So. Farewell Sir Nicholas. Yes, you were monumentally wrong

In memoriam of the career of Sir Nicholas Macpherson, upon his retirement
After E.J.Thribb, Private Eye’s 17½ year old poet

So. Farewell
Then
Sir Nicholas
Permanent Secretary to
The Treasury

How did you
Manage
Within ten years

To nearly destroy not once but
Twice
The UK economy

Which blew up thanks
To your
Ideology

Followed by your
State-shrinking
Poor-hitting
Plan-failing
Austerity

With such a record
Of monumental error
You should surely have
Been

A very
Temporary Secretary
To the Treasury

Yesterday’s Financial Times included an article by political editor George Parker on Sir Nicholas Macpherson, outgoing Permanent Secretary to the Treasury.  It contains this passage:

“I see myself as one of a number of people in finance ministries, central bank regulators, in the UK and the US who failed to see the crisis coming, who failed to spot the build-up of risk… This was a monumental collective intellectual error.” (My emphasis)

It was certainly a monumental collective error, but I doubt “intellectual” is the right adjective. “Ideological” is far more accurate.  For what we saw was a perverse and deliberate refusal to “see the crisis coming” since for free market fundamentalists such as Sir Nicholas, and that admirer of Ayn Rand, Alan Greenspan, there could be no such crisis caused by liberalisation and deregulation of markets, financial or otherwise.

Well at least now, nearly ten years on, Macpherson accepts that it was a monumental error – for which he and others in charge of economic policy were never held responsible.

But he has certainly not admitted to two other monumental “intellectual” errors – also collectively shared by many others – namely that an economy broken by the private financial sector will be fixed by austerity policies, and his conviction that governments should never intervene in markets, come what may.  On the latter issue, Parker tells us this:

Referring to the crisis at Tata Steel’s British operations and calls for state support, he stands by the Treasury’s Gladstonian belief in free trade and the need for the market to “allocate economic resources”.

“Someone has got to represent the consumer and I think far too much debate in Britain is seen through the lens of the producer,” he says. “In the end the point I would make to people who want to intervene is that supporting the lame ducks has never been a successful policy.”

The idea that the steel industry should be allowed to collapse on the altar of free trade short-termism is truly bizarre (or fundamentalist), given that no one believes there is in fact a true competitive global steel market – and whatever unseen hand there may be is evidently not “allocating economic resources” in a remotely efficient way.  

That the most senior official in the Treasury seems unable to understand that there are strategically important industries in which we must maintain knowledge and capacity – let alone seek to defend these industries against dumping – is again a tribute to the monumental ideological failures of the British establishment.

And so on to Sir Nicholas and austerity.  Parker calls him “a hawkish Treasury austerian”:

Since the crash Sir Nick has been an enthusiastic advocate of austerity and supports George Osborne’s target of an absolute surplus by 2020. “It’s entirely sensible,” he says. “I’ve only had four years in 31 at the Treasury when there has been a surplus. If you don’t aim to get the surplus, you’ll never get there.”

This shows just how ideologically right-wing Sir Nicholas’s politics are – identical indeed to those of George Osborne.  He knows that what is involved is huge exercise in shrinking the size of the supportive/protective state through cutbacks in public services and in benefits – and does not explain why attaining an overall surplus (i.e. including in relation to long-term investment) is itself beneficial.  

The key reason for his failings is that he sees the economy more from a microeconomic than a macroeconomic perspective.  In his speech in 2013 on “the origins of Treasury control”, he explains that after the Harold Wilson’s Department of Economic Affairs bit the dust,

“As Sir Douglas Wass said in the 1970s:
‘as the attempt of the DEA failed … so it fell on the Treasury to fill that gap and to concern itself with the supply potential of the economy.’

And thereafter the Treasury has progressively built up its role on the supply side – not least because of the recognition that ultimately it is microeconomic policy which is most likely to promote growth. As Nigel Lawson said in his Mais lecture of 1984:

The conventional post-War wisdom was that unemployment was a consequence of inadequate economic growth, and economic growth was to be secured by macro-economic policy … Inflation, by contrast, was increasingly seen as a matter to be dealt with by micro-economic policy … But the proper role of each is precisely the opposite of that assigned to it by the conventional post war wisdom.

This focus by Macpherson and others on the microeconomic (supply side) while dismissing the macroeconomic (aggreagte demand) explains a lot about the Treasury thinking about economic policy and austerity – and why they have got it so badly wrong for so long.  For they do not adequately see the impact of influencing demand in the economy via the multiplier, and indeed try to wish the multiplier away altogether.  

At the same time, he and the Treasury have failed in their own terms, since productivity and other supply side indicators remain poor, and even the relative success in employment is due to real wage reductions and a growing pool of marginally self-employed.

Macpherson’s ideological prejudices were apparent in his speech (4th February 2016) on “The General Theory at 80: Keynes and Treasury policy-making today” in which he – having briefly but faintly praised Keynes – curtly dismisses the idea that, post-financial crisis, there is or has been any possible alternative to the policy of the 2010 and 2015 governments, i.e. the Bank of England’s loose monetary policy allied to austerity-based fiscal policies.

The General Theory, Macpherson says,  

also provided much though not all of the basis for what came to be known as “Keynesianism”: a view that government could not just manage demand but seek to smooth the operation of the trade cycle through fiscal policy. Whether Keynes himself would have supported such an approach, had he lived, we will never know: the General Theory was focused on addressing persistent depression.

In fact, we do know reasonably well, from Keynes’s wartime writings, that – while laying most emphasis on monetary policy – he also advocated a strong public investment-led policy that, necessary in its own right, also aimed at maintaining equilibrium.  In June 1943 Keynes wrote

the capital budgeting is a method of maintaining equilibrium; the deficit budgeting is a means of attempting to cure disequilibrium if and when it arises.

  Macpherson, on the contrary, positively favours economic downturns as healthy for the economy:

I would argue that there are positive benefits (as well as costs) to the trade cycle provided it can be kept within reasonable bounds. As Nigel Lawson has said, “the superiority of market capitalism lies in particular in two areas: the freedom and encouragement it gives to innovation and risk taking…,and the discipline that drives up efficiency and drives down costs. The former is stimulated most during the cyclical upswing, and the latter is compelled most during the downswing.

Lawson is clearly one of Macpherson’s favourites.   Lawson, we recall, created the worst trade cycle boom and bust scenario in post-war history after the Barber boom and bust of the 1970s.  As a leading Brexit fundamentalist and climate change denier, Lawson does seem an odd choice for a Treasury Permanent Secretary to idolise, but there we are.  (The 2008/9 financial crisis was of course not a simple trade cycle downswing, but the result of the dis-regulated finance sector being permitted and encouraged to run riot  by policy-makers and top advisers like Sir Nicholas).

Macpherson argues that for Keynes in the 1930s, nominal (and hence real) wages were seen as sticky, with nominal wage cuts being resisted by the trade unions.  This meant that other forms of action than wage cuts in downturns were needed. But those days, Macpherson suggests, are gone:

First, the labour market is much more efficient than it was in the inter war period. Policy since the 1980s has focused on reforming industrial relations, improving work incentives and pursuing more activist welfare to work policies. Just as unemployment peaked at a lower level in the 1990s recession [1], so did it again in the 2009 recession, with unprecedented real wage adjustment facilitating the maintenance of employment.  Keynes’ case for public works in the 1930s rested on his view that nominal (and hence real) wages could not adjust not least because of the strength of the trades union movement. [My emphasis]

Thus Macpherson is arguing that in today’s circumstances, if you cut average real wages by over 10% (as has happened) – and in many cases nominal wages – there is no case for fiscal action such as public works.  In his words, today’s labour market is “more efficient” because it more easily enables workers’ pay to be cut.  Indeed he seems to argue that for Keynes, if wages had been able to fall in a similar way, there would have been no case for public works in the 1930s!

Yet – now as then – income and demand are squeezed out of the economy by this cut in real wages, a point that Macpherson’s obsession with supply rather than demand does not permit to take into consideration. Although the IMF’s Economic Counsellor, Maurice Obstfeld, is making a general point, we should surely heed his comment in the April 2016 World Economic Outlook that 

Monetary policy cannot bear the entire burden of responding to current challenges; it must be supported by other policies that directly boost supply and demand. [p.xiv]

Macpherson, on the contrary, argues that there is no demand-side problem, and – even more bizarrely – that there is scarcely any multiplier effect at all – a remarkable distortion. 

Over my working life, there has been a persistent tendency to mistake structural weakness for cyclical weakness. Keynes was writing at a time of chronically low demand but it’s not at all clear that recent experience fits this description…

On the face of it, output has diverged from trend by up to 4 per cent of GDP since 1990. Using OBR estimates of the multiplier, stabilising the output gap would have required at times interventions of £100 to £250 billion compared to a neutral stance.

While annual increases in GDP have on average been considerably less since the financialisation of the UK economy than in the “Keynesian” post-war era, the main divergence from trend has surely been in the period since the financial crash. 1990 is an odd starting point as it is the start of the post-Lawson bust and recession which resulted from that maestro’s policies.  But the OBR have assumed a notoriously low multiplier, and it is extremely probable that a major investment programme of say £40 billion more per year since 2010 would have had a major positive impact – and led to the deficit declining faster as a percentage of GDP, or at least no more slowly than the actual path.  

For it is precisely under the Osborne/Macpherson austerity policies that the budget deficit has remained higher for longer than at any other period in our post-war life. 

The biggest average overall deficits for any  post-war 6 year period are these, in reverse order:

1992/93 to 1996/97      3.9% of GDP (Conservative government)
2004/05 to 2009/10      4.9% of GDP  (Labour government – includes 2 peak crisis years)
1974/75 to 1979/80      5.1% of GDP  (Labour government)
2010/11 to 2015/16      6.3%  of GDP  (Conservative-led and Conservative governments)

To the winner, the spoils.  And the winners of the big fat UK deficit prize are… George Osborne and Nicholas Macpherson.

So.  Farewell then, Sir Nicholas.  I wish you a long retirement in which to reflect on how and why you got the big things so very, very wrong.

Footnote:

[1]  This is only marginally true.  Unemployment peaked in 1992/3 at 10.7%, and was over 9% for 3 years.  In 1984 it had reached a peak of 11.9%.  Indeed, throughout the last 17 years of the Thatcher/Major governments (from 1980 on), when labour markets were being made “much more efficient”, unemployment fell below 7% – and then only to 6.9%! – for just a few months during the Lawson-induced boom.