The Tory party is burying fiscal conservatism under the magic money tree

The idea that such a delicate plant can only flourish under the Conservatives might prove tricky to sustain

Camilla Cavendish

Artwork for FTWeekend Comment - issue dated 05.10.19
© Jonathan McHugh 2019

Is Boris Johnson about to lose everything, or will he return triumphant from Brussels to preside over a profound shift in British politics? This is an existential moment for the right in the UK. If the prime minister fails to get a deal with the EU and then loses an election, the Conservative party is over — which is why many of its footsoldiers are going along with another radical experiment: the end of fiscal conservatism.

Left and right politicians on both sides of the Atlantic are buying into the theory that persistently low inflation and low interest rates save them from having to worry too much about budget deficits. Traditionally, politicians feared that public debt would slow growth and borrowing would fuel higher prices.

Now, Eurosceptic hawks have discovered there is a magic money tree after all. But it’s a delicate plant and it will only — or this is the pitch — flourish under a Conservative government. That argument could prove tricky to sustain.

At his party conference in Manchester this week, Mr Johnson flung out spending pledges like a two-star general in a third-world country. Post-Brexit Britain will have 20,000 extra police officers, 40 new hospitals, more military might, better-funded schools and youth clubs. Shiny new buses will charge down country lanes. 5G broadband will bring enlightenment to hill and dale, and homes will be warmed by limitless cheap power from miniature fusion reactors.

Although not quite yet. Mr Johnson admitted, in a weird echo of the proposals to replace the Northern Irish backstop with alternative customs arrangements, that this particular technology is not actually ready.

You cannot fault Mr Johnson for optimism. The question is what kind of fiscal reset is implied.

How will a high-spending Conservative party differentiate itself from high-spending Labour under Jeremy Corbyn? “We put up wages,” trumpeted Mr Johnson, “with the biggest expansion of the living wage for a generation; Corbyn would put up taxes for everyone”.

His supporters nodded along, not apparently bothered by the government’s failure to consult business on raising the minimum wage to levels which could be among the highest in the world in five years’ time. There were no frowns over how he planned to fund what the Institute for Fiscal Studies has calculated is a £25bn spending package while cutting taxes.

In Tory minds, uncosted, unfunded pledges are justified by the need to outgun Labour. In this sense, both parties are locked into a mutually assured destruction — or at least a mutually accumulating debt.

With borrowing costs so low, there is a strong argument for chancellor Sajid Javid’s proposed infrastructure spending. With manufacturing output slowing around the globe and Brexit representing a peacetime emergency, some kind of fiscal stimulus is clearly needed.

Even the most enthusiastic pro-Leave economists have predicted a “Nike swoosh” after we leave the EU, with an initial dip in gross domestic product followed by an uptick. Moreover, the rich benefited disproportionately from quantitative easing: as we reach the limits of monetary policy, public spending could target help more effectively.

Yet markets can lose patience. You can’t assume low interest rates for ever. Whoever is in power needs to spend wisely. Mr Johnson’s rhetoric so far contains little detail on how public services — and indeed the wider economy — might be reformed.

The shift among Conservatives is striking. Speaking at a fringe meeting in Manchester this week, I was surprised to find the whole room enthusiastically supporting a proposal to offer personal care to the disabled and elderly for free, at an estimated annual cost of £11bn.

In that same room a few years ago, loud objections would have been made about tax rises. This time, the sole critique came from a councillor worried about burdening the younger generation.

This is partly reflected in polling, which shows rising support for tax rises, especially to fund the National Health Service. But many Tory activists also feel that on social care, the minimum wage and the NHS, keeping Mr Corbyn out of power justifies aping his policies.

Post-Brexit, what does the right stand for? If the Conservative party no longer stands for fiscal prudence, it must deliver an economic boost. Mr Johnson was at pains to talk about productivity and growth this week, but this part of his post-Brexit vision remains alarmingly vague. As he lauded the export of pop star Jason Donovan’s CDs to North Korea, you couldn’t help thinking that Emperor Johnson was even more scantily clad than Mr Donovan, who on the same day was pictured putting out a neighbour’s fire in his underpants.

Ditching prudence may well be a vote-winner. But Brexit demands caution over the public finances. That case has long been made by Rory Stewart, the former leadership contender whose resignation has rocked Tory moderates. His belief that “prudence should be our national strength” reflects the traditional Conservative message at election time of competence based on fiscal responsibility.

Tories see themselves as the diligent guys who roll up their sleeves and fix the roof after the other lot’s profligacy. Hence Gordon Brown and Tony Blair’s adoption of stringent fiscal rules for New Labour in 1997. If Mr Johnson were up against anyone other than the current Labour leadership, his plans would be coming under far more scrutiny. And if this government rewrites the fiscal rules to allow for higher spending, it must be ready for Labour to double down.

The writer, a former head of the Downing Street policy unit, is a Harvard senior fellow

George Friedman’s Thoughts: Command of Space, Command of the Sea

By George Friedman


In order to begin thinking about space-based warfare, we need to think about sea-based warfare. The best place to do that is in World War II with the U.S.-Japanese war. When the United States forced its way into Japan, Japan lacked any powered instruments of production. It was a muscle-driven society.

When they saw American warships, already having intelligence on British operations in China, the Japanese rapidly understood that their country could not be secure without a modern navy and that it could not have a modern navy without modern industrial plants. Japan surged from being a muscle-based economy to being one driven by petrochemical power. It was an enormous achievement.

But it also made Japan vulnerable in a way that it had never been before. Because of Japan’s peculiar geography, it lacked almost all industrial minerals. Japan had to import massive amounts of metal ores and, above all, oil. All of those imports had to traverse sea lanes. That meant that Japan’s economic development was vulnerable to foreign, hostile powers interdicting those sea lanes. Japan had to assume that at some point it would face this sort of challenge.

So, the first edition Japanese navy, built by the British, was to be a defensive power that could protect the homeland from invasion. But that defensiveness also had to extend to assuring that Japan’s supplies of minerals from today’s Indonesia and Southeast Asia were secure. For that reason, its defensive mission appeared to other powers as offensive.

At that time, there were two rising powers in the Pacific: Japan and the United States. They first dueled over a coaling station. In the age of coal-powered vessels, ships had to refuel, as one load of coal gave them only limited range.

For the United States, Hawaii was the key refueling point. There was no land between Hawaii and the West Coast, so if the U.S. held Hawaii, it was secure from attack. For Japan, it was the small islands of the Western Pacific. Japan took control of many of these islands after World War I. The U.S. held the Philippines, Guam and some other minor islands. But neither country could be secure while the other could choose to attack.
And, indeed, the Japanese attacked China, looking for raw materials and markets. The U.S. saw this as a threat; if Japan held China, it could build a fleet that could dwarf the Americans’. And since the U.S. had to have fleets in two oceans, it did what it could to thwart Japan. In the end, the U.S. tried to control Japan by interdicting access to oil from Indonesia and placing an embargo on steel and oil shipments from the United States.

The U.S. believed that Japan would have to subordinate itself to the U.S., as the U.S. fleet was believed to be more powerful than the Japanese. Japan could not survive without oil, rubber, bauxite and all the rest, and the U.S. could cut off its supply.

The Japanese saw what the Americans were seeing, but they drew a different conclusion. They believed that the Americans were trying to break their economy. They also believed that engaging the U.S. at sea was uncertain at best. But where the U.S. had concluded that it had backed Japan into an inescapable corner, the Japanese concluded that they had to redefine the variables. A surface battle with the U.S. fleet could be disastrous. Therefore, they conceived of a war based on an air-sea battle.

Both the Japanese and Americans had aircraft carriers. The U.S. regarded them as an adjunct to surface warfare, but the Japanese saw them as an alternative to surface warfare. In their desperation, the Japanese innovated. They did not innovate technically; aircraft carriers existed along with torpedo planes, bombers and fighter aircraft. Where they innovated was in grasping the advantage that aircraft held against surface vessels and, believing what they saw, building operations and a strategy around the carriers.

The result was Pearl Harbor, where the U.S. Pacific Fleet was shattered because the U.S. Navy had underestimated the possibilities inherent in carrier-based warfare. The U.S. response was to use its own carriers to block the Japanese at the battles of the Coral Sea and Midway. The U.S. then seized a series of small islands to extend its land-based air control, until it could attack Japan proper.

In all of this the battleship, which had been seen as the key to control of the sea, was marginalized. Now, control of the sea did not depend on surface ships but on command of the air. The aircraft carrier was a tool in delivering aircraft, but land-based aircraft were of similar value. The first American offensive on Guadalcanal pivoted on the question of who would control a small airfield there from which to launch aircraft.

The Japanese naval force was smashed at Midway. U.S. aircraft moved closer until they reached Saipan and Tinian, bringing U.S. bombers into range of Japan. This, supplemented by submarines, isolated Japan from its supply of minerals, and, where aircraft supported by amphibious forces broke the back of the Japanese navy, the submarines broke the back of the economy, which was what the war was about from the Japanese point of view.

The point here is that the presence of a new technology, and accompanying assumption of its significance, is often extraordinarily wrong. The Japanese, for all their brilliance, spent their national treasure on the Yamato, the largest battleship in the world. They believed, despite seeing all the possibilities of the aircraft carrier, that the war would be won by battleships. The U.S. evolved more quickly after disaster but still insisted on building battleships for the inevitable decisive surface battle.

The air-sea dynamic changed the rules of warfare. For the first time, command of the sea depended not on surface vessels but on aircraft launched from any base and on submarines. It was not the technology that was lacking. It was an understanding of what the technology meant. The more desperate a power is, the more it grasps the possibilities of technology. The Japanese were desperate when the U.S. placed sanctions on their country; the Americans when their fleet in Hawaii was destroyed.

In every revolution in warfare, the assumption by the more powerful power is that the technology being introduced is an adjunct to existing technology. The recognition that existing technology is no longer relevant is brought to bear only by desperation and defeat. The Japanese saw the possibility of air-based command of the sea but failed to appreciate how rapidly the U.S. would grasp the lesson and how quickly it would turn the lesson into carriers. The Americans failed to appreciate that putting Japan in a desperate position would cause it to attack based on completely different principles of warfare.

The dependency on space in warfare is far more radical than the dependency on air. The technology and the environment are orders of magnitude greater than what they were with aircraft. The United States, however, is treating space as an adjunct to the existing system made up of armored fighting vehicles, manned bombers and aircraft carriers. It sees the value of space. It does not see that space means the decline in value of many systems the U.S. treats as sacred.

The constant discussion of new technologies is important, but it is merely a preface. The real issue is the generation of new concepts and doctrines of war-fighting that arise from the new technology. The battle is won by the side that has resources but also the ability to understand that what was once the foundation of military power is now a drain on resources, and that the center of gravity of war is now something that seems to be a minor addition, like carrier-based torpedo planes.

The country least likely to grasp this is the one that feels most confident and, therefore, complacent. Desperation and fear drive military innovation. What is happening in space will cause all that is solid to melt into the air. It has to. We should bear Pearl Harbor in mind during the rest of our discussion on space.

Democracy on a Knife-Edge

The failure to protect minority rights is a readily understood consequence of the political logic behind the emergence of democracy. What requires explanation is not the relative rarity of liberal democracy, but its existence.

Dani Rodrik


CAMBRIDGE – In Mohammed Hanif’s novel Red Birds, an American bomber pilot crashes his plane in the Arabian desert and is stranded among the locals in a nearby refugee camp. He finds himself talking about thieves with a local shopkeeper. “Our government is the biggest thief,” he explains. “It steals from the living, it steals from the dead.” The shopkeeper replies, “Thank God we don’t have that problem. We just steal from each other.”

This little vignette just about summarizes the key message of Daron Acemoglu and James Robinson’s new book, The Narrow Corridor: States, Societies, and the Fate of Liberty. Acemoglu and Robinson’s thesis is that prospects for freedom and prosperity balance on a knife-edge between state oppression and the lawlessness and violence that society so often inflicts on itself. Give the state too much of an upper hand over society, and you have despotism. Render the state weak vis-à-vis society, and you get anarchy.

As the book’s title signals, there is only a “narrow corridor” between these two dystopias, a slender path that only a few countries, mostly in the industrialized West, have managed to find. Furthermore, getting on the path does not guarantee staying on it. Acemoglu and Robinson emphasize that unless civil society remains vigilant and is able to mobilize against would-be autocrats, authoritarian regress always remains a possibility.

Acemoglu and Robinson’s new book builds on their previous blockbuster, Why Nations Fail. In that book and other writings, they identified what they call “inclusive institutions” as the principal driver of economic and political progress. These institutions, such as secure property rights and the rule of law, are accessible to all (or most) citizens and do not favor a narrow group of elites over the rest of society.

One country that has always given the Acemoglu-Robinson thesis some trouble is China. The Communist Party of China’s monopoly of political power, the country’s rampant corruption, and the ease with which the Party’s economic competitors and political opponents can be dispossessed hardly smack of inclusive institutions. Yet it is undeniable that over the last four decades the Chinese regime has achieved unprecedented rates of economic growth and the most impressive reduction in poverty in recorded history.

In Why Nations Fail, Acemoglu and Robinson argued that Chinese economic growth will run out of steam unless extractive political institutions give way to inclusive institutions. They double down on this thesis in The Narrow Corridor.

They characterize China as a country where a strong state has dominated society for almost two and a half millennia. Having spent so much time outside the corridor, they argue, it is unlikely that China can make a smooth entry back in. Neither political reform nor continued rapid economic growth seems likely.

The other large country that now seems to sit ill at ease with the original Acemoglu-Robinson thesis is the United States. At the time Why Nations Fail was written, many still considered the US a prime example of inclusive institutions – a country that got rich and became democratic through the development of secure property rights and the rule of law. Today, the income distribution of the US is as skewed as in any plutocracy. And the country’s representative political institutions, under attack from a demagogue, look decidedly brittle.

The Narrow Corridor seems to be written in part to provide an account of the apparent fragility of liberal democracies. The authors coin the term “Red Queen Effect” to denote the ever-continuing struggle to uphold open political institutions. Like the character in the Lewis Carroll book, civil society has to run ever faster to keep up with authoritarian leaders and restrain their despotic tendencies.

The ability of civil society to stand up to “Leviathan” may in turn depend on social divisions and their evolution. Democracy typically emerges from the rise of popular groups that can challenge the power of the elites or from splits among elites. In the nineteenth and twentieth centuries, industrialization, world wars, and de-colonization led to the mobilization of such groups.

Ruling elites acceded to their opponents’ demands that the franchise be extended, without property qualifications, (usually) to all males. In return, the newly enfranchised groups accepted limits on their ability to expropriate property holders. In short, voting rights were exchanged for property rights.

But, as I discuss in joint work with Sharun Mukand, liberal democracy requires more: rights that protect minorities (what we may call civil rights). The defining characteristic of the political settlement that generates democracy is that it excludes the main beneficiary of civil rights – minorities – from the bargaining table.

These minorities have neither resources (like the elite) nor numbers (like the majority) behind them. The political settlement thus favors an impoverished kind of democracy – what one might call electoral democracy – over liberal democracy.

This helps explain why liberal democracy is such a rare beast. The failure to protect minority rights is a readily understood consequence of the political logic behind the emergence of democracy.

What requires explanation is not the relative rarity of liberal democracy, but its existence. The surprise is not that few democracies are liberal, but that there are any liberal democracies at all.

This is hardly a comforting conclusion at a time when liberal democracy seems very much under threat, even in those parts of the world where it seems to have been permanently entrenched. But by appreciating the fragility of liberal democracy, we can perhaps avoid the lassitude induced by taking it for granted.

Dani Rodrik, Professor of International Political Economy at Harvard University’s John F. Kennedy School of Government, is the author of Straight Talk on Trade: Ideas for a Sane World Economy.

Should Creditors Pay the Price for Dubious Bonds?

Venezuela’s latest expected debt default raises the question of whether creditors should bear the risk that unauthorized debts can be repudiated. In the final analysis, imposing some risk on careless creditors may be the best way to ensure that politicians honor the limits on their borrowing authority.

Mitu Gulati , Ugo Panizza, Mark Weidemaier

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DURHAM/GENEVA/CHAPEL HILL – In late October, Venezuela is likely to default on a $913 million payment on a key bond. Because the country has already defaulted on most of its debt, one might be tempted to regard another missed payment as no big deal. But this bond, issued by the national oil company Petróleos de Venezuela, S.A. (PDVSA), and referred to as PDVSA 2020, is backed by juicy collateral: a controlling stake in Venezuela’s economic crown jewel, United States-based refiner CITGO.

Ordinarily, unpaid bondholders could tell the bond trustee to seize the collateral. But, given its dubious provenance, the PDVSA 2020 is no ordinary bond. It was issued in 2016, when PDVSA was close to default. To buy time, the company swapped short-maturity bonds for this longer-maturity one. In exchange, creditors received collateral in the form of a 50.1% interest in CITGO’s parent company.

The transaction was unusual in at least one respect. The Venezuelan Constitution requires the country’s National Assembly to approve contracts of national interest. But the opposition-controlled legislature did not approve this bond issue, which it undoubtedly viewed as an attempt by President Nicolás Maduro’s government to buy time for itself.

Maduro still holds power, but the US and other governments deem his rule illegitimate. Instead, the government-in-exile of Juan Guaidó – the leader of the National Assembly – represents Venezuela in US courts and elsewhere. Concerned about the potential loss of CITGO, Guaidó and his team approved a smaller payment on the PDVSA 2020 bond in April this year. But we doubt that Venezuela can afford the upcoming payment. More important, there also are doubts about whether the Venezuelan people should be responsible for honoring a debt contract that their elected representatives did not approve.

Most legal systems recognize that not all contracts have the same degree of sanctity. For example, according to basic agency law in the US, a creditor cannot enforce a debt contract made through an agent of the corporation whom the creditor knew was not authorized to conduct such a transaction. Given that the issuance of the PDVSA 2020 bond was not authorized by the National Assembly, Venezuela might have legal defenses if creditors try to seize CITGO.

Other governments have disputed creditors’ claims in similar contexts. Notably, Puerto Rico has disputed debt issued in 2012 and 2014 that arguably violated a constitutional debt limit. Sovereign states such as Ukraine and Mozambique have recently made similar arguments, and there are a number of older cases involving municipal debt.

These disputes raise questions of both technical and theoretical importance. As a technical matter, a court would have to decide whether Venezuelan law determines the Maduro government’s authority to issue the PDVSA 2020 bond, or whether that question will instead be governed by New York law (which the bond designates as governing most issues). Even if Venezuelan law determines whether the Maduro government was in fact authorized to incur this debt, New York law may govern other important issues, such as whether investors were entitled to rely on the government’s representations about the bond’s legality.

More broadly, disputes like this require courts to decide whether creditors should bear the risk that unauthorized debts can be repudiated. At first glance, it may seem odd to impose such a risk on creditors. Venezuelan officials, after all, are in a good position to understand and comply with their own country’s legal requirements. If they say that the bond issue is legitimate, why should foreign creditors doubt them?

But as Ricardo Hausmann recently pointed out, this view ignores the agency problems inherent in government debt: public officials are supposed to represent the populace, but are sometimes motivated by self-interest. The problem is especially acute with despotic governments. Although the international community still recognized Maduro’s government at the time of the PDVSA bond issue, it had already seriously questioned that government’s legitimacy. Venezuela’s creditors in 2016 knew this, just as they knew that the National Assembly had not approved the bond.

Moreover, creditors are often sophisticated. Investment banks that underwrite complex collateralized bonds like the PDVSA 2020 are surely capable of making informed judgments about whether a loan complies with legal requirements.

In that case, they should bear the consequence of a failure of due diligence. These creditors, not the Venezuelan people, were in a position to block the transaction, yet now ordinary Venezuelans risk losing a crucial national asset. And in the final analysis, imposing some risk on careless creditors may be the best way to ensure that politicians honor the limits on their borrowing authority.

Some may argue that this approach could harm retail investors who bought bonds on the secondary market in good faith. This is unlikely to be the case for the PDVSA 2020 bond, because even retail investors with limited information should have been aware of the unsavory nature of the issuing regime. In any case, this objection could be addressed by establishing a public registry of all outstanding sovereign and quasi-sovereign bonds that were issued with legal or ethical infirmities.

How Venezuela’s latest debt drama plays out will start to become clearer in the coming weeks.

Instead of being just another story of default, the PDVSA 2020 bond may yet become a cautionary tale for creditors around the world.

Mitu Gulati is a professor of law at Duke University.

Ugo Panizza is Professor of International Economics and Pictet Chair at the Graduate Institute of International and Development Studies in Geneva.

Mark Weidemaier is a professor of law at the University of North Carolina at Chapel Hill.