What bond market constraint?

Yes, bond markets are a constraint upon a leftist government - but maybe not the biggest one.

“The cost of government borrowing” writes MP Yuan Yang “constrains policy decisions”. She’s partly right, but this should not greatly trouble the left.

First, we must recognise that to a large extent the bond market constraint is in fact an inflation constraint. If a government were to borrow significantly more, bond investors would fear that the higher aggregate demand would raise inflation. This would lead either to expectations of higher interest rates as the Bank of England tried to control inflation, or to fears that their gilts would be redeemed in pounds that were worth less. Either would force up yields and hence borrowing costs.

On the other hand, government debt in itself is much less of a problem. We know this because yields were much lower in the 2010s than in the previous decade even though debt was twice as high; and because yields hit a record low in 2020 as Covid pushed up the debt-GDP ratio but rose sharply in 2022 when Russia’s invasion of Ukraine raised inflation expectations.

All this is quite compatible with there being a “political risk premium”. A weak government, unable to take unpopular decisions such as cutting spending or raising tax, is more likely to increase borrowing.

But, but, but.

For one thing, higher inflation is a problem whether there’s a bond market or not simply because the public don’t like it; they think a pay rise is due to their own merit but a price rise is someone else’s fault. The bond market just gives governments a more timely signal of this problem.

And for another, this is a constraint upon right-wing as well as left-wing governments. When Truss cut taxes for the rich in 2022 yields rose as the markets feared higher inflation.

The converse of this is that if we were to impose massive tax rises on the rich bond yields would probably fall as the market anticipated weaker demand and lower inflation. The MMTers have a point: higher taxes are an anti-inflationary policy. And bond markets would welcome this.

The bond market would welcome some leftist policies.

But not all. Imagine a government were determined to increase economic growth by improved supply-side policies - be they looser planning laws, tax reform, better financing of start-ups, better competition policy, economic democracy, whatever. And imagine further (which might be a stretch) that the bond market were to believe it would be successful. What would happen to yields?

They’d rise, even if the increased growth were not to cause inflation. This is not because markets hate the left; yields would rise even with the centre-rightist policies advocated by Westlake and Bowman as long as they increased economic growth. Instead, it is merely because if investors anticipated better economic growth they would try to sell bonds to buy assets that were more sensitive to economic growth, such as equities.

Wouldn’t this also add to government borrowing costs?

Yes. But the same growth that causes borrowing costs to rise would also bring in extra tax revenue. It’s not good enough to go “borrowing costs up, ugh”. What matters is why yields rise: one that occurs because of a higher Trump tax (increased oil prices) is a bigger problem than one that is a reaction to the prospect of faster economic growth. Rising bond yields aren’t necessarily a bad thing, and aren’t necessarily a constraint.

Which brings me to my beef. If we’re going to talk about constraints upon government policy, let’s not single out only one. Let’s discuss others.

One is simply the overt power of capital. Under capitalism governments must maintain business confidence if there’s to be investment and growth, which requires business-friendly policies; the lobbyists give big business disproportionate influence not only over politicians but also over regulators; and the prospect of well-paid jobs after politics helps ensure that politicians work for the rich.

Another constraint is our debased public realm. Not only does this amplify Farage’s right-wing lies, it also pushes rank bad economic policy such as austerity and Brexit and distorts the political agenda, giving too much weight to immigration* and not enough to issues that really matter for living standards such as how to better control utilities; how to cut the cost of infrastructure projects and military procurement; how to reallocate labour; how to improve management; how to provide and pay for social care; how to divert entrepreneurs from rent-seeking to productive activities; whether and how to promote economic democracy; and so on. And this is not to mention the Kuenssberg-Mason-Peston habit of ignoring policy in favour of Westminster tittle-tattle and the fact that even the very best journalism (of which we see little) provides a distorted view of the world by focussing on human interest rather than social science.

Personally, I suspect this constraint is less binding than many imagine, and that the power of the media is like that of the Wizard of Oz, an illusion. Whilst governments believe in it and act accordingly, however, it is a constraint not only upon leftist policy-making but all intelligent policy-making.

This belief, however, is not the only mind-forg’d manacle. Politicians are selected to be biased towards an excessive confidence in top-down policies and against decentralized policies and institutions that give agency to ordinary people. So they have too much faith in managerialism and too little in economic democracy, well-functioning markets, freedom and emergence. That forecloses a lot of policy options - not only leftist ones such as more worker ownership or market socialism but also rightist ones such as more use of markets.

Another constraint is an ideology that disposes voters and politicians to be deferential to the rich. Adam Smith famously wrote:

We frequently see the respectful attentions of the world more strongly directed towards the rich and the great, than towards the wise and the virtuous. We see frequently the vices and follies of the powerful much less despised than the poverty and weakness of the innocent...The great mob of mankind are the admirers and worshippers, and, what may seem more extraordinary, most frequently the disinterested admirers and worshippers, of wealth and greatness.

Several cognitive biases feed into this disposition.

One, described by Kris-Stella Trump, is an anchoring effect: our perception of what is fair is coloured by the actual existing distribution of resources. So when the top 1% get 13% of pre-tax income as they do now we think big inequality is more acceptable than we did in the early 80s when their share was only 7%.

Related to this is a status quo bias, a preference for the existing state of affairs even if a change would benefit us. Building on this, John Jost has developed system justification theory (pdf), the idea that “even members of disadvantaged groups would – for psychological reasons – want to believe that the existing social system is legitimate and justified.”

A third bias is wishful thinking. People over-estimate their future incomes and under-estimate risks, leading them to be overly supportive of austerity and benefit cuts. The same bias might cause them to be too sympathetic to Reform’s plans to deport immigrants, believing these will only affect “bad” immigrants rather than their friends, neighbours and relatives.

A fourth bias arises from reference groups; we tend to compare ourselves to those around us. This causes the poor to be less hostile to the rich (who are out of sight, out of mind), and more so to benefit claimants and migrants who are their neighbours. And so we get not class envy but rather within-class envy (pdf).

And so we have an ideological bias against questioning inequality and towards despising the poverty and weakness of the innocent. That’s a constraint upon egalitarian policy-making.

Now, we can and should argue over just how binding these constraint are: I suspect they are less so than you would infer from Labour’s current behaviour. But that is a separate issue. The main point is that the bond market is by no means the only constraint upon intelligent leftist policy-making, and very likely not the biggest one.

* As Ben Ansell has shown, people actually living in diverse areas are more supportive of immigration. Which suggests anti-migrant sentiments are at least in part a media confection rather than the result of actual lived experience.