British politics is poised on a knife-edge. With Theresa May’s cabinet split between fervently pro- and anti-Brexit-factions, a snap general election could happen at any time. If Labour Party leader Jeremy Corbyn were to win power – as seems increasingly possible – the shock to global markets would be much greater than the fall-out from Brexit itself.
Specifically, the prevailing assumption that low inflation and interest rates are here to stay would be immediately challenged – not just in the UK, but as a general proposition. Instead, it would become apparent that the current configuration, far from being structural, is the result of political choices.
In essence, the Corbyn project is an attempt to roll back the 1980s, reversing the emphasis on deregulation, financialization and market-based solutions collectively known as Thatcherism. Since Thatcherism was itself a response to the high inflation and trade union power of the 1970s, Corbynomics implies a reversal of the disinflationary tide.
The UK is a bellwether for political trends because of its openness to regime shifts such as the coming of Thatcherism in 1978. The first-past-the-post electoral system and the lack of US-style checks and balances makes the executive all-powerful. As the UK is not in the euro and has voted to leave the EU anyway, a Corbyn administration with a working majority in the House of Commons would have a free hand to put its programme into practice.
Reeling back the years
Corbyn, a maverick figure on the left of Britain’s Labour Party since the late 1970s, has been reticent about the specifics of his economic policies but the outline can be gleaned from the position papers of close advisors. Key aspirations are stimulating productive (as opposed to real-estate related) investment, boosting the UK’s notoriously poor productivity and reducing inter-regional inequality via infrastructure programmes and directed bank lending.
A Corbyn administration would establish a Strategic Investment Board to co-ordinate relations between the Bank of England, the Treasury and the Department of Business, Energy and Industrial Strategy. The Bank of England’s mandate would be re-written, perhaps to include a wage growth target.
Symbolically, the Board would be located in Birmingham, the nation’s second city and former industrial heartland. Some functions of the Bank of England would move there too, though it is unclear whether Governor Mark Carney would be housed somewhere near Birmingham’s famous Bullring.
The diagnosis of the UK’s economic ills is accurate. Whether the proposed cures would work is unknown. By the standards of today’s conventional wisdom, they are heterodox and radical, but it is worth noting that they are not far from the two party consensus of the 1960s and early 1970s.
Other policies can be inferred from various comments of Corbyn and his likely Chancellor of the Exchequer, John McDonnell. Stepped-up public spending on health and education is practically a given, as are higher taxes, more redistribution and higher wage settlements. Nationalization of railways and water companies would also be on the agenda. Public ownership of utilities is standard in several European countries, but a renationalization at fair value would cost a lot of money.
Put all this together and the current, extraordinary phenomenon of negative real UK bond yields (bond yields below the rate of inflation) would likely come to a traumatic end. Given the UK’s yawning current account deficit of 4.6% of GDP, capital flight and a plunging pound is a serious risk.
Even so, it would take many years before the final verdict on Corbynomics could be pronounced. As with the early years of Thatcherism, voters – especially younger voters – might be prepared to put up with a certain amount of turmoil. Higher inflation and interest rates, perhaps significantly higher, would likely be tolerated as inevitable by-products, just as mass unemployment was a tolerated by-product of the fight against inflation in the early 1980s.
Explanations or excuses?
Demographics, secular stagnation, disruption, “amazon-ification”, globalization, the new normal, the gig economy, death of the Phillips curve, the coming of the robots– these are some of the concepts that have been used to explain a phenomenon that almost nobody predicted. Since the Global Financial Crisis of 2008, despite massive programmes of quantitative easing (QE), inflation has remained at rock bottom levels across the developed world. Recently real growth has picked up and unemployment has fallen dramatically, but wage growth has been stuttering at best.
The search for structural explanations is understandable. And the concepts cited above derive from real and highly visible features of the contemporary world, which gives them intuitive plausibility. Who has not taken advantage of music and movie streaming, taxi apps and “free” video chat services and marvelled at the convenience and cost compared to old technologies?
Yet this is hardly the first time in history when technological change has devastated industries and communities: the economic restructuring of the early 1980s was far more brutal, yet accompanied by relatively high inflation. Furthermore, today’s consumers are not spending less of their incomes as result of the lower costs of services, but merely spending differently.
The demographic explanation is similarly unsatisfying. Researchers at the Bank of Japan have laid the blame for deflation on Japan’s ageing population structure. If accepted, this deterministic view would absolve policy makers – such as the BoJ itself- for any responsibility for Japan’s “lost decades” of deflationary stagnation. Yet the Bank of International Settlements has published a report which comes to the opposite conclusion. According to Charles Goodhart and Manoj Pradhan, “as the world ages, real interest rates will rise, inflation and wage growth will pick up and inequality will fall.”
In labour markets, supply shocks – such as the rise of China, mass immigration and increasing female employment – have reduced the bargaining power of employees and contributed to the golden age of capital of the past quarter of a century. Yet the way these shocks have been absorbed inevitably involves political choice.
It was a political decision – a mistaken one, in the opinion of U.S. President Donald Trump – to allow China to join the World Trade Authority in 2001. Likewise, it is quite possible for rich, ageing countries to reject mass immigration, as Japan has done. On the other hand, many countries, with Japan one of the most prominent, have accommodated an increasing number of female workers in a part-time category that enables employers to secure the same amount of labour at roughly half the standard cost.
Political choice was also evident in the nature of the response to the Global Financial Crisis. The scale of the QE programmes was enormous, but the content was conservative. Commercial banks ended up swapping one kind of low return asset, a government bond, for another, reserves at the central bank. Without the fiscal expansion required to channel newly created money into the real economy, the result was tepid growth and stubbornly low inflationary expectations.
The policy wheel is turning
In the British TV series Life on Mars, a modern-day detective time-slips back to the mid-1970s, where he struggles to fit in with the mindset of the era. Economically it was a different world too, with prices and wages spiralling upwards at double digit rates in many countries.
Some thinkers of the time – such as Alan Greenspan, well before his stint as Chairman of the Federal Reserve – believed that inflation was the inevitable result of the adoption of fiat currencies. The prospect of disinflation, let alone outright deflation such as Japan has suffered, would have seemed fantastical. In the end, inflation became public enemy number one and inflation-fighting politicians and central bankers vanquished it, in some cases at great economic and social cost.
Today high inflation seems an impossibility. In the public mind, rising prices have long ceased to be a threat. Indeed, such a mainstream figure as ex-IMF chief economist Ken Rogoff has advocated a 6% inflation target, rather than the standard 2%, in order to erode debt burdens. In Japan, Prime Minister Shinzo Abe, a political conservative, is trying to incentivize major companies into offering higher wages.
In the post-Global Financial Crisis world, job quality, social fracture and inequality of many kinds, including inter-regional and intergenerational, have become the major political problems. Corbynomics is the most radical attempt yet to provide a solution. If electorally successful, it is likely to produce imitators elsewhere.
Even if Corbyn does not win power, we are probably just one recession away from more overtly inflationary policies adopted by pragmatic mainstream politicians keen to stay in power.
