Economists and the Euro: for the record

Almost every time I write something about Brexit, I get at least one comment along the lines of ‘you economists got it wrong on the Euro, so why should we take any notice of you on Brexit’. This is beginning to annoy me, because in reality the opposite is true: it was because of economics and economists that we didn’t join the Euro in 2003. So the next time someone says the same to you, send them this blog post.

As far as I can see, the source of this ‘you got it wrong’ line is a poll that the Economist magazine did of academic economists on whether the UK should join the Euro in 1999. In that poll 65% said yes, and 35% said no. It was a good piece of journalism and a sensible survey, and it roughly corresponds with how I viewed academic opinions at the time. Claims by Andrea Leadsom that the Bank and IMF also recommended joining are simply wrong.

This poll has zero relevance to the Brexit issue for the following reasons:

1. Academic economists split 2 to 1 in favour of joining in 1999. In the case of Brexit, for every one economist that thought leaving was a good idea, there were 22 that said the opposite. So while a majority of economists favoured joining the Euro, the overwhelming consensus was that Brexit would involve economic costs.
   
   
2. Ask any academic about the Euro, and they will tell you that there are pros and cons, and it is largely a matter of judgement whether the pros or cons win. A key issue which I did some work on (with Rebecca Driver) was whether countercyclical fiscal policy could deal with asymmetric shocks. Our work suggested they could to a significant extent, but that made the proposed Stability and Growth Pact a concern. Others, looking at other types of risk, might come to a different conclusion.
   
   The contrast with Brexit is total. There are no major economic pros that need to be compared with the cons. Instead there are just economic costs, and the debate is about how large these will be.
   
   
3. Euro membership involved macroeconomics. Membership of the EU is mostly about trade. These are different branches of economics with little in common. Brexit involves the impact of geography on trade (gravity equations) and the impact of trade on productivity, while Euro membership involves the macroeconomic response to asymmetric shocks. It is a bit like refusing to have your hip replaced because your flu jab didn’t stop you getting flu.
   
   

The poll was in 1999. The UK did not decide to make a decision whether to join the Euro or not until 2003, and thankfully it did more than take a poll of economists on the issue. The Treasury was given plenty of time to analyse the pros and cons of entry, and it did so by undertaking a large number of studies. This is how policy advice should work in the absence of delegation: you do not ask the expert what the decision should be, but instead ask what the issues are and let the politician make the decision. I have discussed the so called 5 tests process, overseen by Dave Ramsden, in detail here. Most of the studies were done ‘in house’ by Treasury economists, but advice was sought from a large number of leading academics in the field. Peter Westaway was brought in from the Bank to write a couple, and I wrote a study on the optimal entry rate, extending and developing work I had begun back in the days before we entered the ERM.

The analysis was at the highest level, and I could detect no overt bias one way or the other. Some studies found significant benefits from joining, and others found significant costs or concerns. Although it is easy to be cynical, I have talked to some of the actors involved and it does seem as if the economics, encapsulated in these various studies, was critical in first convincing Gordon Brown and then Tony Blair that now was not the right time to join.

So the reality is that studies that summarised state of the art academic economic analysis stopped the UK joining the Euro. Without that, the decision on UK entry would have been down to politics, much like the formation of the Euro itself, and who knows how that would have gone. The economic analysis anticipated some of the problems behind the Euro crisis but not all. Economics is far from perfect, but that is no reason to ignore it when it says things you do not like to hear.

For economists Project Fear is Brexit

Ironically we have the Union’s side in the Scottish referendum debate for inventing the idea of Project Fear. Alex Salmond, who knows a bit about spin, immediately saw its potential, and the economic case against Scottish independence was branded Project Fear by the SNP. The implication of that label is that those using Project Fear are hugely overplaying their hand to frighten voters.

In the Scottish referendum the UK government’s case was that people would be significantly worse off in the short to medium term in an independent Scotland. It may have been met with the jibe that it was Project Fear, but in reality it was a pretty reasonable assessment of what independence might mean, parts of which were backed up by independent analysis from the IFS and the OBR. But together with some wishful thinking of their own, the SNP were able to dismiss all this economics analysis as just scaremongering.

Yet in reality things turned out to be even worse than the Treasury and independent analysis had suggested. That analysis assumed that the high oil price at the time would stay high. What actually happened was a sharp fall in the oil price, which would have been a disaster for an independent Scotland. So in the end the UK government’s case against Scottish Independence was understated. But Nicola Sturgeon keeps calling it Project Fear and journalists hardly ever challenge her on that. So by the rules of the politicisation of truth, any reasonable but negative assessment of the economic consequences of change is now seen as potentially politically counterproductive because can be called Project Fear.

It was therefore inevitable that the Leave side would pick up on this trick. They too knew that the economic facts were stacked against them. So they called the analysis produced by the Remain side Project Fear, and political commentators in the broadcast media - being balanced and all - found it easier to repeat the label than try and go through the arguments.

Yet the arguments are not rocket science. Countries find it easier to trade with others that are close by. If you make that trade more difficult by leaving the single market, some of that trade will go elsewhere, but not all of it for sure. The end result will be less trade. It is common sense, which happens to be backed up by lots of empirical evidence. There is also strong evidence that less trade leads to lower productivity growth, which means incomes grow more slowly. What is a key reason why China been growing so rapidly since the 1980s? Because it opened up to trade.

It is also common sense that if we leave the EU, foreign investment into the UK will fall. Invest now and you get easy access to the huge market that is the EU, so after Brexit many firms will go elsewhere to gain that access. This is why 9 out of 10 economists think we will be poorer after Brexit, with only 4 in every 100 thinking we will be better off. [1] As the IFS’s Director Paul Johnson wrote: “That degree of unanimity on any poll of any group of people about just about anything is almost without precedent.”

Faced with this level of unanimity, some in the leave campaign have tried to suggest that economists generally get it wrong. Yet ironically, one of the examples they choose shows completely the opposite, as Paul Johnson notes and I had also pointed out earlier. The UK’s decision in 2003 on the Euro was similar to the Scottish and EU referenda in the following way. Some politicians, for essentially political reasons, liked the idea of doing something they saw as bold: in 2003 it was adopting the Euro. The Treasury did an incredibly thorough job of looking at all the pros and cons, taking extensive academic advice, and convinced first Gordon Brown and then Tony Blair that the risks were too big. And just as in the case of Scottish independence, that analysis underestimated the problems the Euro would face. Luckily neither Brown or Blair thought this analysis was Project Fear.

The 2003 Euro work, and the Scottish independence work, were both headed up by the same man: Dave Ramsden, now Chief Economic Advisor at the Treasury. Having got two big calls right, he is just the guy you would want to be in charge of the Treasury’s analysis of Brexit. That Treasury analysis is once again pretty reasonable, and - just as with the Scottish referendum - has been shown to be reasonable by other studies [2]. The idea that you shouldn’t trust economists now because they always get it wrong has it completely backwards in this particular case.

But as Paul Johnson, myself and others have noted, the message from economists is either being ignored or has not got through. I do not think it is being ignored, for reasons outlined here and here. Which is why journalists in the broadcast media must stop this nonsense of obscuring the truth by being too literal about political balance. The problem, as I noted here, is that one point in the overall debate is obvious: you cannot control immigration from the EU within the EU. So if the media insist on obscuring the economic costs of Brexit by putting up nonsense analysis against the consensus among economists, or continuing to dismiss that consensus as Project Fear, they are effectively taking sides. Let’s hear less from political journalists about Project Fear, and more about the economic consensus that after Brexit wages will be lower and there would be less money for the NHS.

[1] There is this strange idea among Leave supporters that we cannot say people will be ‘poorer’ under Brexit, because being poorer can only mean less well off than you were in the past. I guess if the Brexit side are going to misuse numbers (£350 million a week), they are going to try and misuse language at the same time.

[2] Martin Sandu has a brief summary

Is evidence based policy left wing?

The answer in principle is of course not. In practice, not so clear. This is something I talked about back in October 2013, and there are no signs that things are getting better. Alex Marsh makes the same point in the context of the latest budget. This antagonism to ‘unhelpful’ evidence is out there in plain sight for all to see in the UK government’s current attempt to deny academics in receipt of public funding the ability to talk about the policy implications of their work. I talked about this in terms of the misuse of the term ‘public money’ a few weeks ago, but it is also a pretty direct attempt to suppress unhelpful advice. (Note that ministers have the power under this proposed legislation to revoke this ban in individual cases, presumably when evidence is ‘helpful’ - to them.)

Of course we are not talking about a hostility to evidence based policy by everyone on the right on all occasions. In a THE article by Ben Goldacre, where he also highlights the dangers of the government’s proposed legislation, he details the extent to which he is talking to ministers about evidence based policy. But that interest does not seem to extend to big macro decisions. I was reminded in reading this about what I regard as a triumph of evidence based policy making in my own area: the UK Treasury analysis of Euro entry in 2003. (Disclaimer: my little contribution is the fourth one down in the picture of the reports.) Why didn’t this government do something similar for both the Scottish referendum and the EU referendum?

Everytime I mention the 2003 exercise someone responds that it was just a smokescreen for a power play between Brown and Blair. I think this is an overly cynical view, a view that evidence never changes anyone’s mind. Ramsden’s own view is that the civil service, using the evidence, “ultimately persuaded both the Chancellor and in particular the Prime Minister that it wasn't right to join." It was also the right decision. With both recent referendums we have seen proponents of change putting out documents suggesting that change will not be economically damaging, when most evidence shows pretty clearly that it will be. With the EU referendum in particular, would it not have been better if the government had asked the Treasury to do a similar exercise to 2003, using outside experts where appropriate to provide or validate the technical analysis?

Ben Goldacre’s piece reminded me of my own recent place on John McDonnell’s Economic Advisory Council (EAC). From Ben’s tweets I knew that he was not the greatest fan of this government, and in particular their current treatment of junior doctors, so I asked him whether he had received any negative comments from doctors or others about him giving advice to the government. I was not surprised to hear he had not. Who could object to him taking the opportunity to argue for better use of data and trials in medicine and elsewhere with people who just might do something about it?

It is a shame that some people did not take the same view when I agreed to be on the EAC. I would lose credibility as a macroeconomist, I was told. When McDonnell did his U-turn about supporting the fiscal charter, some suggested this reflected badly on me, even though he had turned in the direction I thought was correct! One charge in particular was levelled at the time. We were being used to make the leadership look respectable, but our advice would in practice be ignored. A couple of weeks ago Labour adopted a fiscal rule which is based on my own work with Jonathan Portes, and in particular by a presentation I made to the group. Mariana Mazzucato’s own work has also featured strongly in Labour party speeches, with good reason.

At the end of the day, policy makers need to look at evidence. If they do not we need strong mechanisms that allow them to be confronted by this evidence. Policy makers that make space for evidence and take decisions based on it need to be congratulated for this, rather than being told their efforts were just a smokescreen. They should be congratulated because letting evidence in often involves a risk: not just to the policy maker’s priors or preferences but also for scrutiny of past actions. Equally we should regard policymakers who knowingly ignore evidence with great suspicion, and those that try to deliberately keep evidence out of the public domain should be condemned.

Privatisations: why we need a fiscal watchdog

When the government sold its shares in Eurostar (the London to Paris train service) around a year ago, its primary motive according to a recently published national audit office (NAO) report was to reduce the level of government debt. [1] As the NAO says “Some asset sales are justified by government on the basis that the sale will result in improved efficiency for the business but this was not the case with Eurostar.”

The key point with privatisations is that reducing current debt may harm the health of the public finances. Any normal investor would only sell an asset if they thought they could get a price that exceeded what the asset was really worth. Although selling the asset would reduce the government’s net borrowing today, it would increase their net borrowing in the future because the government would not get the dividends the shares paid out.

The fact that the government had the wrong motives is an unfortunate by-product of debt or deficit targets. By necessity these targets have to be ‘realisable’ (to use a term from my paper with Jonathan Portes) - they have to be targets that are within the lifetime of a parliament. But that gives any government an incentive to effectively cheat: to sell off assets (like Eurostar) that help meet targets in the short term, but make managing the public finances beyond this more difficult. (This post discusses the point in more detail.)

So how do we judge if selling Eurostar was a good or bad decision? Reports that there was a general belief that the value of the shares would rise are worrying. To be honest I do not know the answer to this question, but in essence that is my point. Given the clear danger that the government will sell assets just to meet its short term targets, we need some independent institution to assess whether the government is being sensible or is cheating. (In some other cases, like selling off the student loan book, the cheating is pretty clear.)

The NAO had a remit which did not address these issues, although it tries in its report to at least raise them. [2] The obvious body to analyse and publicly report on issues of this kind is the OBR, but this is also not in the OBR’s remit, and at present it can at best only drop hints. With a large privatisation programme over the next five years, the government was never going to extend the OBR’s remit in this way, and (coincidentally?) the Ramsden review does not seem to have addressed this issue directly. The OBR needs to become not just a producer of forecasts, but more of a fiscal watchdog.

Without some independent oversight of this kind, we will have the irony of government ministers arguing that privatisations are needed because we must reduce government debt for the sake of future generations, when in reality they may be increasing the burden on future generations. We need a fiscal watchdog to protect future generations from shortsighted governments.

[1] Although the headline level of public debt is often described as net, it in fact only nets off liquid financial assets.

[2] The key technical issue is discounting, and how you handle uncertainty. Even if the government gets the current market price, that price may be low because the private sector discounts future returns heavily. That heavy discounting may reflect vulnerability in the face of uncertainty, whereas the public sector has much less vulnerability.  

Fiscal council developments

As longstanding followers of this blog will know, I have a particular interest in what are called either ‘fiscal councils’ or ‘independent fiscal institutions’. As I have been and will be preoccupied with other issues for a while, I thought I would try and squeeze in one post on recent developments both in the UK and abroad.

In the UK we had Dave Ramsden’s Treasury review (pdf) of the OBR. The most positive aspect of the review is the recommendation for more resources. I guess the headline news was that the OBR would not be asked to cost opposition policies before elections, as the Dutch fiscal council has done for some time, and as the Australian PBO now does. I would have liked a different decision, but my disappointment is mitigated by three factors:

• the report does recommend the “OBR should ensure greater availability of tools and data to allow third parties to cost alternative policy options”.
  
• in the UK we have the IFS, which does do this and currently (and rightly) has a quasi-official status
  
• the level of the fiscal debate in the UK media is currently so poor that I’m not sure how much such a development would improve things.

This last point raises something of a paradox. People like me hoped that fiscal councils like the OBR would improve the public debate. This paradox reflects in part the particular nature of the OBR, which would not be allowed to say - for example - that the fiscal charter is economically illiterate (i.e. no economist agrees with it). Fiscal councils in some other countries can do that, and indeed were set up to do that. This is a gap the IFS cannot fill. I guess the OBR will not be allowed to comment on the economics of different fiscal rules until the UK gets a more sensible rule. I think it is quite likely that if the OBR was able to say such things, we would not have had this particular fiscal charter and we would all be better off as a result.

With the rapid growth in the number of fiscal councils around the world, the case for some kind of international network has become much stronger. It is therefore good news is that one is about to be established for those in the EU. There are at least two important roles such a network can have, apart from the obvious one of spreading best practice.

First, it can help establish and maintain independence for individual fiscal councils, which may be put under various kinds of pressure by their national governments. Sometimes this pressure is just verbal, and often indicates that the council is doing its job. I have just come back from Ireland, where the Irish fiscal council criticised a pre-election giveaway by the government. Its chairman John McHale also suggested that it might break the Commission’s fiscal rules. The government then revealed that it had obtained agreement from Brussels, but had not told the fiscal council. It managed to spin this as an error made by the council, which journalists dutifully parrotted. Substantive criticism was thereby deflected. That kind of thing from governments is only to be expected. It becomes more serious when governments react to criticism in financial or even existential terms, as has happened in Canada and Hungary. In those cases, the council needs all the defence it can get.       

Second, a network can act as an important pressure group on the Commission. The Commission itself has recently established an Advisory Fiscal Board, which if nothing else can increase the dialogue between the fiscal councils and the Commission. I talked about the dual system of fiscal monitoring within Europe here, and how I hope we will see a gradual reduction in central control and more discretion given to national governments monitored by strong national fiscal councils. If Daniel Gros is right and German hegemony is coming to an end, then maybe it might just happen - one day.