Forging capitalism

12 Dec 2014

This is the text of my recent book review in the Financial Times

Astute observers of capitalism have long recognised there is a tension at its heart. Although the market economy is based on the pursuit of self-interest, its legitimacy depends on benefiting the wider society.

These two contrasting elements were understood as far back as the second half of the 18th century. Adam Smith, viewed by many as the founder of modern economics, famously argued in The Wealth of Nations: “It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest.” Less well known is that in his other great book, The Theory of Moral Sentiments, he emphasised the importance of human sociability. Smith saw virtue as necessary to keep the pursuit of self-interest in check.

Capitalism’s subsequent history amply illustrates both the broader benefits of a market economy and the problems that arise when self-interest becomes selfishness. There can be little doubt that popular living standards have increased enormously over the decades. Even the poorest sections of society have access to material possessions that the wealthy of the 18th century would have found unimaginable. On the other hand, there is always the temptation for those pursuing honest profit and self-interest to cross over the line to greed and fraud.

Forging Capitalism is an engaging history of how Britain attempted to negotiate this tension in the century running up to the outbreak of the first world war. The title is a pun. It is a study of the rogues, swindlers and fraudsters who tried to benefit from the market economy through the use of deceit. It is also an examination of how capitalism itself was forged through evolving mechanisms to curb these dishonest tendencies.

Ian Klaus, a member of the policy planning staff of the US state department and a former Harvard academic, includes many colourful rogues. Among them are Lord Thomas Cochrane, who in 1814 attempted to benefit from spreading false rumours of Napoleon’s death. Since the Napoleonic wars were coming to an end such news would have a substantial impact on asset prices. Cochrane quickly sold his holdings in Omnium, a form of government stock, which had risen in price on the false news.

If such stories have a familiar ring it is probably because they provided raw material for some of the most prominent figures in English literature. Novelists such as Charles Dickens, William Thackeray and Anthony Trollope were inspired by some of the same characters and tales.

The other side of Klaus’s story is how different mechanisms evolved to tackle breaches of trust. In the early 19th century the emphasis was on status and virtue. Transactions were typically underpinned by the standing of those involved and market participants were expected to behave virtuously.

By the mid-19th century these notions were giving way to reputation. Although the concept was not new, it became more important and prominent. An increase in literacy and technological developments played an important part. The expansion of the press meant that news about an individual’s reputation could be more easily transmitted to the public.

Finally, in the latter part of the century, there was the shift to what Klaus calls verification. This form of regulation is closer to what exists today, including institutions such as credit rating agencies and the financial media, to check the veracity of transactions. There were also new technologies, such as fingerprints, to verify individual identity. It was during this period that the state came to play a much more prominent role in authenticating information.

The one weakness of Forging Capitalism is that it underestimates the extent to which the market economy was transformed over the century it covers. Klaus sometimes refers to free market capitalism as if it is a system that still exists. Yet by the late 19th century it was already clear the state was playing a central role in supervising and underpinning economic activity. Certainly by the eve of the first world war the role of government was vastly greater than a century earlier.

There is considerable room to debate whether this transition was desirable or even inevitable. But it is striking how few contemporary commentators are willing even to acknowledge it.

In the light of today’s publication of a report by the Organisation for Economic Co-operation and Development (OECD), a rich country think tank, my spiked essay on inequality is worth rereading. The OECD broadly argues that high and rising inequality damages economic growth whereas I contend that, if anything, causality runs in the other direction. In other words rising inequality in the developed world is in my view a symptom, rather than a cause, of economic weakness.

It is worth noting that much of the media coverage on the OECD study overstates the certainty of its conclusions. The headlines of the report are simply being used to confirm the pre-conceptions of the anti-inequality brigade.

It is sad fact that as the emerging economies have become wealthier the discussion of development has become ever more degraded. Whereas the focus used to be on economic transformation, attempting to turn poor countries into rich ones, the new generation of experts promotes behavioural correctness.

Take a look at the 2015 edition of the World Development Report, the World Bank’s flagship publication, with its focus on “Mind, Society and Behaviour”. Among the interventions it suggests are giving lentils and metal dinner plates to those who have their children immunised, showing inspirational videos on escape from poverty and sending weekly text messages to remind patients to take their HIV medicine. It is a long way from the old orthodoxy where the emphasis was on such projects as building dams, power stations and roads.

The patronising “nudges” favoured by contemporary experts are based on supposed insights gleaned from behavioural finance. Although psychology can throw light on individual behaviour its use by development experts tends to be banal and misleading.

To begin with it identifies three principles of human decision-making: automatic, social and using mental models. The first and third of these are drawn from the work of Daniel Kahneman who won the Nobel prize for economics in 2002, except he refers to system one (fast) and system two (slow) thinking.

Fast and slow thinking are contrasted with the economists’ conception of rational economic man. Individuals often make quick fire judgments and they also use mental models which can sometimes be misleading.

The problem with the behavioural argument is that the notion of rational economic man is made of straw. Few economists would argue that humans act solely as calculating machines when it comes to making decisions. People often do make decisions without much thought and they can indeed be misled by the concepts they use. These are not the great insights that the behavioural finance experts often suppose.

On the contrary, humans have the ability to interact with each other and to reflect on their choices. This provides the opportunity to make important decisions through the clash of ideas in public debate.

Although the World Development Report does discuss social decision-making its conception is exceedingly narrow. The focus is one-sidely on how social pressures can influence people to think in a particular way: “human sociality implies that behaviour is also influenced by social expectations, social recognition, patterns of cooperation, care of in-group members, and social norms.” There is little appreciation of how, through social interaction, it is possible to change society for the better.

The behaviourists have a dim view of the ordinary people of the developing world. Such pundits are so pessimistic about human potential they think progress consists of nudging individuals towards behaviour that the experts deem as correct.

The most positive outcome would be for the nudgers to be ridiculed. Living standards in Asia in particular have risen tremendously in recent years through ignoring the obsession with individual behaviour and promoting economic growth.

This blog post was first published today on Fundweb

The audio recording of my Battle of Ideas 2015 session on “PIGS can’t fly? Surviving austerity” is now available to listen to online here.


Two of my articles, a book review  and a feature, are published in today’s Financial Times (free registration may be necessary to read). I will upload the text at a later date.

This article was first published in the December issue of Fund Strategy.

Of all the confusing areas of economics one of the most bewildering is public spending. Despite its centrality to public debate in Britain most people probably shrug their shoulders when they hear it being discussed. Yet its profile is likely to get higher still with the Autumn Statement and next year’s election.

It is not that it is inherently that complicated. The problem is that some basic distinctions get muddled. Sometimes there is deliberate obfuscation on the part of politicians and experts debating the subject. So, in the interests of clarifying a key subject, there follows some key points to bear in mind.

Let us start by taking public spending as a whole – rather than dividing it into constituent parts. There is a pervasive assumption that the Thatcherite wing of the Conservative party wants to slash it and Labour wants it to remain high.

That premise does not stand up to critical scrutiny. Those who want to examine the question in more detail are fortunate to have comprehensive data freely available at: There is also further information on the Office for Budget Responsibility ( ) and HM Treasury ( ) websites.

One way to measure public spending in real terms over time is to look at it as a proportion of GDP. There was clearly a huge surge in spending during the second world war but in recent decades there has been no clear trend either way. Spending has risen and fallen with the economic cycle but it has fluctuated around roughly the same level.

For example, public spending for 2014 is forecast at about 43.5% of GDP according to That is about the same level as in 1967 and 1968. In the meantime it fell as low as 34% in 1989 and rose as high as 48% in 1975. In other words, despite all the talk of Thatcherism and neo-liberalism there has been no clear trend towards cutting public spending. Indeed one of the sharpest falls, over five percentage points in four years, came during the Labour government of the late 1970s.

However, if spending is measured on an inflation-adjusted basis and per head basis (taking into account the rising population) the trend looks more like one of steady increase. Spending per head in 2013 (the latest available figure) is calculated at just over £10,000 in constant 2005 pounds. That is not far off twice the level in real terms as when Margaret Thatcher became prime minister in 1979.

Both sets of figures beg the question of why there is so much talk about spending cuts. It is clear from the record that, whatever the rhetoric, spending is stubbornly resistant to such initiatives over the long term.

A closer look at the figures over the last few years helps explain recent developments. In 2008, with the economy going into recession, public spending surged. According to the OBR’s figures it increased from 39.9% of GDP in 2007-08 to a peak of 45.3% in 2009-10 (see graph). This was under a Labour government but it is likely that more-or-less the same would have happened under the Conservatives.

The forecasts for the coming years are even more striking. The OBR forecasts public spending to be at 40.2% of GDP in 2016-17 – that is higher than it was in 2007-08 despite all the talk of cuts. It is also worth noting that public spending is forecast to rise this year in real terms compared with last year. Public spending is only being cut relative to its recent, artificially inflated, peak.

So all the figures on total spending show without doubt there is no trend towards a shrinking state. On the contrary, it looks certain that government will continue to play a huge role in society and in the economy. The claim that Britain is a free market – if that is taken to mean a minimal role for he state – is contradicted by the data. It may or may not be a desirable goal but it is certainly not what exists at present nor is it on the agenda for the foreseeable future.

If spending is not being cut in real terms it begs the question of why it is being so widely discussed. One answer is that spending is falling in certain areas even if aggregate cuts are small.

Take the estimated spending of £731bn in the 2015 fiscal year as an example. The Government has said it is going to protect health spending (about 18% of the total), education* (12%) and overseas aid (1.5%).

There are also large areas of spending which are not classified as departmental spending such as debt interest payments (7%), pensions (20%) and welfare benefits (15%).

That means there are areas which are suffering substantial cuts, such as local government spending, but there are others which are not being cut at all. The cuts get most of the attention but such a one-sided focus provides a grossly misleading picture of the overall trend.

It is high time that debate on the subject was better informed.

* School spending in particular is protected.

The biggest challenge facing the world economy is not the difficult economic conditions but what could be called gloomsters. These are the fatalists who think nothing much can be done about economic problems besides tinkering with monetary policy or public spending.

Gloomsters are not what Margaret Thatcher long ago called “moaning minnies” . On the contrary, they can appear on the face of it to be relatively upbeat about economic prospects. But underlying their policy prescriptions is a deep pessimism about the prospects for creating a more dynamic economy.

Gloomsters can take Labour and Conservative forms. Labour politicians tend to argue that a little less austerity is in order until the economic cycle turns. Conservatives, on the other hand, say a tighter squeeze on public spending is necessary. But neither has much of a clue about how best to promote economic restructuring. Raising investment levels and bolstering productivity plays little part in their discussions.

Take the prime minister’s recent claim that the “red lights are flashing on the global economy”. The thrust of David Cameron’s argument was that the British economy is doing well but the coalition government has to stay on course with spending cuts because of global economic weakness. Essentially it was an exercise in complacency. Britain may be forecast to growth more strongly than other developed economies this year but its medium and longer-term record is poor. The prime minister prefers not to put Britain’s record into its proper context as he is a gloomster: he believes that little can be done to tackle it.

Mark Carney, the governor of the Bank of England, takes a similar view to Cameron. In a recent speech  he echoed Karl Marx and Friedrich Engels when he noted that “a spectre is haunting Europe”. Only Carney was not talking about a communist revolution but economic stagnation. He then went on to argue that Britain is doing better than continental Europe. After that he talked narrowly about inflation and monetary policy.

Of course monetary policy is the Bank of England’s remit. It should be up to elected politicians rather than central bankers to devise a broader economic strategy. Unfortunately there is little sign of this broader debate anywhere.

The trend towards gloomsterism is even stronger in Japan. From late 2012 onwards the Japanese prime minister, Shinzo Abe, pursued an approach that became known as Abenomics . This consisted of three “arrows”: monetary policy, fiscal policy and structural reform.

In the event the Japanese government promoted an expansionary monetary policy and a looser fiscal policy, at least in the short term, but only limited structural reform. The basic weaknesses of the productive economy were left intact. It should not therefore have come as a surprise that the economy contracted in the third quarter to fall into its third recession in four years. Japan is facing yet another election as a result.

It is time that gloomsters of all stripes were challenged. There is a desperate need for a focus on promoting dynamic growth rather than tinkering with monetary policy and fiscal deficits.

This is my latest blog post for Fundweb.

Sabine Beppler-Spahl has interviewed me on Israel and anti-semitism in the latest edition of Novo magazine (in German). The text is not available online but the publication can be ordered here.

There follows the text of my recent spiked article on austerity.

It is widely accepted that Britain’s coalition government, like many of its counterparts across the developed world, is wilfully imposing harsh austerity on the public. In this view, the government is subjecting the population to an ideologically motivated squeeze on living standards in a desperate bid to balance its finances. Widespread misery and hardship are portrayed as the inevitable result.

Unfortunately, this version of events is seldom questioned. Its rare critics tend to be fiscal hawks who argue that current spending cuts are insufficiently severe. There is an urgent need to interrogate the notion of austerity to draw out its underlying assumptions more clearly.

This is not to deny that many people are suffering from a squeeze on their living standards. On the contrary, it is to argue that what is happening is in many respects worse than generally recognised. Many have suffered stagnating incomes for a decade or so, and, even worse, the public is becoming increasingly marginalised from the democratic process.

This is one of those times where it helps to start by defining terms. The Oxford English Dictionary website defines austerity as: ‘Difficult economic conditions created by government measures to reduce public expenditure.’ Although economists typically add more jargon, this gets to the heart of the matter.

The definition is generally taken to embody three questionable assumptions: that public spending is being cut; that this reduction is the main force behind falling living standards; and that the economic malaise is essentially cyclical or short-term. Let’s examine each premise in turn.

First, the assertion that the government is cutting public spending, although not entirely false, is grossly misleading. A little historical perspective helps put the cuts in their proper context.

It is true that the Conservative-led coalition was elected to government in May 2010 on a programme that included public-spending cuts. Only it preferred the coy language of reducing the deficit – that is, the amount the government borrows each year – and promoting fiscal responsibility. Nowadays, the preferred jargon often refers to fiscal consolidation.

It is important to remember that in 2010, the UK Labour Party did not oppose spending cuts in principle. Instead it argued that the government’s fiscal retrenchment was reckless and premature. In other words, Labour claimed it would have made its implementation of cuts more gradual if it had won the election. Indeed, the Labour government’s final budget, introduced in March 2010, was already promoting ‘savings’ in public spending. The differences between all the main parties in relation to economic policy are much smaller than widely assumed.

There was a consensus that recovery should not be far off. If there were differences, they focussed on exactly when it was likely to arrive. After the economic contraction of 2008/2009, all the main parties assumed the economy would be able to turn the corner before too long. From that perspective, it seemed that public spending, which had surged during the recession, could be gradually reduced from its 2009/2010 peak.

Just before the emergence of the recession in 2008, the level of state spending in the UK – what is technically called total managed expenditure – was running at slightly below 40 per cent of GDP (39.9 per cent in the 2007/2008 financial year, according to the official Office for Budget Responsibility data). With the onset of the recession, it rose to a peak of 45.3 per cent in 2009/2010, while the level forecast for the current financial year is 42.5 per cent. Public spending had surged during the economic contraction as more money was pumped into the economy. In addition, the amount spent on what economists call ‘automatic stabilisers’, such as unemployment benefit, also rose as the economic situation deteriorated. According to the most recent budget – and this assumes the government will be successful in meeting its plans – it will not be until 2017/2018 that spending will be lower in real terms than it was a decade earlier.

So the government has made cuts in its total spending if these are measured from its peak at the end of the last decade. But in historical terms, this year’s level of spending remains high. Leaving aside the exceptional period from 2008 to 2012, the last time public spending exceeded the current level in real terms was in 1986/1987. The first part of the definition of austerity – that the government is trying to reduce public spending – should be highly qualified.

Second, the implication that recent cuts in public spending are responsible for stagnating living standards is misleading. The relationship between these two factors is not clear-cut. Living standards in Britain have in some respects deteriorated for a decade or so – predating the recent surge and subsequent fall in public spending.

According to a study by the Resolution Foundation, a think tank, median wages flatlined and disposable incomes fell in every English region outside of London from 2003 to 2008. So for a large section of the population, the squeeze on living standards predated the talk of austerity by several years. The parallel trend in America and Germany goes even further back.

It is true that spending cuts in certain areas, such as local authorities, have hit living standards. This does not necessarily translate into a drop in individual incomes, but it often means that the quality of public services has deteriorated. Benefit cuts can mean falling living standards for many, too.

However, the key driver in stagnating living standards for the bulk of the population is the lack of earnings growth. According to official statistics, real wages have fallen in real terms since 2009. By last year they had dropped to their level of a decade earlier. This trend was already becoming apparent to many before the peak in government spending.

Finally, Britain’s economic weakness is primarily structural rather than cyclical. In other words, it is not simply a short-term glitch that will fade away as recovery materialises. Nor can it be explained in terms of malevolent government policy or the callous pursuit of neoliberal ideology. It reflects, instead, a lack of underlying economic dynamism.

Those who favour the term austerity often condemn those who advocate spending cuts as austerians. Behind this derogatory label is the Keynesian assumption that the drive to cut the deficit at this stage is ideologically driven. If only the austerians would wait until a recovery emerges, then, so many Keynesians argue, it would be the right time to impose cuts.

This ignores the deep-rooted character of the West’s economic malaise. As Phil Mullan argued in a spiked essay in June, the average rate of economic growth started to fall in the 1970s and has dropped in every subsequent decade. This has been accompanied by low levels of investment and a poor record on innovation.

The Keynesian response is essentially to keep trying to postpone initiatives to tackle these structural weaknesses into the future. Rather than work out how best to promote economic restructuring and expansion, the emphasis is on muddling through by pumping money into the economy. The result is that fundamental economic problems never get resolved. They simply reemerge at a higher and more destructive level.

One result of this failure is that future increases in average living standards are likely to be weak at best. Poor economic growth is generally translated into a slow rise in household incomes. The government’s muddling-through approach is a key factor underlying aneamic growth.

So, characterising the period since 2010 as one of austerity is misleading. Public spending remains high, incomes had already started to stagnate before that year’s election, and the economic malaise is structural rather than cyclical.

However, there is one additional and arguably even more important reason for refusing to describe the recent period as one of austerity. That is not because of what the label includes but what it excludes. Critics of austerity fail to see any problem with the increasing marginalisation of the public from the democratic process. On the contrary, it is often a development that they welcome as a necessary precondition for economic stability.

There are countless examples of public disenfranchisement, but in the economic sphere perhaps the most blatant is the move towards independent central banking. It is often forgotten that until 1997, an elected politician set interest rates in Britain: the chancellor of the exchequer. This was important, as it meant they were directly accountable to an elected parliament.

The shift to letting central bankers set rates was made with the explicit goal of insulating an important part of economic policy from public pressure. Advocates of central-bank independence argued that there was a danger that politicians might be tempted to keep interest rates artificially low. The underlying assumption was that they would be tempted to kowtow to a supposedly greedy and foolish public.

Yet since 1997, central bankers have come to play an ever-more central role in economic policy. Not only do such elite technocrats set interest rates – they also feel free to make public pronouncements on fiscal policy, too. Elected politicians seem to want to outsource as many decisions as possible to the technocracy.

The charge of austerity misconstrues the economic challenges facing Britain and the West more generally. Not only is the economic malaise more deep-rooted than generally assumed, but the public is routinely excluded from democratic debate.

This is not austerity

10 Nov 2014

My latest spiked article  disputes the claim that Britain, and the West more generally, is suffering from austerity. The malaise is deeper and wider than the A-word suggests. I will post the full text in the next few days.