Thursday, September 11, 2014

On 18 September the people of Scotland will decide in a referendum whether they want independence from the UK. A majority in favour of independence have a profound impact on labour markets on both sides of the border.

Evaluating exactly what these implications might be is not straightforward. While we will know the outcome of the referendum at the end of next week, we will not know what party would form the first government in an independent Scotland. Neither do we know which party will win next year's election in the UK. Moreover, the status of either country as members of the EU remains uncertain, with the Conservative party in the UK promising a referendum on this in 2017.

There remains uncertainty about the currency that would be adopted by an independent Scotland. While Alex Salmond has expressed a preference for a currency union in which both UK and Scottish interests determine monetary policy, the UK government has ruled out the loss of sovreignty over its own currency that this would imply. Of course, Scotland could still use the pound, but with interest rates being determined by the Bank of England its room for manoeuvre in economic policy would be limited. Indeed the extent to which it could be considered an independent country would be limited - in much the same way that the independence of European countries could be questioned when a leadership of 'technocrats' was installed during the worst of the debt crisis.

The Scottish government's white paper on independence includes a proposal to set a 'competitive' corporation tax as a means of attracting business to Scotland (p.120). Corporation tax is, of course, one piece in a large jigsaw of factors that contribute a firm's location decision - and a cynic might suggest that many multinational firms already act creatively in order to make sure that they minimise their tax liabilities. But if Scotland were to succeed in this aim of attracting business from the UK, we should not be so naive as to suppose that the UK government would be passive.

The white paper suggests reducing corporation tax to 3 percentage points below the UK rate. This ignores the fact that the UK too could change its policies - and businesses already knows that. It seems that there would in truth be little benefit to either government of a race to the bottom - the outcome in terms of which jobs go where would be unchanged, but tax revenues for both governments would diminish. Yet such a race might be an inevitable consequence of independence.

The white paper (p.237) also envisages the removal of the nuclear facilties at Faslane. The likely outcome of this would be a transfer of those facilities to the UK, involving a transfer also of employment. Jobs in related industries could follow, and there would be knock-on 'multiplier' effects.

The uncertainty over currency has already led to banks stating that they have contingency plans that involve moving to the UK from Scotland in the event of a 'yes' vote in the referendum. This is motivated by their need of access to a central bank that can serve as a lender of last resort. The loss of jobs in the financial sector in Scotland would again have knock-on effects.

On the UK side of the border, some regions might benefit from jobs that are lost to Scotland, particularly in banking and defence. If the Scottish government manages to strengthen its business-friendly credentials - and if the UK government does not respond - then some firms could move in the opposite direction, and this would have adverse implications for the employment position in some UK regions. Of course, anyone who loses their job as a consequence of these events - on either side of the border - could become available for other employment. They would need to be flexible, willing to retrain, and willing perhaps to take a pay cut to regain employment. The long term effects on individual workers could therefore outlive short term turbulence - it could seriously disrupt careers.

There is nothing sacrosanct about current national boundaries. There is no reason why Scotland could not be a successful independent country. But to benefit from that independence, it would need its own currency and all the degrees of freedom in economic policy-making that that would imply. It would also need to ensure that its government fostered an economic climate that was seen by businesses as favourable, so that firms could with confidence create jobs in Scotland. If it could do so without setting off a tax race to the bottom with the UK, then it could succeed. The half-baked nature of current plans do not, however, provide much encouragement.

Thursday, August 07, 2014

The latest statistics on industrial production, published yesterday, show some slowing in the rate of growth. The April figures indicated an annual growth rate of 2.9%, but this slowed to 2.2% in May and to 1.2% in June. These data provide further evidence to suggest that the speed of recovery is now starting to go into reverse and that growth in 2015 will be noticeably more modest than it has been in the current year.

Tuesday, July 29, 2014

The government is working on a proposal to allow universities to buy the loan book of their own graduates. While graduates of universities that opted into this scheme would continue to pay back their loans through the tax system, that part of the student loans company's assets that comprises loans made to students and graduates of a given university would be sold back to the university itself. The student loans company might expect to get a better price for this asset from the university than from other investors because the university can do things to maximise the probability with which loans are fully repaid. In other words, the university would be incentivised to optimise the labour market experience of its graduates.

An immediate issue concerns the ability of universities to afford to buy the loan book. Over a very short time, the cost associated with the loan book would swamp the finances of a typical institution. But it would be possible for institutions to borrow from the financial sector to fund their purchases - and it is reported that a large financial investor is already interested in the scheme.

Several 'top' universities are said to back this proposal. The scheme certainly does have some attractive features. One is that it shifts the risk associated with the loans system from the government onto the universities - and that is a good thing because the universities are positioned to mitigate tha extra risk by enhancing their careers support, making their courses more relvant to the needs of the labour market, and so on. Where exactly the risk resides will depend on the price at which a loan book is sold, but the likelihood is that it would be sold at a higher price under this system than under the current system.

There are two ways in which this type of scheme could work out in practice. One would be for some universities to opt into the scheme while others opt out. Amongst the former group, we would expect to see a response to incentives such that these universities' graduates become more employable - a clear gain. The value of the loan book of the second group of universities would, however, fall as adverse selection ensures that these are the universities whose graduates are least likely to repay loans in full. By reducing the averaging out effect of pooling loans across all universities, some degree of toxicity is thus introduced into the loan books of the universities that do not opt into the scheme. If employers then use this as a signal that these universities' graduates are less employable than others, the costs thus imposed could offset the benefits associated with the other universities' response to incentives.

So allowing universities to opt in or out of the scheme may not work, simply because all universities feel that they have to opt in. What if this were to happen? Selling each university its part of the loan book at a given price per £ loaned would penalise universities whose graduates are less successful in the labour market. In effect, as such graduates pay back less of their loans and as the universities would receive less net income, this would be similar to - though considerably more complicated than - a system in which universities whose graduates are less successful have to charge lower fees. All institutions would be incentivised to improve the labour market performance of their graduates, since by doing so they could recover more of the loans on the books.

The key issue that needs to be addressed in higher education finance is the long term sustainability of the funding model. The resource accounting and budgeting (RAB) charge - that part of the student loan book that will not be paid off - has risen to 45%, highlighting this concern. The proposed changes may do something to help. The present system has encouraged all institutions to charge the maximum tuition fee, and this has not encouraged discipline on costs. The proposed system, by way of contrast, might encourage universities whose graduates are less successful to reduce their costs.

So, while much of the detail remains to be worked out, the new proposals - inasmuch as they might lead to something better than we have at present - merit a cautious welcome. They promise to buy an increase in efficiency at the cost of increased complexity. Hopefully the exchange will be a beneficial one, but the proof of that pudding will be in the eating.

Tuesday, June 10, 2014

The industrial production statistics for April show continued healthy expansion in this sector, providing further evidence of continued economic recovery. The data continue to suggest that we are experiencing a spike in growth, however. The prospect for this year is for the rapid pace of growth to continue, but - while continued growth is likely into next year - the rate of growth is likely to slow down quite sharply as we look further ahead. The latest forecast from my neural network model is shown below.

Monday, May 12, 2014

The CBI has revised upwards its forecast of GDP growth for the current year, to 3.0%. This prediction appears reasonable. The confederation now expects growth in 2015 to be 2.7%, and that may be optimistic.

A striking feature of the detailed aspects of the CBI forecast is that - like the EY ITEM Club - it signals a substantial growth in investment during the current year. While total business investment fell by 1% in 2013, the CBI expects it to grow by 8.3% this year and by a further 9.1% next year. With growth and confidence returning, a return to growth in investment would not, of course, be surprising. But the magnitude of these estimates is striking.

The growth we are now experiencing is, of course, welcome. There are, however, aspects of the economy's trajectory that look like bubbles. The housing market is one, and business investment may turn out to be another. Some observers have suggested that the Bank of England should look to raise interest rates sooner rather than later. In light of the considerable spatial disparities that are emerging (with London booming while the recovery is still nascent in peripheral regions), an interest rate hike would be premature in the absence of substantial support to the regions. A reduction of fiscal stimulus to the core region - particularly through housing market support - may, however, be timely.

Friday, May 09, 2014

Industrial production data were published earlier today, an event that always causes me some excitement because it means I can update the forecasts produced by my neural network model. Here they are. They continue to suggest that the current rapid recovery is set to continue, but that the rate of growth will become much more modest over the next two years. The recovery is good news, but we should not get carried away - it looks a lot like blipping, and we may need to get used to slower growth than we are currently experiencing.

Thursday, May 08, 2014

The latest index of house prices produced by Halifax reports an annual rate of growth of 8.7% across the UK. The rate is highest in Greater London, at 15.7%, but several other regions are now experiencing substantial increases in prices. These include the North West (12.7%), Northern Ireland (11.4%) and the West Midlands (9.6%). By way of contrast, price rises in the North have been very modest indeed (1.5%), and in Scotland prices have fallen by 1.4% over the past year. The recovery in the housing market does appear to be spreading at last, but it remains patchy.

Increases in prices in the South East have been modest relative to those in the capital - some 5.3%. Of course, prices are determined by a mix of demand and supply factors, and there is scope to raise supply in London itself.

Doing so is important - with such an uneven economic recovery, lagging regions would be ill-served by a premature hike in interest rates. Ensuring that the housing market is not constrained in areas where supply needs to expand is key to spreading the benefits of recovery to all.