I am writing this post not as a Conservative activist but as a professional economist.
I am going to try to be as bipartisan as possible, and will not include any cheap jibes at the present leader of any of the main British political parties.
Obviously, when one sets out to write about the lessons we can learn from the mistakes of the past there will inevitably be comments which could be taken as implicit criticism of previous PMs and Chancellors from all parties which have been in governmentm including my own.
However, while I am not planning to ask either of them, I suspect both George Osborne and Ed Balls would privately agree with the majority of what I am about to write.
In his book on "The World's Greatest Mistakes" the late David Frost described three things as "always a mistake" ...
* Invading Russia
* Marrying Henry VIII
* Accepting a cabinet post in Iraq or Liberia
Many a true word is spoken in jest. Are there things in economics which are similarly proven to be mistakes by any objective look at the past? I believe there are.
Economists are a disputative lot, and the joke has often been made that "where there are three economists you will find four opinions." This has been known to obscure the degree of consensus which in fact exists.
Almost all economists would agree that many suggestions made by John Maynard Keynes to avoid or get out of a classic recession work in the sense that they do actually have the effect of preventing or ending a recession, provided you don't over-use them and generate an inflationary spiral.
Many of those who have heard of the statement "We are all Keynesians now" probably assumed it was a statement from the "Keynesian" school of economists.
This statement was actually made in 1965 by Professor Milton Friedman, the arch-monetarist. He meant that all mainstream macroeconomists, regardless of political persuasion, accepted the basic aggregate income-expenditure framework that underlies the so-called "neo-Keynesian" model.
Similarly the context of the reply "We are all monetarists now" was not a triumphalist claim from one of the "Chicago school" of monetarist economists. It was a complement to Friedman by a prominent Keynesian, Franco Modigliani. One version of the full quote reads as follows:
'Milton Friedman was once quoted as saying "We are all Keynesians now" and I am quite prepared to reciprocate that "we are all Monetarists now" if by monetarism is meant assigning to the stock of money a major role in determining output and prices.'
So what can we learn from the lessons of the past? I would suggest four rules as follows
RULE ONE: Never trust anyone who claims to have found a one-way bet to wealth or any other kind of "magic bullet" which overturns all previous rules of economics or immediately solves all the problems of the past.
Sometimes there is a genuine improvement in our economic knowledge but there is always a price. Claims of an easy route to an economic miracle have a 100% record of being disasters.
* The 18th century creators of the "South Sea Bubble" were wrong when they presented investment in this stock as a one-way bet to wealth. The inevitable collapse which followed almost bankrupted the British economy.
* Over the channel John Law, a scot who was put in charge of France's finances in the same century, was equally wrong when he proposed to stimulate industry by replacing gold with paper credit and then increasing the supply of credit, and to reduce the national debt by replacing it with shares in economic ventures. At first people thought he had found a miraculous solution to the problems France was facing but just like the South Sea Bubble it went up like a rocket and down like a stick, with even worse consequences for France than the South Sea Bubble had for Britain.
* Towards the end of the last century and at the beginning of this one, people became convinced that investing in "dotcom" shares was a one-way ticket to a fortune. None of them noticed at first that although many millions of people were using the internet, very few internet companies were actually generating a profit. When this reality finally hit home the correction took down several major telecoms companies, a lot of "dotcom billionaire" fortunes vanished and many investors lost out in a big way.
* Then a short time afterwards, large numbers of banks and investment analysts from America, Britain and much of the rest of the world, who should have known better, became convinced that the latest way to generate wealth from nothing was to invest billions of pounds, dollars and euros in the "Sub-Prime" market e.g. selling mortgages to people who could not afford them. When this in turn collapsed, this of course became the main trigger for the world recession and economic difficulties from which we are slowly, with the greatest of difficulty, emerging now.
* And of course, you should never trust a politician who claims to have abolished boom and bust ...
RULE TWO: Never allow your country to suffer a sudden massive drop in the available supply of money. If you do, recession will follow as night follows day.
The main trigger for the great depression of the 1930's was a series of bank failures following the Wall Street crash which reduced the money supply in the USA by about 30%, and touched off similar problems in much of the rest of the Western world.
This is why, while we may argue until the cows come home about the extent to which shareholders and senior management in banks should have been supported, the last government had absolutely no choice but to bail out the banks to at least the extent that bank deposit customers were protected. Personally I would have allowed Richard Branson to buy Northern Rock rather than nationalising it, but they could not allow the customers of any major banks to lose all their money.
If they had, and if other governments had done the same, we would have had a depression as savage as the one in the thirties, and which would have made the problems we actually did have over the last eight years look like a vicar's tea party.
RULE THREE: Never allow your country to suffer a sudden massive increase in the available supply of money which is disproportionate to the productive capacity of the economy. If the available amount of money increases dramatically faster that the economy can produce goods and services, inflation will follow as night follows day.
If your economy is in recession and has a lot of spare capacity, a once-off increase in spending power can help get things going again. That's why the recent policy called Quantitative Easing has largely been a qualified success. But if you overdo it, or keep it going too long, the result will be a serious inflation problem.
Governments putting too much money into circulation is not a new problem. Problems with debased coinage (pretending there was more gold or silver in coins than there actually was) goes back at least as far as Archimedes, two and a half thousand years ago - the problem whose solution caused him to shout "Eureka" in the bath was how to tell whether the gold in a crown had been mixed with less precious metal. Dishonest rulers played the same trick with the coinage of their national currency both back then and subsequently, and when they did it always caused inflation.
But too much gold can cause nearly as much of a problem. When the Spanish conquered the New World and brought massive quantities of gold and silver back to Europe, at a time when the currencies of Europe were based on these metals, and roughly doubling the amount of them in circulation, it touched off a century of inflation.
RULE FOUR: ridiculously high tax rates do not generate more revenue.
The higher the rate of tax, the more the incentive for people to evade or avoid it, the more high-earning people go abroad, and the lower the incentives to work. Which means that above a certain point, raising tax rates does not bring in more money.
There is some scope for argument about when this applies, but none about whether it happens. My personal opinion is that the tipping point above which higher income tax rates do not bring in more revenue is somewhere between 40% and 45%.
When Margaret Thatcher and Geoffrey Howe cut the highest British tax rates at a stroke from ninety-eight pence in the pound on investment income and 83% on salaries to forty pence in the pound, did the amount or proportion of tax revenue paid by the richest people in the country go down? Absolutely not, both went up. Yes, the rich got richer - but they also paid a lot more tax both in absolute terms and as a proportion of total revenues, providing literally billions of pounds more money to spend on the things which everyone needs such as schools and hospitals.
Similarly the increase in the top tax rate from 40% to 50% under the last government brought in little if any extra revenue: and the partial reversal of that increase back to 45% under the present government reduced revenues by little if anything. It may also have assisted in getting more inward investment to Britain by sending the signal that the country was determined to be more business friendly.
Provided everyone actually pays the taxes you do impose - and in general more people will pay up rather than try to get out of it when a tax rate is 40% than when it is 80% - there will be more money to provide services for everyone including the poor if the richest 10% are paying, say, 40% of £10 billion rather than 80% of £4 billion.
