An assessment of messages emanating from the Conservative Party Conference 2023
| |In 2015 I interviewed the constitutional economist Hector McNeill concerning his development of the Real Incomes approach to economics when he reviewed the macroeconomic problems facing Britain and suggested solutions. It is notable that his analysis at that time has turned out to have been precise and, as he predicted, the current state of the economy.
The British Government party, the Conservatives are holding their Party Conference in Manchester and contrasting statements are emanating from this platform.
In this interview with Hector McNeill I seek his assessment of some of the more notable statements.
During the course of this interview, Hector covered topics which readers might wish to explore further so I have placed some links to some short briefs on these matters in a box on the right of this page.
Nevit Turk, Senior Economics Correspondent, Agence Presse Européenne, Paris
Hector McNeill is Director of the Real Incomes Objective (RIO) Development Programme at SEEL-Systems Engineering Economics Lab.
A graduate of both Cambridge and Stanford Universities he read agriculture, economics and systems engineering.
He initiated the development of the real incomes approach in 1975 when be realized that Keynesian and monetarism could not tackle inflation or stagflation without imposing significant prejudice on the electorate.
RIO is a distinct theory and its policy propositions are designed to close the operational gaps in Keynesian and monetarist policies. The RIO alternative is the only current policy proposition able to eliminate inflation.
Hector coordinates the Strategic Decision Analysis Group (SDAG) and is Editor of this year's British Strategic Review.
Nevit: It is very good to meet you again and have a chance to review your thoughts. Last time we met was in 2015 when you set out the problems with macroeconomics and proposed solutions. Most of your comments of defects in macroeconomic policy have turned out to be correct, given the current state of the British economy. I want to limit this interview to what the governing party in Britain is saying about the economy and to ask, essentially, if they are on the right track.
Hector: It is a pleasure to meet you again and I note that you followed that interview up with some useful analyses on the Real Incomes Approach which are a sound representation of the then current state of development. The theory has advanced considerably and the propositions remain the same.
Thank you. I would welcome the opportunity to review these developments at another time but today we have agreed to review some of the Conservative Party Conference declarations. The former Prime Minister, Liz Truss, made a notable presentation in essence repeating, in part, a presentation she made perhaps a couple of weeks ago at the Institute of Government. This time she emphasized lowering corporate taxation to attract investment, reducing the size of government to get rid of red tape and to emphasize house building. She ended her presentation expressing the desire that the UK should " .. build more and make things."
Hector: Truss's objective of building more and making things is of course correct. However, the policy solution of lowering corporate tax rates while appearing to be logical is unlikely to work as expected. Her emphasis on the corporate taxation factor is crucial and a far better proposition than the supply side economics marginal tax rate reductions for high income individuals. This approach under Thatcher and Reagan simply augmented income disparity because the windfall gains were largely pocketed by high income individuals and executives.
Nevit: Why is Truss's taxation angle unlikely to work as expected?
Hector: It is very evident that Liz Truss wants her followers to focus on the last 25 years of economic decline, I think because this coincides with the beginning of the Labour Blair administration. However the national economic decline, which is now self-evident, started around 1975 when monetarism became the central paradigm of macroeconomic policy. This initiated an industrial decline, falling export balance in goods, an expanding low wage services sector, declining real wages and rising income disparity.
Nevit: But what has this got to do with monetarism?
Hector: Monetarism has two unfortunate properties which detract from the essential growth imperative of innovations in technical processes. First of all, monetary policy never eliminates inflation. Inflation is a constant factor throughout the monetary policy decision cycles including high and low interest phases as well as when the policy objective of 2% inflation are attained. Under constant but varying inflationary conditions wage earners and companies face the constant challenge of a declining disposable income purchasing power because of the declining value of the currency caused by inflation. The second issue if that between 1975 and 1995 monetarism coincided with a globalist movement to reduce investment in British onshore innovation and technical growth and to increasingly invest offshore in lower wage regions, largely in South East Asia, so as to lower the unit costs of production. This of course raised profits on imports to the United Kingdom sold to a population undergoing a gradual decline in real incomes. As a result the industrial and manufacturing base in this country declined along with the loss of skilled and semiskilled better paid jobs. This created depressed regions in the Midlands and North of England, in Scotland, Wales and Northern Ireland, these regions today are those requiring levelling up and better infrastructure with such projects as HS2.
Nevit: You are highlighting monetary policy as a cause of economic decline, is there any relationship between this and Rishi Sunak's announcement to cancel the final leg of HS2?
Hector: Yes, monetary policy is a major cause of this outcome. Since the mid-1950s to date, the average CPI inflation rate has been around 3.5%. Of course basing inflation on goods and service prices significantly underestimates the actual inflation rate. For example under generally inflationary conditions companies deploy "anticipatory pricing" whereby prices are raised to compensate rises in input costs. These price rises are designed to ensure that at the end of any trading period the company will have sufficient cash flow to purchase the inputs required for the next production period. Naturally the higher the rate of inflation the higher the rate of output price increases based on anticipatory pricing. To avoid not having sufficient cash flow, companies tend to raise unit output prices at a rate that slightly exceeds the input price inflation. Since over the stated period average inflation rate has been around 3.5% this does not include the other important prices
which affect the cost of living and company input prices. Rather than save, many corporations purchase assets in the knowledge that their value will increase over time. In the case of land and real estate, over that same period prices rose 25 fold while wages rose just 12 fold. Land and real estate not only represent higher rents and prices for wage earners wishing to purchase or rent a house, they also represent rising input costs in the form of industrial, retail, warehouse and office units. There has been therefore over the same period a hidden addition to the CPI of perhaps a 20% addition or a average real inflation of around 4.2%.
|Some useful references|
This brief explainsin simple terms why the Quantity Theory of Money identity is flawed.
Theories of Money
This brief explains how monetary policy imposes income disparity favouring asset holders and traders and prejudicing wage earners.
This brief explains how the prejudice of the errors in monetary theory affect all conventional macroeconomic theories and practice.
A common error in macroeconomic policies.
Nevit: Is this anticipatory pricing the basis of the "greedflation" accusations against companies?
Hector: Yes, well spotted. Some academics have made a fuss about this and some assert that this is a new discovery. These academics seem to lack business experience or haven't followed real incomes development. We pointed out this phenomenon as far back as 1975. It is a widespread common practice of businesses facing input cost inflation and it follows logical financial procedures of maintaining cash flow value.
Nevit: With respect to Liz Truss statements how do these impact the feasibility of her propositions?
Hector: If one is dealing with her "building" part such as HS2 or housing, such projects take time, so this 4.1% real inflation is a problem. The longer the project, the more impact monetary policy has on feasibility. For example, in the case of HS2 the original budget was £37.5 billion in 2010 so after 13 years the purchasing power of that amount would have declined by 42% based on a simple projection at -4.2% each year. However delays and unexpected complexity of aspects of the work saw funds spent on other activities. As a result what might have been a 42% budgetary problem doubled bringing required budgets up to in excess of £70 billion. This degrading of purchasing power slows down work as procurement attempts to fit things into the current budget and government decision making is also slow so building anything to budget and on time under the current monetary policy environment becomes impossible. This applies to Liz Truss's ideas concerning house construction.
What is even more tragic is that her appeal that we should be "making things" falls flat because we are an economy which under the influence of 50 years of monetary policy effects employs just 17% of the working population "making things" in industry and manufacturing surrounded by a very large low income services sector which makes nothing. More successful economies have at least 26% of their working population in industry and manufacturing.
Nevit: What you seem to be stating is that the Bank of England mandate of managing money volumes and price stability, has not only failed it has contributed to the decline in the economic capabilities of the country.
Hector: Yes, this is the state of affairs. This constant erosion of the purchasing power of the economy resulting from the Bank of England never bringing inflation down to zero affects local authority budget values eroding effectiveness, it undermines the effectiveness of NHS budgets and maintains a serious cost of living issue.
Nevit: It is notable that the Prime Minister in his address did not refer to the cost of living crisis but then he has previously stated that this is due to supply chain issues during Covid and the war in Ukraine.
Hector: I think the Covid-related constraints have now been worked out of the system but the Ukraine question is not new. I first started investigating macroeconomic policies in the wake of an OPEC sanction of oil importers linked to the fact that this country had supported Israel in military clashes with Arab States related to the question of Palestine. Then, as now, our inability to manage our international affairs concerning foreign, security and military involvement policies have landed this country in another serious inflationary crises linked to energy prices. The last on between 1973 and 1993 lasted 20 years and was associated with the introduction of monetarism as a way to solve this inflation. But as we have seen, monetary policy, to this day, was never able to eliminate inflation.
Nevit: Why does the Bank of England have a 2% inflationary target? Surely this guarantees that they will never eliminate it.
Hector: You would need to address that to the Bank of England because there is no logical reason. The Federal Reserve Chairman, Jerome Powell, was asked this question some weeks ago and he could not provide an explanation. There was a stage discussion the other day involving Andrew Bailey of the Bank of England, Jerome Powell of the Fed and Christine Lagarde of the European Central Bank all seriously reflecting on the need to raise interest rates to get back to 2%.
The constant depreciation in the value of the currency resulting from their failure to eliminate inflation will maintain a need for finance to compensate but this on the face of it is unconstitutional. The Bank of England should not be there to drum up business for banks. On the other hand central banks venture to suggest that bringing inflation to zero (0%) risks a downward spiral of deflation and depression.
Nevit: Is there a relationship between zero inflation and the onset of depression?
Hector: No there is not. There is no evidence to support this assertion. Andrew Atkeson & Patrick Kehoe completed a detailed study on this across many countries and covering an extended period and found no such association. The nearest a country came to this sate of affairs was the case of Japan in the 1990s associated with quantitative easing.
Nevit: So why does the Bank of England cling to this notion?
Hector: It seems to be related to an assertion made by Milton Friedman around 1969 where an "optimal" monetary policy would have a nominal interest rate of zero resulting in prices falling steadily at the real interest rate. What is missing from this analysis in technological advance and innovation which result in important benefits including deflation or price reductions. A typical example is how the prices of digital devices, linked to the nature of this technology, constantly decline even when the real interest rates are fairly elevated and inflation exists in other products.
Nevit: Why did Japan approach this combination of deflation and depression?
Hector: Monetarism and monetary policy is based on the notion of the role of money volumes determining demand and inflation. In reality John Maynard Keynes applied the same theory substituting money volume by aggregate demand raised through government borrowing. Both of these notions find agreement in the so-called Quantity Theory of Money which states that money volumes determine average prices of goods and services. That sounds logical but in reality the economy has many "money sinks" to which money flows, other than goods and services. These money sinks are assets including land, real estate, shares, commodity positions, precious metals, rare art and objects, financial instruments, cryptocurrencies, savings and overseas flows. Therefore, the application of quantitative easing involving massive injections of money and close to zero interest rates created bubbles in asset markets and a depression in goods and service markets. Those companies who for technological reasons could lower their prices encountered difficulties as a result of falling real incomes and demand for goods and services and rising costs resulting from assets used in production experiencing steep price rises. Part of our work in real incomes has resulted in the creation of an alternative to the Quantity Theory of Money which includes variables for the main asset classes and this is referred to as the Real Money Theory (RMT) and this makes it self-evident that the Quantity Theory of Money, the mainstay if monetary policy and Keynesianism, is flawed.
Nevit: How does this flaw show up in practice?
Hector: This flaw shows up as a constant flow of money to financial intermediaries, banks and hedge funds. In the low interest period money flows into larger holdings of assets by banks, hedge funds and corporations and during high interest rate periods money flows to the banks as the difference between the base rate and the interest rates charged. In either state of affairs wage-earners lose out in relative terms resulting in a constant pressure creating income disparity. Then at the 2% "policy target rate"" of inflation the purchasing power of the currency continue to decline at a rate of around 18% each decade. This maintains a latent demand for loans and credit as real wages decline in value.
Nevit: All of this is of some concern because it sets a somewhat worrying perspective on how the United Kingdom has mismanaged the economy and maybe explains why during this Conservative Conference there has been no reference to these serious structural issues. After all the cost of living crisis was hardly mentioned and any levelling up priorities appear to have been canceled by the cancellation of HS2.
Hector: Yes, until we move macroeconomic policy away from this monetary policy foundation the economy will continue to decline.
Nevit: In the previous week, Liz Truss did mention that she thought the Bank of England mandate needs to change. Do you think she was referring to this?
Hector: I doubt it. You might note that both Labour and Conservative parties extol the virtues of Bank of England independence while being incapable of stating what these are. At the moment it is very evident that the Bank serves the interests of the tiny faction of the financial community, asset holders and traders as a preference over the particular concerns or interests of the majority of the British electorate who are wage-earners. In the political realm both Labour and the Conservatives know that any attempt to intervene in this cosy relationship would result in enormous financial and media pressure threatening the future of the party or the prospects of those politicians advocating change.
Nevit: Is this the logic of the mantra, "There is no alternative"?
Hector: Yes it is a mix of the perspective of politicians and dishonest economists, whereas for the interests of the nation, which all politicians seek to convince the electorate is their whole reason for existence, it is self evident that this approach to macroeconomics is highly prejudicial and for this reason alternatives need to be sought.
Nevit: I am aware of your alternative propositions under the RIO banner but I feel that we need to discuss this as a separate interview. Could we do that sometime in the coming weeks? But to bring this interview to an end I would comment that I found to be surprising in the final analysis of the Conservative Party Conference was the lack of reference to the current very obvious concerns of the electorate. HS2, a new baccalaureate and reducing smoking was a strange mix of announcements by a party hoping to gain support in the next General election.
Hector: The actual economic and financial situation has the Conservative and Labour parties in denial at the inappropriate nature of monetary policy and monetarism in general. They refuse to openly analyse economic and financial problems, the same can be said for many conventional economists so as to avoid a bad press. The depressing reality is that in terms of monetary policy and its prejudicial nature on the prospects of this country and the wellbeing of the majority neither the Conservatives or the Labour party offer any viable options. My own conviction is that we need a fundamental change to independent representatives with sound alternative economic policies to replace what has become a Uniparty.
Nevit: Something else to explore in another interview perhaps? Thank you very much for this informative exchange.