Monday, 11 July 2016

The Many Messages of Brexit (Part III)

It is now about two and a half weeks since the world woke up to Brexit and the entirely predictable financial instability has led to a great deal of finger-pointing and hand wringing. As usual, conventional wisdom misses the point - as it is more or less designed to do. The current situation is comparable to the 1986 explosion of the Space Shuttle Challenger. The body tasked with investigating the cause of the disaster, the Rogers Commission, ultimately found that the cause of the conflagration was a faulty sealant (known as an O-Ring) which had insufficient resilience to maintain its flexibility in the unseasonably cold weather in Cape Canaveral on the morning of the launch. Perhaps the most famous moment in the televised portion of the Commission's hearings occurred when Commission member and physicist, Richard Feynman, demonstrated that by immersing the rubber material in iced water and stretching it, he could show that the material did not return to its original shape at a temperature of 32 Degrees Fahrenheit. "I believe that this has some significance for our problem", said a visibly irritated Feynman to the NASA executive giving evidence to the Commission. 

In his memoirs, Feynman identified the true cause of the Challenger disaster. It wasn't, he explained, cold weather, but a failure to ensure that crucial technical elements of the Space Shuttle were fit for the pressures that predictable use would exert on them. That a component designed to withstand the pressures exerted on it by the sub-Arctic temperatures of outer space was unfit for those exerted on it by a cold morning in Florida, he said, demonstrated that the true cause of the disaster was a massive scale breakdown in best practice at a managerial and technical level which called into question the fitness for purpose of almost every element of the Space Shuttle Programme. Feynman cited, as an example of the information disconnect in NASA, the fact that NASA executives believed that the chances of a catastrophic event with a shuttle to be 1 in 100,000, whereas NASA's technical and engineering staff estimated the probability at a much more sobering 1 in 200. 

The anti-Brexit propagandists on the financial markets have been proven correct in their predictions of a Pound in meltdown and an earthquake in the City of London. Unlike the NASA executives in 1986, however, the financial markets have been guilty of some degree of self-fulfilling prophecy. By ginning up fears of what Brexit would do, they (at least to some extent) made their own weather, so to speak. However, like the NASA executives, their big sin was that they ignored an underlying substratum of weaknesses which Brexit ultimately revealed. The UK, with a current account deficit north of 5% of GDP, is in its worst underlying financial shape since 1948. This could perhaps be explained away if the UK had a high savings rate. However, UK households save well below 5% of their annual incomes and after eight years of "austerity", the hapless George Osborne is still running a deficit of more than 4% of GDP. However, financial markets which have been anaesthetised by Central Banks have heretofore treated the UK as if it were some model of financial probity. 

Brexit was akin to the cold snap in Cape Canaveral. It was an event for which any healthy financial market ought to have been well prepared. The fact that it wasn't demonstrated an underlying systemic weakness, namely the chronic mispricing of risk in the currency, equities and sovereign debt markets. However, unlike Feynman's field of physics, economics is a human discipline and not a science. It's not that there are no Feynmans to call out the facts. It's that few wish to listen to them. While the brilliant former OMB Director for the first Reagan Administration, David Stockman and (the rather hit and miss but occasionally incisive) Ambrose Evans-Pritchard and Jeremy Warner of the Telegraph have been pointing to Britain's colossally awful financial situation as the real reason for the collapse in Sterling and the jitters in the global financial markets, mainstream commentary bathes itself in the fantasy that everything was fine before Brexit and everything can be fine again if we can just find a way in which to slither out of it.

The financial commentariat and their frenemies in the progressive establishment are repeating their Lehman mistake. Just as the received wisdom in finance is that the 2008 financial crisis happened because of the failure to bail out Lehman Brothers, they are now writing a future history in which calamities to come are the fault not of years of dysfunctional monetary, regulatory, fiscal, trade and immigration policy but of the "populist" refusal of an electorate to do what their betters told them to do. Plus ca change, plus c'est la meme chose. Beyond the contagion though, what is Brexit telling us about the politics of the economy for the next generation? In this final post on Brexit, we shall explore some key themes.

1. There has been a huge change in the mindset of the elite class in the last generation. The elite and upper-middle class cohort of the population (what I have previously defined as the "talented tenth") has traditionally been split between two principal groups that could best be defined as the commerce-oriented cohort which made its money and derived its status from trade, industry and finance or professional activities closely associated therewith, and a more or less non-commercial cohort who primarily derived their wealth and status from government or activities closely associated with government institutions, rules or money. The former tended to be hostile to taxes (which they had to pay) while the latter viewed them benignly (often because taxes paid them). The former disliked regulation (which they had to obey) while the latter revered regulatory agencies (off which they often made a living). The commercial cohort took a rather neutral and pragmatic view of matters of immigration and national sovereignty, while the more public sector oriented division of the elite tended to regard immigration as a human right and national sovereignty as a threat to order and peace. Twentieth century politics largely revolved around the conflict between these two wings of the elite, with the more commerce-oriented not being averse to using immigration restrictionism and nationalism to appeal to working and lower middle class voters and the public sector cohort falling back on ideas such as class warfare and redistribution.

The Brexit debate seems to indicate that this division is largely at an end, with an elite class which may be superficially split but which is, fundamentally, more unified in its views than ever before. The reason for this is, I think, largely a function of the incursion of government into more and more private sector activity through the proliferation of Byzantine and highly complex codes of taxation and regulation and the increasingly prevalent interface between central banks and virtually every aspect of industry and commerce. This has led to three principal phenomena. First, an ever larger cohort of the private sector professional class works in jobs like financial compliance and employment law, which largely revolve around helping businesses to navigate the complex fiscal and regulatory terrain created by government. Second, the complexity of taxation and regulation and the increased importance of financial engineering mean that an increasing portion of the elite and upper middle cohort of the private sector works in big businesses which are able to use teams of professionals to attain profitable arbitrages in the fiscal and regulatory space, while the number of people who are self-employed or engaged in small business has comparatively declined. Thirdly, a toxic combination of fiscal, monetary, trade and regulatory policy has increasingly outsourced manufacturing to Asia, leaving the elite classes increasingly relying on the services sector to make their fortunes. This has had the consequence of changing elite perception in relation to the principal issues which lay at the heart of the Brexit vote: immigration and regulation.   

2. For the Talented Tenth, mass immigration is a holy sacrament. As I've previously opined, the right to grant or withhold the entitlement to reside in one's country is rather like having a spare room in one's house, a spare car parking space or an acre of land. In other words, governments, much like landowners, have a valuable property right which can be tendered or auctioned to non-citizens (i.e. people with no intrinsic right to live in a country) at great profit or loss, depending on how it's done. Let's focus on the spare room analogy. What if a prospective roommate couldn't afford to pay rent or what if the rent he could afford to pay didn't cover his share of the fixed costs of the household like utilities? Would you consider moving him in to be a provident transaction? What if you were faced with a potential room mate who could pay €500 per month and another who could afford €650? Would you say "first come-first serve" and take your chances? Or would you rent the room to the higher bidder? If one wanted a twelve month lease and the other a two monther, would you ignore the disparity? If you couldn't get an employer reference from a prospective tenant, would you think twice about his tenancy or not? What if your prospective tenant had an obvious BO problem or said something that indicated bad habits? A society vetting a potential immigrant is making equivalent trade-offs to the landlord vetting a tenant and until the last decade or so, there was no great controversy about this. Amongst the masses, there's still no controversy about it. Amongst the talented tenth, however, such thoughts have attained the status of apostasy. Why?

Fifty years ago, most wealthy people worked in business, industry and the professions. Even the most cerebral of these people needed to make their livings in close proximity to sales, marketing and payroll. Indeed, for most of human history, a people-person with an ability to interface with the money-men, the marketing men and the help has been at a distinct advantage in business, whereas the fortunes to be made by an academic genius who couldn't be trusted to go the market without coming home with magic beans were fairly limited. The former were the people who made the money, whereas the latter either enjoyed less remunerative "expert" careers or, like JK Galbraith or JM Keynes, grabbed one of the few coveted "public intellectual" roles that allowed the impractical to talk and write for a living. The latter were invariably prominent but always statistically negligible in number. However, in today's rather artificial world of Bits, Bytes and Bips, of social media entrepreneurship and hedge funds and of code writers, techies and quants, there is an unprecedentedly large group of the private sector monied class which lives a cloistered and professorial life far away from the more humdrum aspects of commerce. For the first time in human history, we see a critical mass of people who make handsome livings in commerce whilst not truly understanding its principals.

This appears to rub off on attitudes to public policy. For all of the unfortunate hyperbole he adopts, the septuagenarian Donald Trump, who is the very epitome of the old-style mid-twentieth century businessman, seems to view immigration much like a real estate owner views a prospective tenant - he wants the best he can afford and doesn't want to sell a valuable privilege cheaply. In the mid-twentieth century, businessman politicians like William E. Simon or John McKone would have had attitudes fairly similar to Trump's and wouldn't have needed to dial their rhetoric up as controversially as he does in order to make their point. However, today's nerdier elites don't see immigration in this practical manner. Whether justifying their ideas based on integration of markets (on the right) or progressive internationalism (on the left), today's plutocrats (whether cynically or idealistically) look at immigration through the prism of rights and not as a bilateral arrangement. Hence, ideas which would once have been typical of sociology professors but not businessmen have increasingly come to define respectable groupthink amongst the entire elite. To the elite, restricting immigration has become anathema and the idea of ending absolute freedom of migration across Europe by leaving the EU was an almost unimaginably distasteful thought. In this regard, the members of the elite who dissented from Remain orthodoxy, like Michael Howard, Nigel Lawson and Norman Lamont tended to be older and (presumably) less impressed by metropolitan anti-nationalist sentiment.  

Moreover, the fundamental economic interests of the wealthy have changed. Until comparatively recently, the wealthiest people (the Carnegies, the Mellons, the Courthoulds, the Dassaults, the Quandts, the Flicks etc.) tended to make their money out of employing skilled or semi-skilled blue collars. It was much harder to make money from employing vast armies of experts and professionals because their massive remuneration ate into investor margins. This meant many billionaire industrialists (who could make big bucks from hiring manual workers and craftsmen) and few billionaire financiers (who had to pay expensive experts and executives to engage in the equivalent of "production line" work). Meanwhile, it was possible to make massive fortunes from hiring unskilled service industry workers (e.g. in retail) but in these areas, the barriers to entry were low, value-added was modest and competition was fierce. With society's richest and most influential people hiring people from the middle of the skills spectrum and those hiring low skilled and professional labour being comparatively poor, priorities amongst plutocrats were different. Not so today. With manufacturing having declined and with the growth in IT and finance, the profile of the plutocracy is decidedly different, as is its view of immigration.

Today's plutocracy is more disproportionately dominated by the employers of cheap unskilled labour (retail, leisure, hospitality etc.) and those of expensive professional, technical or scientific labour (finance, software etc.). The former view mass immigration as a handy mechanism for obtaining cheap unskilled labour and socialising a large portion of its cost to the welfare state and the long-suffering taxpayer. The latter group, with employees who can make or lose them vast amounts of money in staggeringly short periods of time, are obsessed with the corrosive effects of borders stopping them from getting precisely the workers they want, precisely when they want them. Hence the tendency of the pro-immigration plutocracy to fanatically support the EU. The list of Remain and Leave supporters in business told a tale. More traditional industrialists like Lord Bamford (who manufactures the famous JCB bulldozers) and Sir James Dyson (who manufactures bagless vacuum cleaners) seemed to see little intrinsic value in free movement of workers, being less reliant on holders of PhDs in financial mathematics and on unskilled migrant labour than most of their peers. By contrast, Lord Rose, who made his pile running retailer Marks & Spencer (cheap labour) and Peter Sutherland, who made his from investment banking (expensive labour) showed an obsession with free immigration and were very enthusiastic Remain supporters.

3. The same type of change has been evident in the plutocracy's view of regulation. The dwindling band of businessmen who make their money out of independant and family-owned businesses (like Bamford and Dyson) tended to view the EU as a source of expensive and cumbersome regulation. Likewise, those in manufacturing (again, Bamford and Dyson) were more likely than those in services and finance (like Rose and Sutherland) to regard EU regulation as a nuisance. By contrast, bigger businesses love entities like the EU because their lobbyists influence the content of the regulation and their vast armies of compliance professionals can crush smaller competitors. Likewise, big finance lives cheek by jowl with the bureaucracies and the central banks, whilst manufacturers feel far less love - especially from environmentalists and labour regulators. In the services sector,, meanwhile, profits can always be made because most services need to be produced in close proximity to consumers (I can buy my car from Japan if I want, but if I want a coffee, I can't go to Osaka for a cheaper one) and, once again, size matters and regulations crush small and independent competitors.

Moreover, the gigantically oversized financial services and IT sectors of the economy have another reason to love the regulatory state. As regulation crushes traditional activities that involve making, mining and growing things, this pushes dwindling investment capital into growth by acquisition strategies like LBOs (which benefit the likes of Goldman Sachs) and areas of the economy which are unregulated because they don't require physical space or materials (the aforementioned Bits and Bytes that make up the modern tech economy). Again, the big business elites are more and more involved in regulatory arbitrage and public-policy profiteering, two activities which the EU actively promotes. This meant that as libertarian-oriented Brexiters and Matt Ridley, Daniel Hannan and Douglas Carswell talked about Brussels red tape strangling business, the people who, in a previous generation, would have been enthused by such a message were only too happy to line up with the unions, the academics and the bureaucrats. It would seem, therefore, that 20th century socialism has succeeded where it could never have hoped for success: it has converted the upper classes to internationalist dirigisme - an impressive feat.

4. Behind the emotions, both sides voted according to their own rational perception of their self-interest. The Remain side has trafficked in the narrative of Leave voters being ignorant and ill-informed and responding to a campaign of lies. Meanwhile, to Brexit sympathisers like me, the reaction of the Remain side to the result has seemed quintessentially hysterical, irrational and emotional. In truth though, this seems to be an instance of tribal loyalties emotionally intensifying the depth of otherwise sensible convictions.

In reality, beyond the narrow technicalities of what a vote to remain or leave actually entailed, both sides seem to have picked up the same two key thematic conflicts between globalism and nationalism. Notwithstanding the rhetoric, both sides knew that a Remain vote would strengthen the political momentum behind mass immigration and the supranationalisation of rules and regulations and both sides equally knew that a Leave vote would generate political momentum going the other way. On this basis, Remain voters perceived their interests to lie with continued membership and the Leave voters perceived their interests as lying in departure. This could be one of those interesting instances in which both sides got it more or less right.

In the aftermath of the vote, both sides have agreed that those who had been "left behind" by globalisation voted to leave while those who benefited voted to stay. The myth serves both sides. It allows Remain to paint its opponents' voters as ignorant and uneducated and it allows Leave voters to portray the Remain side as arrogant and elitist. The reality, though, is a bit more nuanced and paints a picture of two sides who fundamentally knew what they wanted and whose interests will not be quiescently or amicably reconciled.

First, the geography is patchy. Tory voting southern constituencies went narrowly for Brexit. However, London (including its Tory enclaves) voted to stay. Labour constituencies in London voted heavily to stay, as did the former Labour heartlands of Scotland. On the other hand, Labour's traditional strongholds of Wales and the North of England voted overwhelmingly to leave. To confuse matters further, the more "centrist" Midlands, which have tended to swing between the Tories and Labour depending on the election voted most heavily of all to leave. The income divide was less clearcut than has been portrayed. Prosperous constituencies like Sevenoaks and Wealden voted Leave, whereas the not terribly well-healed city of Liverpool voted Remain. These kinds of anomalies muddied the waters. However, a few trends were clear.

London, which is heavily reliant on financial services, voted Remain. Major regional hubs like Liverpool and Manchester, which contain large expanses of welfare reliant voters and which have large concentrations of regional public sector entities like universities and regional policing centres also voted Remain. Meanwhile, Edinburgh, which is both heavily finance reliant and heavily public sector dependent voted Remain as well. However, voting patterns were different in places which still have a significant manufacturing/industrial base, agricultural areas and places which are not regional hubs and thus benefit less from prestige public sector employment. For instance, Coventry, where the Jaguar cars are made, Chichester, the site of the Rolls Royce Motors plant and Crewe, the home of Bentley cars, all voted to leave the EU. Meanwhile, Sunderland, where Nissan's UK operations are based and Birmingham and Sheffield (two cities which have retained relatively large manufacturing bases) made headlines early in the count by voting to leave. Meanwhile, while places with large immigrant populations and low unemployment (like London) voted Remain, places with large migrant populations and high unemployment (like Bradford and Rotheram) voted Leave.

If one ties these votes into the earlier themes identified and 1, 2 and 3 above, this pattern makes a great deal of sense. The political agenda of which the EU forms a central part has the effect of sweeping money into the centres of fiscal and regulatory decision making (public sector) and into the financial hubs in which the various acts of bond auctioneering, book running, market making, leveraging and hypothecation which keep the various bureaucratic systems afloat are undertaken (high finance). Meanwhile, its free movement doctrines send gushers of migrants into prime locations in which land values rise and generate speculative collateral for further swings of the financial merry go round. Outside these conurbations, such wealth accretions are nowhere to be seen and the price, in terms of deindustrialisation, are paid as jobs which create tradeable wealth are priced out of existence by regulation and the capital draw of the public and financial sectors. Put simply, on June 23rd, people who saw their interests as being aligned with regulatory arbitrage, debt pyramiding, rising land prices and nosebleed levels of public spending voted Remain; meanwhile those who saw their economic interests as lying in traditional mercantile activities of production, distribution and exchange voted Leave. In the narrow sense (and perhaps not so narrow), both were right.

5. The era of Thatcherite aspiration has ended. A new era of class warfare has begun. In the 1980s, a massive social conflict developed between those who supported and opposed Margaret Thatcher's free market reforms. What made the resultant conflict so civilised, relative to what I fear is to come, is that the divide cut across social classes, with the split elites firmly rooted to a substantial section of their own population. While the Tories had little sympathy for the Northern industrial working class clinging to its jobs in manufacturing and mining and the Labour grandees were contemptuous of a new aspirational Southern working class which sought home ownership and foreign holidays, the stripy jacketed elites in the City of London and the Hampstead Heath intelligentsia which clung to the social democratic Postwar settlement loathed one another too much to turn their backs on the masses, whose support they eagerly sought. No more.

Today, the divide within the elite is dwarfed by the elite's increasing divide from the entire population it rules. In the 1980s and 1990s, left wingers bemoaned the death of class politics. Well now it's back - and the left is now largely lined up on the elite side of it. The donor class that rules both parties has seen its interests diverge from those of the Demos below. The managerial state has come to suit the Tory voting stockbroker belt; meanwhile deindustrialisation serves the interests of the technocratic class that holds sway over the left. Meanwhile, this division of politics into class muddies all of the ideological waters and is fast turning the 20th century left-right divide into a museum relic.

While many on the Leave side were motivated by a desire to throw off the yoke of over-regulation from Brussels, the entire margin of victory for the Brexit side (and some) came from working class voters motivated by immigration and trade restrictionist sentiment. The former are less than keen on immigration restriction and trade protection. The latter are less than keen on deregulation. Either would probably be more comfortable in a traditional left or right wing coalition. However, the establishment left and the establishment right have moved to brutally purge Eurosceptics from their ranks (just ask Boris Johnson or Jeremy Corbyn), so these two groups must ultimately find a way in which to work together. On the other side of the political divide, another conflict looms: between the left of centre elites, who are comfortable with redistribution, and the respectable right, which would prefer to dispense with it. However, both wings of this elite have put their commitment to open borders and supranationalism ahead of traditional ideology. They must pay the price - and that price is a fractious and unpleasant long term political alliance.

The great tragedy of this looming conflict over globalism is that while the battle still rages, we may be in for years and perhaps decades of intellectual sterility in our politics as the politics of identity struggle to establish an equilibrium. The emergent ideology of our age is not economic liberalism or social democracy but conservative nationalism and those who are first to make a political accommodation with it will be fancied to win the future war of ideas that our dilapidated world demands we must one day have.