Politics vs Econ101

Politicians are ignorant of basic concepts in economics

Once upon a time, the phrase "classical liberal" meant something other than "racist crank". In that idyllic era, those liberals loved to point out how their opponents were failing to understand Econ101. I yearn for those happy days, because our government is actually committing just this failure.

Giles Wilkes points to one way it is doing so. In her Spending Review, he says, Reeves did not tell us what programmes were being cut to finance her pet projects such as Sizewell C or Transport for City Regions. This, says Giles, means it's impossible to say how much (if at all) the Review will boost economic growth, because we don't know (and I suspect not does Reeves) how much the green-lighted projects will boost growth relative to the projects not undertaken. She is ignoring opportunity cost.

A more egregious example of this lies in the government's promise to raise military spending to 3% of GDP. This, of course, means that almost a percentage of GDP less will be spent elsewhere - on either private sector capital spending, other public services, or private consumption. All these cuts (relative to what would otherwise be the case) carry costs - one being that they risk continuing the visible symptoms of economic decline such as pub and shop closures that have fostered support for the far right.

Maybe these costs are worth it, maybe not. My beef is that Labour isn't trying to show that they are costs. That's a failure of basic economics.

And it's not the only one. Another is an apparent reluctance to recognize the concept of comparative advantage, the notion that countries (and indeed regions or people) should specialize in what they are least bad at.

Like it or not, much of the UK's comparative advantage lies in higher education and the creative arts. But Labour is restricting these by imposing a levy on income from foreign students; making it hard for musicians to earn a living by red tape on EU tours or by allowing nimbys to restrict music venues; or by allowing the theft of writers' work. By contrast, the government is supporting less competitive industries such as steel, even though it makes little sense for this to be produced in a country with some of the highest energy costs in Europe.

There's another way in which this government, like its predecessors, are ignoring Econ101: transactions cost economics. Why do companies exist? Why not instead just pick up workers to do specific tasks (as with TaskRabbit) or buy all inputs on spot markets from suppliers? The answer, wrote (pdf) Ronald Coase in 1937, is that it is sometimes expensive and difficult to use the price mechanism as the buyer often cannot specify in advance (or even verify after the fact) precisely what he's getting:

Owing to the difficulty of forecasting, the longer the period of the contract is for the supply of the commodity or service, the less possible, and indeed, the less desirable it is for the person purchasing to specify what the other contracting party is expected to do. It may well be a matter of indifference to the person supplying the service or commodity which of several courses of action is taken, but not to the purchaser of that service or commodity.

Coase's work inspired a massive field devoted to the question of when things should be allocated by the price mechanism and when by companies. And it's a field successive governments have ignored in contracting out services that are subsequently badly or expensively done. It might be easy to tell if your office is cleaned well, but can you really tell whether a child is well brought-up or an old person well cared-for? And if you can't, then you can't enforce the contract. (I strongly recommend Sam Freedman's Failed State on this.

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If you're beginning to see a pattern here of ignorance of basic economics, you'd be right. Here are five other examples:

- Competition. Strongly competitive markets don't just help customers get a better deal. They also improve productivity by forcing bad companies out of the market and enabling good ones to expand. Rachel Reeves, however, seems to be weakening the Competition and Markets Authority in an attempt to "attract investment" by permitting more takeovers.

- Free trade. Econ101 advocates this for the same reason it likes competitive domestic markets. Of course, global free trade is impossible whilst the orange abomination is in the White House, but the government's remaining outside the Single Market - whatever other case there might be for it - is unjustifiable by conventional economics.

- Balance sheets have two sides. Rachel Reeves has said that nationalizing utilities "just doesn’t stack up against our fiscal rules”. But in acquiring a company the government would get an asset that pays a higher return than debt. That would actually strengthen the government's balance sheet. Reeves ignores this obvious fact because the fiscal rules look only at debt but not at assets, as if a home-owner focused only on his mortgage and ignored the value of her house. Which of course makes no sense.

- Regulatory capture. "Regulation is acquired by the industry and is designed and operated primarily for its benefit" wrote (pdf) George Stigler in 1971. And this is true of Ofwat and Ofgem, who offer regulators the prospect of well-paid jobs, thereby acquiring the freedom to pollute and overcharge. To its credit, the government is aware of the "failure of regulation and governance" in the water industry. But it has been slow to change this, and seems unaware that this is a systemic problem with regulation.

- The tragedy of the commons. Back in 1968, Garrett Hardin pointed out that commonly-owned assets were in danger of becoming worthless as people over-exploited (pdf) them - for example as herdsmen overgrazed common land, or fishermen depleted fish stocks or (we might add) as polluters put too much carbon into the atmosphere. In many ways, Hardin overstated his case because as Elinor Ostrom showed (pdf), people devise ways of conserving the commons. But there's one way in which he was right. The public sphere is a common asset that is being degraded. The media pushes an agenda which squeezes out many issues; dishonesty often prevails over honesty; and politicians are selected sometimes for incompetence and often for a distorted view of the world. And yet the government shows no sign of wanting to do anything about this.

In all these respects, what we have is a government largely detached from economics. Not that this is true only of the Labour party: almost all I've said applies equally or more so to the Tories and Reform 2025 Ltd.

You might reply that this is a good thing, because Econ101 is wrong. True, it sometimes/often is. But this doesn't explain or justify Labour's ignorance of it, any more than can Trump's tariffs be justified by the errors of basic trade theory. In fact, the opposite. The government is most deferential to Econ101 in just those areas where it is wrong - for example in not recognizing the many imperfections in labour markets, or in equating a high wage with high social utility.

The question of whether one subscribes or not to heterodox or orthodox economics is logically if not sociologically largely independent of one's politics.

In terms of policy recommendations, I'm not making an especially leftist point here. Yes, Econ101 might oppose privatization in its current forms and urge restictions upon those media which produce intellectual pollution, which is as much a negative externality as environmental pollution. But wanting competition and free trade were once conservative principles.

In another sense, though, I am posing a radical question. Why is it that our politics has become so degraded that it has abandoned basic economic reasoning? Might it have something to do with the nature of UK capitalism?