Friday, August 14, 2015

The political aftermath of this year’s general election looks set to be played out over an extended period. However this point, 100 days after the election, seems to be an appropriate time to provide an early analysis of the economic dimension of the new administration’s performance. The election confirmed the positions of many key players – David Cameron and George Osborne are still in residence in Downing Street – but the change from coalition to majority Conservative rule has freed the government of some constraints. In many respects, then, this is indeed a new government.

The economic importance of this political change was evidenced by the second Budget of the year. The Chancellor took the opportunity to introduce a new wave of government spending cuts, many of which would have been difficult to implement within a coalition. His plans to reduce the deficit sharply were blown off course after 2012, and this year’s Budgets have provided renewed impetus to the austerity drive. The March Budget was criticised for its rollercoaster properties - implying as it did a severe downswing in government spending before a pre-election upswing. In the Summer Budget these fluctuations were smoothed out, and the period over which the deficit is to be removed was extended. These are welcome developments, restoring some sense to the time profile of fiscal retrenchment. But the impact on growth of the spending cuts that will be imposed over the next couple of years will need to be monitored carefully, and policy should be adjusted in line with this impact if need be.

The broader macroeconomic context has continued to develop reasonably favourably, with output growth looking to be on course for around 2.5% over the year. Meanwhile, inflation has been subdued. This has been largely the result of falling oil prices (nothing to do with the government), and the short period earlier this year when, on average, prices were falling does not look set to trigger a harmful and sustained deflation. Indeed this period of low price inflation has allowed real wages to rise for the first time in several years.

Whether this increase in earnings reflects a much needed upturn in labour productivity remains to be seen. Shortly after the Summer Budget, the government published Fixing the Foundations, its plan to restore productivity. This contains some good ideas around employer-led training, the role of universities in developing human capital and innovative capacity, transport, digital infrastructure, and housing investment. It is certainly the case that investment is needed across the full range of economic activities in the country in order to secure productivity gains. Business investment is critical, and encouraging such investment requires a stable environment which is difficult to guarantee in present circumstances – given in particular the recent trauma of the Eurozone centred on Greece and the uncertainty surrounding a British referendum on continued membership of the EU.

While the commitment to supporting investment in infrastructure is welcome, less pleasing has been the government’s ability to turn this commitment into reality. Major investments in upgrading the rail network have been ‘paused’, leading many to fear that they might ultimately be scrapped. In the North of England, in particular, this has severely challenged the government’s own concept of the Northern Powerhouse, and some considerably clearer thinking around this (and indeed around other aspects of regional devolution) is urgently needed.

Economic opinion is divided about whether the cuts announced in the Summer Budget come at a better time for the UK macroeconomy than did those introduced in 2010. But whatever one’s view on that, it is certainly the case that the microeconomic effects of the current round of cuts will attract attention. In particular, the distributional effects will need monitoring closely, with large cuts being made to the welfare budget. This being so, it is highly regrettable, indeed shameful, that the Treasury will no longer publish a distributional analysis of the effects of policy. This is a step back. An important future measure of this government’s economic performance will be how the poorest have fared – and it is too early yet to come to any conclusions on that.

For a variety of reasons, there has been an increased concentration of low wage workers in the UK. Most significantly, technology is leading to a polarisation of jobs, with concentrations at the top and bottom ends of the skill and wage distribution. Many lower skill workers have been employed at wages below the Living Wage, and this has imposed costs on the welfare system. The Chancellor’s announcement in the Summer Budget of a new Living Wage (at a level between the existing national minimum wage and the Living Wage) should encourage employers to address the issue of productivity amongst their lowest paid workers, and should reduce the burden imposed on the welfare state by low pay. Whether this alone can be sufficient to address the large trends that have caused the problem of low pay in the first place is, however, moot. The impact of technology on the labour market, just like the impact of the ageing workforce, requires some big thinking, not just in government. That has yet to surface.

Returning to the overall macroeconomic picture, the Chancellor’s imposition, in normal times, of a ‘fiscal lock’ – limiting his own room for manoeuvre in spending and tax decisions – is unfortunate. It seems to reflect a view on the government’s part that its primary economic objective should be to balance its own books. Over the long run, it is certainly important that the government should not accumulate debts that are unsustainable. But, as someone once observed, in the long run we are all dead, and in the shorter run it is vital that the government should retain for itself discretion over all the levers of influence on the economy. Maybe, though, the definition of what makes for normal times will turn out to mean that the fiscal lock amounts to little beyond the hype. The early abandonment of 2018-19 as the target date for clearing the deficit certainly suggests as much. As he showed in 2012 when easing back on austerity, the Chancellor’s practice is generally markedly more sensible than his rhetoric.

Overall, then, the first 100 days have seen quite a lot of action in the economic sphere. The government’s policy will evolve, surely, as events unfold. There have been positives – smoothing out the rollercoaster, the new Living Wage – but there remain some very real concerns, particularly around the distributional impact of policy and the climate of uncertainty surrounding a possible Brexit. When all is said and done, 100 days is just that. The horizon over which these policies will ultimately be judged is much longer.

Thursday, August 06, 2015

The latest statistics on industrial production show a dip in output over the month to June of this year. Nevertheless, inputting these data into my neural network forecaster indicates that year-on-year movements in this series can be expected to be somewhat more positive than forecasts have indicated in the past. The rate of growth can be expected to slow, but the imminent danger of this series turning into negative territory appears to be receding somewhat.

Friday, July 24, 2015

If, as it did, the recent general election presented the electorate with a dismal choice, the sense of dismay has only been exacerbated by the process of choosing the next leader of the Labour party. Having lost two consecutive elections, Labour is now in complete disarray, having apparently lost all sense of identity. Of the four candidates for the leadership, three offer moderation - a sense of drift that places them somewhere to the left of the Conservatives, but bereft of any true mission. The other offers a return to a left wing agenda that fails to address the issues of the day, and that fails to offer any prospect whatsoever of gaining power.

Some of Labour's grand ideas of the past have been implemented, have proved successful, and have been appropriated by other parties. The minimum wage was initially met with great hostility by the Conservatives, but with the recent announcement of a national living wage the idea of a wage floor has become uncontentious. The National Health Service is another example of a great Labour idea that has come to be 'owned' by all parties. For Labour to have fought the last election largely on a fancied Conservative threat to the health service appeared patently absurd to impartial observers. These are big ideas that succeeded. They were tried out, came through, and - backed by the evidence - they became depoliticised and are now part of the fabric of the country. Some other ideas, for example, nationalisation, were not so successful. In those cases, backed by the evidence, the trials were reversed, and, though there may be arguments about the detail of how privatisations were conducted, few people would argue in favour of a wholesale return. With the evidence that comes from trying things out, some issues leave the political arena and become essentially technocratic. We move on.

But while we move on, the values on which grand political movements are constructed remain the same. I shall focus on three such values that have, across the generations, characterised the Labour party.

The first concerns aspiration and social mobility. My parent's generation was the first to have access to a full secondary education, and the first (without access to parental wealth) to be able to progress to a higher education. This enabled them to break through economic and social barriers in a way that was simply not possible for previous generations. This is something with which the Labour movement has been associated from its early days. The modern union movement in the UK can be dated to the creation of the Trades Union Congress at Manchester's Mechanics' Institute in 1868. The Mechanics' Institutes typified a range of organisations that promoted adult education amongst working people. This was a business-friendly approach - indeed the Institute was set up by business leaders who noted the gains to their own companies that would arise from a better trained workforce. But it was also one that enabled social mobility, allowing workers from humble backgrounds to aspire to great things. It ensured the best for the country by enabling the best for each individual. The modern Labour party retains its commitment to help those who are disadvantaged, but has become less focused than it once was on answering the question: help to do what? The answer, surely, has to be: help to develop, to transform and to succeed. And the leadership candidates should all be asking themselves, and answering, questions about how the education system can be reinvigorated so that social mobility and aspiration are once more fostered. Today's Sutton Trust report suggests that current policy does not always help. So much remains to be done. There should be no tension between individuals' aspirations and business success; and Labour should find ways of promoting both.

The second area in which Labour values are pertinent is that of ownership. This is a difficult area for the party because ownership of the means of production has been such a totemic issue in the past. There is a natural aversion to wealth endowment arising from accidents of birth, not least because it hinders the kind of social mobility to which I alluded earlier. But the large nationalised industries of the past demonstrated that concentrating ownership in the hands of the state was disadvantageous in other respects; governments, as the owners of state industries, do not necessarily serve their peoples as best they might. And monopoly power begets inefficiency, whether that power is concentrated in the hands of capitalists or the state. Thatcher's dream of a property owning democracy, where the major privatisations led to large numbers of share owning individuals, had merit in spreading wealth widely. But inevitably many shareholders were passive, and many others sold their stocks so that once again ownership became concentrated. Clearly public ownership is not a panacea, but equally a free market in the ownership of companies has delivered problems. Will Hutton has identified the early sale of embryonic businesses, often to overseas investors, as a major impediment to the realisation of benefits from innovation. Solutions to the problem of ownership, ensuring that all stakeholders maintain an interest in business, perhaps involving various kinds of golden share arrangement, need exploring. While not returning to tried and failed solutions in this space, the Labour party thus has much to offer in the general arena of ownership. In a week in which the Financial Times has been acquired by Nikkei, it is easy to focus minds on how important this issue of ownership can be.

Thirdly, social protection is another area that has been central to Labour values. This has proved to be a highly controversial issue in the last week, with the party's leadership facing rebellion over its demands that MPs should abstain in a parliamentary vote about welfare cuts. Protecting the poor while ensuring that aspiration is rewarded is fundamental. Less fundamental should be the means by which this is done. A number of shibboleths therefore need, at minimum, to be opened up to debate. So, for example, most observers would agree that people who are unemployed through not fault of their own should receive some support. Whether this should be done through the tax and benefits system or through a system of compulsory private insurance (with no claims discounts to finesse moral hazard issues) is another matter. Likewise, few would argue against a universal health service, but whether this is paid for through the tax system or through a private insurance system is not - or at least should not be - fundamental. The important thing is surely that those with few resources receive sufficient support to ensure that they can insure themselves. The basic income proposal is radical, and in pure form might not be affordable, but with modification it might provide one possible avenue for welfare reform that deserves investigation. At the very least, it poses a question that deserves to be asked.

The whole issue of benefits is made more difficult by the fact that the current system is clearly broken. In-work benefits essentially supplement the earnings of many workers, distorting the operation of the labour market. The current government has regarded this as a latent subsidy to firms, allowing them to pay low wages, and it has responded by hiking the minimum wage. It is easy to sympathise with the government's frustration, but it remains the case that the minimum wage is a very blunt tool to use in the alleviation of poverty, since poverty affects households and not the individual recipients of (minimum) wages. Moreover, the ageing population presents challenges to the current system that successive governments have swept under the carpet. There is an opportunity for radical thinking to address this. In a nutshell, prospective Labour leaders should not be so defensive about the current system of welfare support that they fail to recognise the need for a root and branch review.

All of the above areas concern core Labour values. They are areas where we should not be thinking of returning to old, tried, tested (and proven or not) ideas, but where we seek solutions for today. It is profoundly depressing that most of the Labour leadership candidates are offering what is essentially a Tory-lite prospectus. People will only vote for that if they become disillusioned with the competence (as opposed to the underlying philosophy) of the real thing; that seems a ludicrous gamble to take. The fourth candidate at least has the merit of offering the electorate some choice - even though it is a choice they will not find appealing. The contest - and, possibly, the electorate of 2020 - is crying out for some ideas that define an identity for the Labour party, and for the country, of today and tomorrow. It can be done. It just needs someone who has the qualities of a leader. And, unfortunately, that looks like being someone outside the current group of contestants.

Monday, June 29, 2015

The recent events in the Greek saga have been remarkable by any standards. A week ago, it looked as though a deal had been reached – bar dotting and crossing of is and ts – that would have released the last tranche of bailout money, enabling Greece to repay loans due at the end of this month. The Greek government had produced proposals that appeared to meet the requirements of the Troika (composed of the European Commission, the European Central Bank and the International Monetary Fund). These proposals entailed: further substantial fiscal retrenchment, with a budget surplus gradually rising to 3.5% in 2018; pension reform, with strong disincentives for early retirement and a raising of the retirement age to 67; VAT and other tax increases; and some privatisation. Markets responded favourably, with the spread on Greek 10 year bond yields falling sharply.

Following encouraging noises, the Troika rejected the Greek proposals, concerned that they rely too heavily on tax hikes and not enough on spending cuts. The prevarication of the Troika is, of course, understandable given its composition. The Greek government is seeking to negotiate with a group of three separate bodies, which is tough enough in itself, but the European Commission serves as representative of the 27 member states of the Union (excluding Greece itself). Negotiating with a coalition of this complexity presents a unique set of hazards, particularly in an age when a raised eyebrow is enough to go viral in the twittersphere.

The Troika’s concern about tax hikes versus spending cuts is, in itself, interesting, and it is likely to come from two sources. One is the influential work of Alberto Alesina, who presented a case to European Finance Ministers some 5 years ago arguing that government spending cuts can (in contrast to tax hikes) stimulate an economy. This doctrine of ‘expansionary contraction’ has been largely discredited since, notably in work done by the International Monetary Fund and also in Alesina’s own further investigations. Nevertheless, the ideas seem to be sticking in people’s minds, possibly because (in spite of all the evidence) the fantasy that deficits can be removed without pain is superficially appealing. The second source of the Troika’s concern is perhaps more serious, in that it has a more rational foundation. It is a deficit of trust. Based on track record, there is simply too much scepticism that Greece will succeed in bringing in the extra tax revenues. It is difficult to see how that trust deficit can be closed, at least without entailing a fundamental loss of Greek sovereignty.

Following the Troika response to the Greek proposals, Greek Prime Minister Alexis Tsipras announced a referendum to be held on Sunday. This is, of course, after the date at which the loan repayments are due and means that these repayments will be, at least, deferred. The Greek government is advocating a ‘no’ vote in the referendum – that is, a rejection of the austerity measures that the Troika is seeking to impose. Such a vote would likely lead to loss of support from the European Central Bank, forcing Greece out of the Eurozone and (surely?) also out of the European Union. A ‘yes’ vote would compromise the ruling Syriza party, generating considerably political uncertainty.

With Greece outside the Eurozone, it would have to set up its own currency – a new drachma. The value of this currency would quickly depreciate, leading to inflation in Greece as imports become more expensive. The inflation would erode the value of the Greek debt, in effect representing a partial default on that debt. In addition, it is possible (likely, even) that there would be an explicit default on some part of the amount that Greece still owes to its creditors.

The Troika has been reluctant to discuss debt relief as part of the deal it has been seeking to negotiate with Greece, but the reality is that some relief, in one form or another, is inevitable. There is no real reason not to discuss it. For sure, there are moral hazard issues – debt relief on one occasion makes recalcitrant behaviour in the future more likely – but we are where we are, and the negotiators need to acknowledge and respect that.

The impact of the last week’s events on the markets has been noteworthy. The yield on Greek 10 year bonds fell sharply when a deal looked imminent. When, with the announcement of the referendum, it became clear that talks had broken down, the yield rose sharply again. This is a textbook case of how news affects market returns.

A major concern for countries in Europe other than Greece is the extent to which a default (of whatever form) would have adverse effects on other economies within the Union. Creditors may have insulated themselves from excessive exposure to a default, at least to some extent, over the last couple of years. The response of yields in Italy, Portugal and Spain (below) is not altogether encouraging, however. The degree of contagion may be less than it would have been in 2012, but the potential is still there for Greek default to have a severe impact on economies whose recovery from severe economic recession remains vulnerable.

Meanwhile, over recent weeks people have been withdrawing their money from Greek banks, concerned by several possibilities – including the imposition of restrictions and also the possibility that their safe currency (euros) might be replaced by a new local currency (drachmas) of lower value. Such action, while perfectly rational, rapidly becomes a self-fulfilling prophecy. Consequently Greek banks will be shut for the whole of this week, at least, and restrictions have been imposed on ATM withdrawals. Times are tough, and the liquidity that is needed for the normal functioning of an economy is seriously restricted now.

To come so close to reaching a settlement and then to fail betrays some pretty dismal negotiating skills on both sides. The Troika is particularly to blame for its intransigence – though this comes partly from its own cumbersome composition. It has succeeded in appearing willing to trample over democracy in order to achieve technocratic solutions, and this can only have an adverse effect on the way in which EU institutions are regarded in the wider European community. Meanwhile, while the Greek government has made all the compromises, they have failed to acknowledge and address the trust deficit, failing also to recognise and allow for the Troika’s intransigence; put simply, they have misjudged their own position in the negotiation.

Last night it appeared as though President Obama was working behind the scenes to secure a solution – pressing Angela Merkel to ‘make every effort to return to the path that will allow Greece to resume reforms and growth within the Eurozone’. Such a statespersonlike intervention was sorely needed, and it is to be hoped that the President’s intervention can help the negotiators on both sides see this through.

Wednesday, June 10, 2015

In the run-up to the recent General Election, the Conservative Party announced that it would legislate to ban increases in income tax, VAT and national insurance over the course of this parliament. The new government is now announcing that it intends also to legislate so that governments, during ‘normal’ times, must balance their budget.

To stipulate that, over the course of an economic cycle, the government should (at least approximately) balance the budget is not controversial. Gordon Brown introduced the ‘golden rule’ for fiscal stability in the 1998 Finance Act - though he subsequently demonstrated that such rules can be finessed. What is new about George Osborne’s plan is that a lock on borrowing now accompanies a lock on taxation. The co-existence of both locks implies that the government will retain no discretion to vary government expenditure.

Fiscal policy will thus be locked. With interest rates at the zero lower bound, abstracting from unconventional measures, monetary policy is – for the time being – locked too. Hence the whole of demand management policy is locked. Subject to interpretation of the word ‘normally’ (and what a wonderful word that is), the Chancellor has wrapped himself and the rest of the country in chains. Mr Osborne is, normally, a very astute politician – this may be smart politics, putting the opposition on the back foot. But, normally, it is also daft economics.

For a wise Chancellor keeps his or her options open. And that is where the interpretation of ‘normally’ comes back in. The years around 2007-09 were not, by any stretch of the imagination, normal. The lock on the government budget would not have applied then, and would not have saved the UK from the accumulation of a large fiscal burden. Quite right too – the desperate nature of the period called for action using all available policy levers.

One might hope that the Chancellor and his successors will be able to tell the difference between what is normal and what is not. For at least a couple of years before the financial crisis, Gordon Brown demonstrated that the problem with Chancellors is that they are human; they suffer from human nature and believe the hype that suits them. Rules have the benefit of offering the rest of us some protection from this, but at the end of the day there are times when such rules ought to be broken, and that inevitably involves a call of human judgement.

At best, the lock on demand management policy is silliness – a rule that can be broken at will. At worst, it could seriously harm the ability of the government to respond appropriately to what Harold Macmillan called ‘events, my dear boy, events’ – and in this eventuality it would look like crass foolishness.

And at any point in between, the policy lock could have adverse implications for economic growth and employment. It should be remembered that these, not the deficit, are the legitimate objectives of policy, and that the regulation of borrowing should be but a means to meeting those ends.

Tuesday, May 12, 2015

The latest data on industrial production are better than expected. They show industrial output to be at its highest level in more than 3 years, and, after some flattening in recent months, the March data show a marked month-on-month improvement. After a partial stall of growth in the second half of last year, these data may provide the first real sign of renewed improvement.

Plugging the data into my neural network model reveals that the dip in industrial output that the model has, over recent months, been predicting has not disappeared from the forecast - but it has been pushed back. This in itself is welcome news, but it is also a reminder that the recovery is still not fully consolidated.

Friday, May 08, 2015

One of the common, and justifiable, refrains heard in recent weeks has taken the form of a lament for the poverty of the offerings of all political parties in the general election campaign. What excitement there has been has come from the intelligence of the opinion polls that suggested - wrongly, as it turned out - that the election would be a close run thing.

On offer from all the major parties was further austerity. This varied in its format. The Conservatives promised to achieve a surplus on the budget by the end of the parliament, and to achieve this more or less exclusively by way of spending cuts. Labour promised a substantial reduction in the deficit - not quite the same retrenchment as the Conservatives - and promised also to achieve it through a mix of spending cuts and tax hikes. There is some distinction between the parties here - not least in the underlying philosophy. The Conservatives want to reduce the size of the state, while Labour do not. That difference in philosophy gave the electorate something on which to base their decisions. But in practice, the differences between the parties are probably not all that great in these respects. The rollercoaster budget proposed by the Conservatives is unlikely to be as dramatic as it appears (and indeed, heaven forbid that it should) simply because it is unlikely to be even remotely achievable.

There were other distinctions between the main parties. Ed Miliband, the Labour leader, had a good campaign, and performed most strongly when stating his convictions. It is hard to doubt that his heart is in the right place. Many of the policies that his party offered were well-intentioned. Cutting university tuition fees, capping energy prices, and a form of rent control are examples. Yet all of these policies could well, had they been implemented, have had unintended adverse consequences. Since the poorest students do not repay their loans in full, cutting fees would benefit most the richest. Since energy companies could raise their prices before the threat of a price cap was implemented, the cap could have the opposite effect to that intended. And, even in the refined format proposed, rent controls can have an adverse effect on the supply of housing. In short, there was a naivete about many of Labour's proposals that seemed to sit curiously alongside Miliband's undoubted intelligence.

The Conservatives, meanwhile, offered a referendum on membership of the European Union. The economic impact of a Brexit has been evaluated thoroughly in a recent study. This finds that, while the balance of costs and benefits depend on the form that withdrawal might take, the most likely scenario is that the UK would lose out by leaving the EU. But, the evidence being mixed, different people have different opinions, and a referendum could go either way. A government of any complexion is one thing; a government taking the UK out of Europe is another entirely. It is therefore to be hoped that the electorate will get the answer right when it comes to the referendum.

The Conservatives campaigned also on two other major things: a rather curious line against the SNP (implying that representation in government by that party would in some sense have been undemocratic), and Labour's record of economic management while in office. Both of these appear to have had some political traction. The first is just bizarre. The second has been widely discussed (see, for example, blogs by Simon Wren-Lewis and Paul Krugman). I reported my own concerns about Gordon Brown's tweaking of his 'golden rule' as long ago as 2005, but in reality any fiscal irresponsibility at that time was small beer. The economic crisis originated in the US financial sector, and we were particularly exposed because of the size of that sector in the UK. The government of the day responded more or less appropriately. Desperate times and all that. With understandable political interests, the Conservatives and others created a myth around this that Labour - not least during the election campaign - have been utterly inept at debunking. Either the myth needs to be addressed in a way that the public can understand, or Labour needs a fresh team so that it can start to rebuild a reputation for economic management. As a result of the election, the latter course will be forced upon them.

And so back to the pollsters. How did they get it all so remarkably wrong? With the Greens and UKIP attracting many votes and with the Liberal Democrats in decline, the electoral dynamics were inevitably hard to predict. It is striking that John Curtice's exit poll came so close. It seems likely that there are features of his methodology that would make good learning points for the other pollsters.