Wednesday, September 22, 2004

I have, for decades, been a supporter of Christian Aid, both through regular donations and as a door-to-door collector. I have, however, been appalled by half page advertisements placed by the charity in today's newspapers. They exhibit a dreadful level of economic ignorance.

The advertisments argue against free trade and in favour of 'fair trade'. They cite the particular case of onion farmers in developing countries whose output is priced out by cheap imports from Europe. Let's disentangle that example.

Suppose trade is free. European farmers could price out farmers in developing countries only if they could produce onions more cheaply. If this is the case, then people in developing countries should consume the European onions, and be grateful that their own farmers can then be freed to produce something else - something that they are better (in relative terms) than the Europeans at producing. That way everyone gains - in the developing countries they get cheap onions and their farmers can switch to producing something that earns them more income. This is the principle known to economists as comparative advantage, and it supports the argument in favour of free trade. To be sure, the transition of switching from producing one thing to producing another can be painful, but it is a transition that has to be made sooner or later - as countries as diverse as the UK and the USSR discovered during the 1980s, you can't buck the market forever.

There is another possiblility. Maybe trade isn't actually free at the moment. Maybe European farmers are dumping cheap onions onto foreign markets. This might happen if they seek to sell their onions in Europe at prices above the level that would clear the market. To achieve this, they would have to restrict supply to Europe by selling cheaply abroad. This certainly would not be fair trade, and if this is happening, Christian Aid would be right to oppose it. But by the same token, this is not free trade either.

I regret to say that Christian Aid has got it very wrong. They should be arguing for, not against, free trade. Free trade is fair trade.

Wednesday, September 08, 2004

The Conservative party has today published its proposals for the funding of higher education in the UK. The proposals involve the scrapping of all tuition fees, and an increase in the interest rate paid by students on student loans. Students will gain from the former and lose from the latter, but on average will be better off.

By scrapping tuition fees, universities and colleges will be denied an important source of income. To alleviate this, the Conservative proposals include an intention to hand over to the higher education institutions themselves the claims on student debt. The universities and colleges could then sell this debt to financial institutions, releasing funds that can be spent now to alleviate the funding crisis in higher education.

These proposals raise a couple of interesting issues. First, if universities and colleges are given the authority to claim back student debt, it is not at all clear that they would be able to do so through the income tax system. The innovation of income-contingent loans was one of the most attractive features of the reforms ushered in in the wake of the 1997 Dearing Report. If loan repayments are not contingent on income, a return to mortgage type loans would be very hard on graduates who fail to get high paying jobs, and on those who interrupt their careers for family reasons. Presumably it would be possible for the universities collectively to subcontract the loan repayment process to the government tax collectors, but it is not clear that this is what the Conservatives have in mind.

Secondly, while it is clear that the Conservatives wish to allow the universities and colleges to receive loan repayments from students, it is not clear where the money to make the loans will come from in the first place. If the government makes the loans (as now), it will need to find the money to do so. If the higher education institutions make the loans (and one wonders whether this might be the hidden agenda), then it is not clear that the new proposals will do anything at all to solve the higher education funding crisis. There seems to be some alchemy at work here, a black hole at the heart of the proposals.

The higher education sector faces a funding gap of between £6 billion and £10 billion per year. If we want an effective higher education sector, that gap has to be plugged. Alchemy will not plug it, and it seems that the introduction of differential tuition fees remains the only really persuasive and honest proposal in town.

Thursday, August 05, 2004

Interest rates are up again today, to 4.75%. This is the fifth hike in the last 8 months, and suggests continuing concern in the Bank of England about inflationary tendencies in the UK economy.

The latest figure (for quarter 2, 2004) for the annual rate of growth of real GDP is 3.7% (up from 3.4% in the first quarter). As a measure of unemployment, the claimant count is still falling, and has been below 900000 throughout 2004. These are both signs of a buoyant economy.

The continuing rise in house prices, and concerns raised by the high price of oil, have generated some concern about inflation. But the former should be self-correcting and the latter should be a one-shot event.

The annualised rate of growth of the consumer price index rose during the second quarter of the year - from 1.1% in March to 1.6% in June. This remains low in relation to the target level, and in this respect it is surprising to witness the sustained hikes in interest rates; it seems to be a severe policy response.

There is, however, reason underpinning the Bank's policy reaction. Over the year to June 2004, lending to individuals increased by some 15%. Much of this is due to house purchases, but growth in consumer credit has also been dramatic, at around 12%. These figures suggest that, unless credit is reined back by rising interest rates, aggregate demand will outstrip supply and inflation will set in. The Bank's decisions on interest rates may therefore be seen as a response to a useful leading indicator of economic activity; rather than responding to what inflation is now, the Monetary Policy Committee is responding to where inflation might be in a few months time.

As things stand, this carries a danger. We might reasonably expect the housing market to self-correct, and we might also expect this to involve quite a substantial fall in the price of a typical house. If this happens while interest rates are still being hiked, consumers will face a double-whammy - house price collapse and high interest rates. Certainly the economy may need to be slowed down in the months ahead. But the housing market may ensure that it does some of the slowing down of its own accord - interest rates are not the only thing that can brake the economy. The MPC needs to toe a very thin line between doing too little and too much. The signs are that it has done enough for the time being.

Wednesday, June 02, 2004

The increase in oil prices (to over $40 per barrel) has caused much concern. Political instability in Iraq and Saudi Arabia are largely the cause, with the price of oil futures in particular being lifted as a consequence of the risk factors involved, fear of a cutback in supplies generating worries about future price hikes. Inevitably this stimulates memories of the 1970s, when OPEC, the cartel of major oil producing countries, succeeded in quadrupling oil prices. At that time, the price rises were accommodated by expansionary monetary policies in many Western economies, this fuelling inflation. Cartels are notoriously unstable, however, and it does not appear that this time around OPEC will be able to exacerbate the high price of oil - indeed major players within OPEC are committing themselves to raising supply, thereby dampening the upward pressures on the price.

Oil prices are critical determinants of the prices of many other things, owing to the importance of oil as a fuel for transporting goods. So oil prices matter. But a one-shot increase in the price of oil is not, of itself, inflationary. It does not set off a sustained chain reaction of price increases. In the 1970s, however, governments' responses to the OPEC oil price hike did set off an inflationary episode. At that time, governments reaction to the increase in the price of oil was to expand the monetary base so as to accommodate the oil price shock, that is to try to dampen the decrease in aggregate demand that is consequent to the one-shot price rise. But by expanding the money supply, the authorities merely generated further price increases, setting off an inflationary sequence.

The monetary policy response to the oil price rise now should take heed of the lessons offered by the experience of the 1970s. Interest rates should not be cut to accommodate what is happening in the oil markets. But neither should fears of inflation due to oil price rises necessarily mean that interest rates should be raised. The oil price hike is a one-off event; it does not mean that inflation has re-emerged, and the appropriate response is not a knee-jerk anti-inflationary adjustment of the interest rate.

Whether the Monetary Policy Committee should have raised the interest rate last month is moot. It should not have done so for fear of inflation in the housing market, and it should not have done so for fear of the effects of rising oil prices.

Sunday, May 23, 2004

Interest rates have risen recently in the UK, with the Monetary Policy Committee apparently fearing the effects of a house price boom and bust on the overall economy. Inflation, meanwhile, remains well below the 2% target. The interest rate hike is in my view premature. Rather than ensure a soft landing for house prices, it might precipitate a crash. Holding rates constant for a while longer might have been more prudent at this time.