Reeves has placed an uncertainty premium on the British economy
Rachel Reeves promised to restore economic stability, but the outcome of her various actions has been to increase uncertainty, says Paul Ormerod
Daniel Ellsberg, who died in 2023 in his 90s, was a true Renaissance Man.
After a stellar career as an economics student at Harvard, he served in the Marines before working for the Rand Corporation on nuclear strategy. In the Pentagon in the early 1970s, he leaked top secret documents, which became known as the Pentagon Papers. He was put on trial for treason and sensationally acquitted.
In the early 1960s, he made a fundamental contribution to behavioural economics which is of great practical relevance to the current economic situation in the UK.
His paper, esoterically entitled Risk, Ambiguity and the Savage Axioms, was based on a deceptively simple experiment.
Ellsberg presented people with an urn containing 50 black and 50 red balls. They were first offered a bet to win if a red ball appeared, then a bet to win if a black was drawn. Not surprisingly, given that they were told the mix, the participants were indifferent between the two bets.
There was also an urn containing 100 balls in which the mix of red and black was unknown and offered the same bets. These bets were much less liked than the previous set.
Ambiguity aversion
Ellsberg described this as “ambiguity aversion”. People knew there was a risk they would lose in the first experiment, but they understood the chances. But they positively disliked the uncertainty of the second.
Labour came to power last July promising to restore economic stability. But, ironically, the outcome of their various actions has been to increase uncertainty.
Neither firms nor consumers know exactly where they stand when it comes to making spending commitments.
It started immediately after the election, with the endless repetition by the Chancellor of the mantra the “£22bn black hole” in the public finances.
Whether this hole existed in reality and, if it did, the extent to which Rachel Reeves herself had created by stuffing money into the pockets of public sector workers, was not really the point.
The very phrase “black hole” is profoundly unsettling to most people. Although the Chancellor put a number on it, a black hole sounds scary. It might be even bigger, and in any case how is it to be filled?
The former Chief Economist at the Bank of England, Andy Haldane, took Reeves to task about this last September. He attacked the Chancellor for creating a sense of “fear and foreboding” which could undermine the economic recovery which was underway.
All this has been compounded by the ambiguities, as we might put it, around the intentions of the government on tax.
The litany of events is well known. Before the election, Labour pledged not to raise taxes on working people. After the election, we have seen endless contortions to try and claim that raising National Insurance rates on employers – a tax on jobs – is not actually a tax on workers.
The various ambiguities around these verbal niceties only serve to undermine the government’s credibility on whether there are more tax rises to come.
The various ambiguities around these verbal niceties only serve to undermine the government’s credibility on whether there are more tax rises to come
It is the uncertainty which the government has created which, along with the increase in NI, is leading the labour market to stall.
It is the uncertainty which has led the yield on government bonds to rise to levels not seen in well over a decade.
It is the uncertainty which explains why consumers are now saving 10.3 per cent of their income compared to 7.9 per cent a year ago – a difference in money terms of around £10 billion, money which would otherwise be spent.
It is far from easy to see how the government can deal with this problem of their own making. But until uncertainty is reduced, growth will continue to be at best anaemic.
Paul Ormerod is an Honorary Professor at the Alliance Business School at the University of Manchester, an economist at Volterra Partners LLP, and author of Against the Grain: Insights of an Economic Contrarian, published by the IEA in conjunction with Morning Wire