Avoid the technocratic trap, the wishful thinking trap, the mediamacro trap and the false analogy trap
The American economist Alan Blinder once set out what he called the lamppost theory of economic policy. In his words, “politicians use economics the way a drunk uses a lamppost, for support, not for illumination.” (1)
In an earlier age, John Maynard Keynes made a different criticism. He thought politicians did use economic ideas for illumination, but the problem was they often used outdated ideas which were no longer valid. He famously wrote, “Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist.” (2)
It is true that economists and politicians inhabit very different worlds. Few economists have experience of working in frontline politics. When they offer prescriptions for, say, increasing growth or reducing the budget deficit, they are – entirely understandably – less able to assess what the political costs will be and whether those costs are bearable. Meanwhile, political strategists focus on how to frame the choice between the parties or candidates in the most advantageous way electorally, but they tend to lack the economic expertise or the short-term incentive to highlight and advise on the difficult trade-offs.
I was an adviser in Downing Street when the last Labour government had to reorient its economic policy and its political strategy in response to the global financial crisis. We had the benefit of some brilliant economic and financial experts but most of us in politics had no prior experience of the forces we were dealing with in the financial markets. So after our election defeat in 2010, I decided to study for a master’s degree in finance and I went on to spend most of the next decade advising companies engaged in mergers and acquisitions. In 2019 I returned to government, this time as a civil servant at the Competition and Markets Authority where I was surrounded by economists, none of whom, happily, defunct.
Political debate this year is likely to be dominated by economic questions more than in any election since 2010, so I have been thinking more about the lessons of that period for policymakers today. If you are interested in my reflections on that time, you can read this article in full, or alternatively you can just skip straight to my thoughts on what it means for policymakers today.
The financial crisis: an economic paradigm shift…but not in time for the political cycle
When Gordon Brown became Prime Minister in June 2007, the United Kingdom was enjoying the longest sustained period of economic growth in over a century. But the coming year would see a crisis that would break the conventional economic paradigm and shift the political tectonic plates in ways that required Labour to find a new approach.
The roots of the crisis were in a set of apparently beneficial financial innovations that ultimately led global banks to the brink of collapse in a way that had been almost entirely unforeseen. In the United States, loans to borrowers had begun to be packaged into mortgage-backed securities (MBS) which could be sold on to investors. Lenders liked the fact that after making a loan they could sell on the risk to investors, so they made more loans. Investors liked the fact that the loans were packaged up and so the risks appeared to be diversified, so they put more and more money in. Borrowers liked the fact that this all meant there was more money to lend to them, including to people on low incomes who would never have been able to get a mortgage in the past, so this meant lots of happy voters, and happy voters mean happy governments. Everyone seemed to be a winner.
But when US house prices fell, borrowers started defaulting on their loans and nobody really knew who owned the ‘toxic’ assets and how risky these mortgage-backed securities were. Investors cooled on them and began to sell, which caused the price of these securities to fall. In 2007, several hedge funds which were exposed to the US housing market went bust, and as time went on it became clear that major banks globally were also affected. When the US financial firm Lehman Brothers failed in September 2008, panic spread through the global financial markets as institutions worried about their exposure to these ‘sub-prime’ mortgages and other distressed loans. They all tried to sell at once, leading to sudden and widespread falls in asset prices, causing major UK and global banks to seek government bailouts. This quickly fed through to the real economy because businesses became less willing to invest and households cut back on spending, which by early 2009 pushed economies internationally into a deep recession. Having bailed out the banks, governments came under pressure to intervene to help struggling households and businesses as well.
Faced with such an unprecedented turn of events, most politicians lacked the technical knowledge to understand what was going on in the financial markets, so two things happened. First, many saw the issue through the prism of debates with which they were more familiar and which reinforced their worldview. For many on the left, the crash showed that markets cannot be left to themselves and tougher regulation was required. For many on the right, the problem lay with regulation, as it was political pressure that had led to irresponsible lending in the US in the first place.
But whatever the cause, the immediate problem now had to be dealt with. Non-specialist politicians naturally looked for technical economic advice on what to do, but the technocrats did not appear to have seen the crisis coming, so how far could their advice be relied on?
In the run-up to the crash, there were some voices in the economics profession voicing concern about the risks being piled up, perhaps most notably Raghuram Rajan. But more widely amongst mainstream economists and central bankers there was a feeling of confidence. The Nobel laureate Robert Lucas confidently asserted that macroeconomics “has succeeded: Its central problem of depression prevention has been solved, for all practical purposes, and has in fact been solved for many decades. (3) ” With central banks apparently being able to prevent depressions occurring, the economic task for governments at that time was widely seen as limited to addressing certain market failures, such as externalities like the consequences of pollution, and measures to increase aggregate supply, such as investment in education and skills. And while considering all these issues, economists were quick to warn policymakers of the possible unintended consequences of government intervention, for example in distorting the information and incentives that would otherwise enable the market to work efficiently.
It is perhaps unsurprising, therefore, that when the credit crunch began in summer 2007 the initial response of the Bank of England was to warn against providing extra liquidity support to struggling banks. Bank Governor Mervyn King told the Treasury Committee at the time that he was worried about “moral hazard” and that bailing out banks would “sow the seeds of a future financial crisis.” Instead, he urged politicians to “put recent events in perspective” and allow the market to work rather than undertake unnecessary and possibly counterproductive intervention.
Just days later, the run on Northern Rock began. And as the crisis widened, it became clear that financial institutions globally had taken on risks that they did not properly understand and that central bankers had not expected. Alan Greenspan, former Chairman of the US Federal Reserve, described himself in October 2008 as being in a state of “shocked disbelief” that markets had failed to work as he expected during the crisis. He told Congress, “I made a mistake in presuming that the self-interest of organisations, specifically banks and others, was such that they were best capable of protecting their own shareholders.”
The upending of economic orthodoxy stretched to fiscal policy too. The financial crisis was impacting the real economy, with businesses going bust, jobs being lost and homeowners under threat. The orthodoxy of the previous two decades was that governments should maintain firm fiscal rules and that it was the role of monetary policy to respond to recessions, with central banks cutting interest rates to spur economic activity. But what should governments do when interest rates had reached the zero lower bound and central banks could reduce them no further?
This was the environment in which Gordon Brown’s government had to respond to the financial crisis and its impact on the real economy. The crisis had thrown economics into flux but the government could hardly wait for an academic debate to settle before taking decisions. Brown and Chancellor Alistair Darling stepped in with a recapitalisation plan for the banks, rescuing them so that the economy would not collapse but forcing them to take injections of public capital and imposing big losses on their shareholders. This was an approach that would end being widely followed internationally.
But looking back on the domestic political debates about our response at the time, I am struck by how narrow they were. The focus of political debate was not to protect the real economy and jobs at a time when private sector investment was falling dramatically, but instead to bring the government deficit under control. In doing so, it was hoped that this would reassure the financial markets and thereby encourage private sector investment, what has sometimes been called “expansionary austerity.” (4)
Again, this can be seen most clearly in the position of the Bank of England. In March 2009, just before the G20 was to plan a coordinated fiscal stimulus internationally, Brown was frustrated that Mervyn King gave evidence to the Treasury Select Committee and warned against the government’s stance. A few months later King called for a reduction path to deal with the “truly extraordinary” deficit and in May 2010 he insisted that month’s Bank of England inflation report call for “significant fiscal consolidation” and a more “demanding path” than had been set out in Alistair Darling’s final Budget. (5)
This official economic advice from the Bank of England gave significant encouragement to the Conservative opposition. With the economy in recession, the economic fundamentals in the coming election would be in their favour anyway. David Cameron and George Osborne now used the opportunity presented by this strong political position and the intellectual cover provided by the apparent economic consensus to prosecute a more aggressive argument on fiscal policy, blaming Labour for the economic situation and calling for significant spending cuts.
At the Conservative Spring Forum in 2009, George Osborne argued, “The public finances are out of control and that presents a clear and present danger to the prosperity of an entire generation. We must act and act fast. We need a government of thrift in this age of austerity.” By December of that year, he was warning that the deficit could lead the UK to face a Greek-style debt crisis, given the threat of rising interest rates, and he added, “The only thing that is saving us at the moment is the expectation that a future Conservative Government will get a grip.”
Not surprisingly, this all fed through to media opinion-formers. In the 2010 general election, when the Times endorsed the Conservatives, it said “the economy is in peril. Mr Brown is the danger.” For the Economist, “Britain’s budget deficit is almost as big as Greece’s in proportion to its economy; its public sector is larger. This is a time-bomb of a legacy.”
And it was not just the newspapers. The focus on the deficit also spread to politically impartial broadcasters. Researchers at the University of Cardiff found that BBC news bulletins of the period reproduced a very limited range of opinion on the issue. “The view that Britain was in danger of being abandoned by its international creditors with serious economic consequences was unchallenged and repeatedly endorsed by journalists. Despite their limited record of success during recessions, austerity policies dominated discussion of possible solutions to the rise in the deficit.” (6)
But there was only one problem. We now know that the warnings about the deficit were either wrong or, at the very least, significantly overblown.
Growth bounced back under Alistair Darling before stopping again following the Conservatives’ cuts in 2010, resuming only after the pace of the cuts was slowed significantly in 2012. Moreover, just as Osborne was making his argument for austerity in 2009, developed economies – including the UK – were starting a decade of ultra-low interest rates, which would have made it exactly the right time to borrow to invest in our infrastructure, much of which is now in a parlous state.
More broadly, over time the economics profession would profoundly rethink the pre-crisis orthodoxy. Olivier Blanchard, then chief economist at the IMF, convened a conference in 2012 on the reassessment of economic policy in the wake of the crisis. When it was over, he concluded that in monetary policy “inflation stability alone is not enough; output stability and financial stability need to be added to the list”; and discussions of fiscal policy had become too reductive to focusing on “government spending minus taxes” with its concomitant focus on the size of the deficit. (7) Indeed, the following year, the IMF would publicly warn that the Coalition government’s planned fiscal tightening would be a drag on growth, particularly as households and businesses were still deleveraging, the UK’s trading partners also faced a weak economic outlook and resources in the UK economy were underutilised.
But in the depths of the financial crisis this was all still a few years away. Political assessments of what was feasible and desirable were conditioned by economic ideas which, while not yet defunct, would soon lose a lot of their force.
Four lessons for (non-economist) politicians
What does this mean, then, for politicians today who are trying to bring the politics and the economics together?
Before some of my friends on the left get too excited, it is not the deficit hawks are always wrong. (Liz Truss could have done with a few more such hawks when she and Kwasi Kwarteng put togethertheir ill-fated fiscal event in autumn 2022.) But it does suggest that deference to what looks like current economic orthodoxy is not always the right approach. So what, then, should non-economist politicians do when confronted with economic problems?
I think there are four traps to avoid.
First is the technocratic trap. Issues such as the right balance between the state and the market, or how much to intervene in the economic cycle, are not just technical questions that can solely be answered by trained economists. The ‘right’ answer depends on your political or philosophical views. For example, when deciding how much to intervene in response to a recession, we need to think about how much importance we give to private property rights and the extent of the obligations we think we have to our fellow citizens in distress. When designing an industrial policy, the appropriate model will depend on whether the objective is to increase growth overall or to improve conditions in regions of high unemployment. As John Kay has argued, these issues are as much about questions of fairness as of market failure. (8) They cannot be resolved by committees of economists but rather must be addressed by democratically elected politicians – and politicians do not need a degree in economics to engage in these debates.
Where economics can be helpful is with identifying and addressing the trade-offs involved in the policy decisions – and this brings us to the next lesson. There is a massive temptation for politicians to engage in wishful thinking based on their reading of a particular economist whose analysis conveniently aligns with their philosophical or political views. For some on the right, you hear about Arthur Laffer’s discussion of the relationship between tax rates and tax revenues. Then, hey presto, you decide this means your proposed tax cut will pay for itself. For some on the left, you read Mariana Mazzucato’s work on cases where private sector investment has only happened as a result of earlier investment by the state. Then, happy days, you decide this means your pet subsidy will both create jobs and make money. The trade-offs have been wished away.
Citing the (apparent) backing of a well-known economist may well be useful as part of a public advocacy effort in support of a particular policy. But when you are using the work of an economist to help make policy, it is crucial to avoid the wishful thinking trap. Asking the following questions can help you steer away from it. How closely do this economist’s findings actually match the public policy question before me? Are there economists who disagree and, if so, what are the grounds for debate between them?
This leads to the third lesson. There are vigorous debates in the economics profession but these are not always reflected in the economic voices that are heard most clearly by politicians. The economic commentators who are quoted in the media can often be the ones with greater political or City links. Avoid the ‘mediamacro’ trap and, instead, seek out the economists who have done the latest academic research on the issue at hand. (9) (I think the risk here is as great with microeconomics as with macro, but I’m using this term in order to acknowledge Simon Wren-Lewis, who I believe coined it.)
The fourth lesson for non-economist politicians follows on from this. If economists disagree it can be extremely hard for a non-specialist to decide which of them is right on technical grounds. But what you can do is learn from history, if you avoid the false analogy trap. In the immediate aftermath of the financial crisis, there were some suggestions that our situation was analogous to that in the mid-1930s, when the US choked off fiscal support too early leading to a further downturn, while others suggested it was more akin to the 1980s in the UK when Mrs Thatcher took a firm fiscal stance and the economy then rebounded.
In trying to learn from possible historical analogues, you have to take a step back and try and establish all the likenesses and differences between your situation and the one to which it is being compared; and to consider what has shaped the thinking of the various protagonists in the debate (including yourself), not only in their personal circumstances but also the public events that they have witnessed. (10)
Conclusion
Economics is too important to be left to economists. Politicians should actively engage in debate on economic ideas, and they have a better chance of making good policy if they sidestep the technocratic trap, the mediamacro trap, the wishful thinking trap and the false analogy trap.
1: Blinder, A., 2019. ‘The Lamppost Theory of Economic Policy.’ Proceedings of the American
Philosophical Society, 163(3), 239-250
2: Keynes, J. M., 1936. The General Theory of Employment, Interest and Money. London: Macmillan
3: Lucas, R., 2003. ‘Macroeconomic Priorities.’ American Economic Review, 93(1), 1-14
4: Alesina, A., Favero, C. and Giavazzi, F., 2019. Austerity: When It Works and When It Doesn’t.
Princeton: Princeton University Press
5: Brown, G., 2017. My Life, Our Times. London: The Bodley Head
6: Berry, M., 2016. ‘No alternative to austerity: how BBC broadcast news reported the deficit debate’.
Media, Culture and Society, 38(6)
7: Blanchard, O. et al (eds), 2012. In the Wake of the Crisis: Leading Economists Reassess Economic
Policy. Cambridge, Massachusetts: The MIT Press
8: Kay, J., 2007. ‘The Failure of Market Failure.’ Prospect, August
9: Wren-Lewis, S., 2015. ‘The Austerity Con.’ London Review of Books, 37(4)
10: Neustadt, R. and May, E., 1986. Thinking in Time: The Uses of History for Decision Makers. New
York: The Free Press
