives to British located producers.

The tariff plus the rise in the import costs noted above (and any consequent rise in UK costs such as wages) will erode a large part of any exchange rate benefit to UK based producers. It is unsurprising in these circumstances that a major car producer such as Nissan which sends most of its output to the EU has indicated that all investment is on hold until such times as the present uncertainty of exchange rates and access to the EU market are resolved. Fuji with a labour force in the UK of 14,000 has also voiced its dismay with the proposed exit from the EU. These are among many companies who have located in the UK to benefit from being inside the EU tariff system who will now be having second thoughts on location and levels of production. In the process investment will be cut back and new direct investment flows be reduced so worsening the overall balance of payments.

The key dynamic sector for both employment growth and as a share of GDP for many years has been financial services. These now account for some 10% of GDP and are a major source of tax revenue for the government. The growth of this sector has been largely determined by privileged access to the EU market together with extremely weak supervision by the British banking authorities. It seems evident from statements made by the EU that the current access to the EU under the so called ‘EU passport’ for British financial firms will be discontinued and that the particular locational advantages of being in UK will disappear. This is analogous to the point made in the last paragraph about firms locating in the UK so as to have access to the single market. Again some banks have already indicated that they will relocate to Frankfurt or Paris if a hard Brexit is pursued, and this will reduce substantially exports of services and thus add to the current account deficit of the balance of payments. It will also of course lead to a loss of jobs and reduced payments of taxes to the Treasury so adding to the fiscal deficit.

Why are we in this mess?

This is the $64,000 question and there doesn’t seem to be any simple answer. The instability of the exchange rate and the scale of the fall are creating major problems for all producers – and consumers as well. The government seems oblivious to the costs of its policy both now and in the medium to long term. Its own internal Treasury estimate of the costs for output and employment and to the public finances are unfortunately only too realistic – if anything they underestimate the size of the problems facing the UK. There are clear conflicts of economic policy since interest rates have to be focused on the state of domestic demand/output and cannot be used for managing the exchange rate. In these circumstances and given the totally unrealistic policy on foreign trade it is inevitable that the sterling rate will depreciate and go on falling against other currencies. There are no benefits to be derived from such a drastic decline in the exchange rate as we have witnessed recently since any adjustment of domestic cost conditions so as to increase net exports will take many years to create.

The changes in economic policy that are needed are self evident; a clear statement that the UK will remain in the single market with all that that implies. There is undoubtedly scope for management of labour flows into the UK that will meet EU regulations and these need to be explored. Many EU countries in practice have regulations relating to employment and residence that effectively restrain the flow of migrants and these seem perfectly consistent with access to the single market. Drawing on international skills is critical to the performance of the economy and should be encouraged. Reducing exchange rate instability will be critical to inducing capital inflows and making the UK a destination for productive direct investment. Uncertainty needs to be reduced and confidence again created in the British economy. Domestic investment needs to be increased – both public and private – and a real effort made to create a larger pool of skilled and educated labour.

Whether the current government understands the depth of the problems it has largely self-created is uncertain. And whether it has the courage and foresight to reverse its present policies is a great unknown. One would like to be positive but this might be a level of optimism too great.

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It is evident that special factors flowing from the decision on BREXIT affect British economic policy, but the UK is not alone in having relied on monetary instruments to stabilise its economy after the financial crisis of 2008. Both the US Federal Reserve and the European Central Bank have pursued a similar path and all the key Central Banks now face the same set of problems. In the UK a policy of fiscal austerity was imposed by government whereas the Eurozone countries were required to operate within the discipline of the so-called Stability Framework. The latter restrained the use of fiscal policy as an instrument of economic stabilisation and as a result many countries in the euro zone have had years of anaemic growth and high levels of unemployment.

Apart from the Guardian most commentators expect the economic situation post BREXIT to worsen. Exactly why the Guardian has taken the rather rosy view of the impact of BREXIT is unclear although one of its most informed commentators (Will Hutton) has outlined in ‘Don’t be fooled. There will be damaging fallout from Brexit’ exactly why the country faces severe and worsening economic conditions due to BREXIT. In this respect Hutton is very much in line with the Bank of England which in its August 2016 Inflation Report set out its analysis of the effects of BREXIT and announced changes in monetary policy. The Bank concluded, ‘the outlook for growth in the short to medium term has weakened markedly…[with] a downward revision of the economy’s supply capacity… and eventual rise in unemployment’.

The Bank predicts little growth during the second half of 2016 with further declines in business investment and weaker levels of personal consumption. Business investment was already falling prior to the EU referendum and continuing uncertainty is expected to depress it further. Against a background of continued weakness in the balance of payments where in Q1 of 2016 the deficit on the current account was 6.9% of GDP and likely to worsen further in the coming months. Furthermore the fall in the exchange rate will have an impact on disposable real income due to rising import prices and their effects on domestic costs of production, and thus depress domestic consumer expenditure.

Given this economic scenario what has the Bank proposed? In summary it is the following:

The Bank of England’s Monetary Policy Committee (MPC) sets monetary policy to meet the 2% inflation target, and in a way that helps to sustain growth and employment. At its meeting ending 3 August 2016, the MPC voted for a package of measures designed to provide additional support to growth and to achieve a sustainable return of inflation to the target. This package comprises: a 25 basis point cut in Bank Rate to 0.25%; a new Term Funding Scheme to reinforce the pass-through of the cut in Bank Rate; the purchase of up to £10 billion of UK corporate bonds; and an expansion of the asset purchase scheme for UK government bonds of £60 billion, taking the total stock of these asset purchases to £435 billion. The last three elements will be financed by the issuance of central bank reserves.

What is one to make of these proposals? Inflation is presently not a problem although the effects on prices from the fall in sterling against other currencies will inevitably feed through into costs and prices at some point. More worrying for future levels of inflation is the impact of Quantitative Easing [QE] where a further expansion of £60 billion is proposed on top of the enormous increases since 2009 – taking the total to £435 billion. Furthermore the purchase of corporate bonds and the new Term Funding Scheme to reinforce the cuts of Bank Rate to 0.25% will also add to domestic liquidity.

It is also worth noting that in July the Bank announced further cuts in banking reserve requirements so as ‘to lower the countercyclical capital buffer rate from 0.5% to 0% of banks’ UK exposures  [which] will support lending to households and companies’. The effects of all this monetary easing are totally unpredictable and the Bank’s rationale unconvincing in the light of recent experience.

On QE the Bank has written that, ‘cash injections lower the cost of borrowing and boost asset prices to support spending and get inflation back on target’. Possibly it does to a degree but does one really believe that the economic benefits of QE derived through changes in asset prices are worth the potential future cost in terms of inflation? QE has certainly been a major factor in house price inflation where the cost of housing (both to buy and to rent) is massively out of line with incomes, with all sorts of negative externalities (including increasing rates of homelessness and massively increased expenditure by the state on housing support). Households are as a result having to pay a much higher percentage of their income on housing.

No one (apart perhaps from the Bank) really believes that a worthwhile expansion of domestic demand is feasible and desirable through the wealth effects of rising asset prices as stock markets have also boomed due to QE and house prices rocketed. If one wants to boost domestic expenditure so as to increase demand then fiscal policy is surely the preferred instrument of policy and not the blunderbuss of monetary easing.

The other key change is the further reduction in short term interest rates which were already at historically low levels. It is hard to believe that a further cut of 0.25% is likely to lead to any increase in long term business investment which has been generally depressed since the financial crisis of 2008/9. In the conditions of market uncertainty, intensified by BREXIT, it seems highly unlikely that firms will want to borrow and invest with major and continuing consequences for growth and for employment. Indeed there is doubt about whether the cuts in Bank Rate will actually be passed on by financial institutions which is the rationale for the new Term Funding Scheme which is to ‘reinforce the transmission of Bank Rate cuts.’

The evidence of past behaviour by banks would leave one sceptical about any cut in Bank Rate leading to a fall in lending rates especially given the current pressure on bank profits. Financial institutions are much more likely to pocket the cut in Bank Rate rather than pass it on to their customers – both business and private. After all QE itself puts downward pressure on bank profits. Many important institutions are facing severe financial problems directly as a result of current monetary policy, with pension funds experiencing severe deficits and increasingly exploring risky investment strategies. For pensioners this will mean much reduced pensions compared with what had been expected with levels well below what are considered adequate for retirement.

Another key question is how will households respond to the cut in Bank Rate assuming that this in part is passed on in lower lending rates. Here there is also great uncertainty in part because falling output will further depress employment which will have some negative effect on disposable income. Much more important will be the direct and indirect impact of rising import prices on real disposable incomes as the 10% fall in sterling exchange rates so far feeds through into prices. These depressive forces will be strengthened by the impact of even lower interest rates on savings which are already so low as to have adversely affected incomes, especially of pensioners, and thus have added to the slow growth in domestic demand in recent years.

The Bank argument that falling interest rates will lead to dissaving looks very unconvincing given the general uncertainty created by BREXIT and savers are likely if anything to cut back on expenditure rather than spend. Even more worrying is the effect of continued extremely low interest rates on the whole culture of savings in the medium to long term since it must surely be an objective of policy to encourage savings for retirement rather than have these costs fall on the state. There can be no doubt that current policies have had significant distributional effects since continuing low interest paid to savers have in effect subsidised borrowers thus inducing a growth in both secured and unsecured debt that is unsustainable.

Also imponderable is how will personal borrowers respond to yet another cut in short term interest rates – whether there will be a greater demand for both secured (mainly mortgage debt) and unsecured credit (on bank cards and so on). It can be assumed that the last thing the Bank wants to encourage is yet further speculation in housing funded by lower interest rates on mortgage debt and easier access to it as a result of QE (which expands bank and building society deposits – assisted by the new Term Lending Scheme). Given the more or less fixed stock of housing and the excessive pressure already in some regions (London and the South East) more mortgage financed expenditure which will merely raise housing costs even further.

Many households since 2009 have been encouraged by low interest rates on mortgages and their plentiful supply to take on large amounts of additional debt so that the ratio of mortgages to income is now extremely high. Any increases in interest rates are thus likely to cause immediate problems with repayments and thus lead to possibly catastrophic falls in house prices. This is a potentially significant effect of any shift in monetary policy away from low interest rates, and yet the Bank may be forced by the state of the external balance to raise these so as to finance a continuing current account deficit by encouraging capital inflows.

There are already some signs that parts of the housing market are feeling the negative effects of BREXIT (especially luxury flat purchases by foreigners who now face much more exchange rate uncertainty and greater probability of property price declines). One would anticipate that domestic borrowers are not likely to take on much more mortgage debt given the existing excessive ratio of borrowing to income and the much greater uncertainty about the path of personal incomes and future house prices.

How about unsecured borrowing? Here it needs to be recalled that total unsecured debt in the UK by households (excluding mortgage debt) rose by £48 billion in 2012-2015 to a total of £353 billion in 2016. So during the years after the financial crash when personal incomes were squeezed and real  wages fell in the UK (more than in all the other OECD countries other than Greece) households responded by taking on additional debt. The scale of the problem is such that a report by the TUC found the following:

Overall, 11 per cent of households holding any form of unsecured debt are estimated

as over-indebted in 2015, more than double compared to the 5 per cent in 2012. Of

the over-indebted households, half are extremely over-indebted and so paying out

more than 40 per cent of their income to their unsecured creditors. In total, 3.2 million households or 7.6 million people are over-indebted, an increase of 700,000 or 28 per cent since 2012. On this basis nearly one in eight of all UK households are currently over-indebted. Likewise, 1.6 million households are in ‘extreme debt’.

It seems highly unlikely and highly undesirable as an object of economic policy to encourage yet further borrowing by a personal sector that is already highly leveraged. So where is the domestic demand growth going to come from if the economy is not to enter a deep recession? As noted above the business sector faces such uncertainty and such weak demand growth that they will not seek to expand their stock of fixed assets. While there might be some demand [net] as a result of the fall in the exchange rate this will depend on the trading arrangements finally concluded as a result of Brexit and be highly uncertain. Monetary policy under present conditions mirrors exactly the state that Keynes wrote about in the General Theory where there exists a ‘liquidity trap’ such that easing monetary conditions simply leads to the holding of excessive balances and a weak demand response [at best].

Key Policy Choices for UK

What needs to happen? Firstly, the British government needs to make it clear now that it will seek a permanent and ongoing trading relationship with the EU that as far as possible retains the existing set of arrangements. Anything else will leave the economy floundering in a world of uncertainty that will lead to falling output and rising unemployment – both avoidable. The EU referendum has already worsened the economic performance of the UK and economic policy needs to be re-set so as to sustain output and employment. We already have lower interest rates than other countries so there is no mileage in further cuts into negative territory for reasons marshalled above.

Secondly, the government needs to re-establish growth through a fiscal and industrial strategy that meets the needs of the country rather than one which is ideologically based. If the UK is to be able to compete in a globalised world then it needs public investment in both infrastructure and in human capital. It is precisely at a time of historically low interest rates that the government should expand its investment expenditure, through borrowing mainly and through higher taxation on the top 1%. The UK cannot possibly compete with China and the rest of Asia in terms of labour costs and cuts in nominal [and real] wages on the scale needed to do so are infeasible. So there is no choice but to invest in skills, training and education if UK is to remain a major trading country.

Finally, the argument that increasing the public debt will be inflationary has been shown to be a fable. During the period of the Cameron government, fiscal policy was a significant drag on the economy – totally unjustified in terms of constraints in financing borrowing in the capital markets. One consequence of neo-liberal fiscal policy was a major cutback in the level of public investment which is so essential for inducing and supporting investment by the private sector. It is unsurprising that productivity slowed further since the financial crisis of 2008/9 given the setting of fiscal policy which was based on rolling back the state. Yet the activities of the state are so critical for inducing productivity growth directly through its investment in people and in infrastructure.

Conclusions; policy choices for Europe

The key question now facing all of the Central Banks is how to re-establish more normal monetary conditions and when to do so. Clearly at some point rates of interest will have to be ‘normalised’ in all of the main countries but how to bring this about and what levels should be established are matters of judgement. The attempt by the Bank of England recently to establish a new lower rate of interest (noted above) was largely frustrated because insurance companies and pension funds (and other institutions) did not want to exchange existing holdings of government debt for cash. So it is not obvious how easy it will be through open market operations for Central Banks to actually move to higher interest rates and the process of trying to do so will probably bankrupt them. Currently the Bank of England and the European Bank are holding huge stocks of debt that they have purchased and in order to push up interest rates they will have to sell this debt with capital losses.

Perhaps more important are the effects on economic and social systems of moving to higher levels of interest rates in the near future. In part Central Banks have been using changes in the level of rates as a means of influencing their exchange rate – a beggar my neighbour policy that is generally condemned, but that doesn’t prevent countries from doing it. Of course shifting to higher interest rates has the potential for causing widespread  economic and social distress. To what extent other countries in the EuroZone will be similarly affected by rising interest rates is unclear but there would inevitably be widespread economic disruption. Given the already high levels of unemployment in Italy, Spain, Portugal and France any further fall in demand caused by higher interest rates would be disastrous.

There is, finally, the question that has been raised by Larry Summers which is whether we are facing in the US and Europe a set of structural conditions where for years to come output and incomes will grow much more slowly than in the past. A similar set of predictions were made during the Great Depression of the 1930s but the expected impact never materialised.  As we have argued many countries are now locked into such a trap and it is not at all clear how they exit and what role monetary policy needs to play. Clearly there is no case for the current fiscal straightjacket that the UK and the Euro Zone have imposed on themselves and the case for injecting demand through budgets has been made by many eminent economists – most notably Paul Krugman.

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