Comment: Tale of the seven wise squabblers

Click to follow
It is always comforting when people conform to type. Economists are supposed to be particularly prone to disagreement; witness George Bernard Shaw's 'if all economists were laid end to end, they would not reach a conclusion'. It should therefore come as little surprise that the panel of seven economists chosen to advise the Chancellor on economic policy should already be at each other's throats.

The issue is whether taxes should be raised in the Budget. Six of the seven thought that they should not; one that they should. Six to one appeared rather strong odds, and this was presented to the world as a rare example of economic near-unanimity. It was assumed that faced with this advice, whatever changes he made to individual taxes in the Budget, at least the Chancellor would not increase the overall tax burden.

However, the odd man out, Professor Tim Congdon, would not lie down. Last weekend he used the newsletter he writes for the discount house Gerrard & National to savage the other members of the panel, using sufficiently rough language to raise squeals from his fellow panellists (one suggested that his remarks might be libellous) to ensure that his views received a wide airing in the press.

One could dismiss this as typical academic rivalry were it not for one important point. Professor Congdon has been rather right. While by no means infallible, he has been better than most of his rivals at forecasting the British economy. He warned vociferously during the second half of the 1980s that the boom was getting out of control and that inflation would result, and he was early in warning that the recession would be serious.


His consultancy depends on this reputation for continuing to get things right. Unlike the other panel members, who work at large commercial or academic organisations, his company, Lombard Street Research, is a small entrepreneurial outfit. It now has commissions from a number of sources, is building up an international side, and has been supported from the start by Gerrard & National. But Professor Congdon has to sell his ideas to the financial markets in a way that only one other panel member, Gavyn Davies of Goldman Sachs (and economic columnist in this newspaper), has to.

The core of Professor Congdon's argument is that the others do not pay enough attention to money. He claims that the other panellists are theoretically incompetent, on the grounds that they ignore the key works of economic theory of Keynes and Hicks in the 1930s: Keynes' General Theory and Hicks' response in the journal Econometrica.

Economists interested in the row should get their copy of his case from Lombard Street Research; the rest of the world needs to know why in common- sense terms he reaches a different conclusion from his fellows on the wisdom of tax increases this Budget.

The whole panel agreed that in the long term the Government would have to do something to curb its deficit, but the other six thought it was too dangerous to do so at this stage of the economic cycle. The recovery was too fragile. Professor Congdon, on the other hand, felt that so much demand can be injected into the economy by easing monetary policy that a start can be made on cutting the deficit right away. Policy would be eased by cutting interest rates further and by abandoning the Treasury's 'full funding' rule - not issuing gilts to match the full size of the deficit but financing part of it by borrowing from the banking system instead.

Well, who is right? It is very hard to know. The basic problem is that while economic theory is a useful tool for explaining how the economy works, it is an imperfect one. The modern market economy of the industrial world is immensely complicated; human behaviour varies from economic cycle to economic cycle; the links between countries, via international trade and the financial markets, vary over time. We never know which bits of the theory matter most at any particular moment, for we do not fully understand the transmission mechanisms.

Take savings. Whether people save their money or spend it has an enormous impact on the state of the economy. But economic theory is very bad at telling us why people save, and is absolutely hopeless at predicting what will happen to savings in the future. Interest rates coming down should, you might imagine, cut savings because people get a lower return on them. But maybe when people find their savings are paying less interest, they decide that they want a higher return in the future and so save even more to boost their cash balances.


The same problem applies to our response to changes in money supply. Tim Congdon was absolutely right in spotting that the surge in money supply in the late 1980s would exacerbate the boom. But that does not necessarily mean that allowing a rapid rise in money supply now would secure the recovery.

The instinct of many people, faced with this sort of morass, will be to jeer at the whole profession and suggest that the idea of having 'seven wise men' to advise the Chancellor was an absurdity. That is understandable, and the adjective 'wise' does seem misplaced. But governments have to make decisions, even though the body of knowledge on which they have to base them is frighteningly thin. The more helpful conclusion should surely be that there is no ultimate truth in matters economic and that therefore the aim of policy should be to try to avoid making really big mistakes.

The message for the Budget might therefore be that even if Professor Congdon is right (and he may well be), the risk/reward ratio of waiting a few months more before increasing taxation in any significant measure is in favour of delay. It would, however, be worth testing the water by nudging some taxes up a bit and seeing what happens. And it would certainly be worth making structural changes in taxation now which will be helpful in raising new money in the years ahead.

Meanwhile economists should be more honest about the limits of their knowledge. Economics is a wonderful, fascinating subject, but it is a seriously uncertain one.

The Japanese telephone company referred to in the column of 26 February is NTT, not NKK.