Thursday, November 09, 2006

It seems likely that the Monetary Policy Committee of the Bank of England will raise interest rates today. This has been widely predicted since the last hike two months ago. But there are some very recent signs that the economy's buoyancy may not be sufficient to warrant such an increase. Manufacturing output has fallen for the first time in months, growth in industrial production has slowed almost to a standstill, sales on the high street have slowed down, oil prices have fallen, the trade deficit has shrunk, and business confidence is down. It is rare for the MPC to confound the commentators in the press, so I expect interest rates to go up - whether that is a good thing or not is another question.

Monday, October 30, 2006

Nick Stern's review of the economic implications of enviromental change, published today, sounds a stark warning. Unless investment, amounting to 1% of the world's gross domestic product, is undertaken to stave off the detrimental effects of global warming, global gross domestic product will be between 5 and 20 per cent lower than it would otherwise be by 2050. At the more pessimistic end of that scale, that is tantamount to a catastrophic recession. At either end of the scale, it makes investment now seem a good option.

A large part of the policy debate on the environment takes the form of discussion on taxes. This has been dreadfully timid so far. New taxes are never the way to an electorate's heart. A braver approach would be to switch on a large scale between existing forms of taxation and environmental taxes. Seriously slash income tax and replace it with much higher taxes on petrol and air travel.

This would have a beneficial side-effect - it would make the payment of taxes more optional, in the sense that it would be largely the consumption of pollutants that determined one's tax bill. Of course, some income tax (and taxes on other things) would still be necessary, if only for redistributive purposes. But the brave course of action for any political party now would be a promise a full review and reform of the structure of our tax system in an eco-friendly way, keeping all options open.

Tuesday, June 27, 2006

The Bank for International Settlements (BIS) has warned that inflation targeting using the interest rate may, in the near future, prove insufficient to guarantee macroeconomic stability. Such targeting has served us well over the last 10 years or so, giving a long period of sustained growth with low inflation and low unemployment.

But now the macroeconomy is facing new challenges. Fuel price increases threaten to push up inflation (unless people's expectations of future price rises can be held in check). At the same time higher production costs feed through into higher prices for goods and services generally, and so the demand for real output falls, threatening employment. Meanwhile, (more controversially) the BIS contends that globalisation necessitates speedier and more drastic adjustments that could make it more difficult to achieve economic stability.

If a repeat of the 1970s stagflation is on the cards - and I'm sceptical about this, but if it is - then clearly more than one policy instrument will be needed to control the macroeconomy. As Tinbergen pointed out, we need as many controls as we have objectives. If we have an employment objective as well as an inflation objective, we must have (at least) two controls. The BIS seems to be appealing for more policy power to be given to the central banks.

Traditionally the policy controls used to pursue macroeconomic objectives were monetary and fiscal policies. Monetary policy is already typically determined by the central bank. Fiscal policy remains in the control of politicians. We have done well under a system where macroeconomic policy has been separated from political influence, but it would make no sense to delegate fiscal policy to the monetary authorities.

The policy implications of a new stagflation are not, therefore, very attractive. The best option for politicians now is to do all they can to stamp out any inflationary pressure by aggressively seeking to reduce people's expectations of inflation. Wage demands must be talked down, and union militancy resisted. Although I do not share the pessimism of the BIS, the stakes are high.

Wednesday, June 14, 2006

Inflation has risen to 2.2%, slightly above the Bank of England target figure of 2%. This is causing a little discomfort and uncertainty about the way interest rate policy should go in the coming months, not least because unemployment has also been rising over the most recent period.

The authorities should certainly not accommodate inflation by relaxing monetary policy in a repeat of the mistakes of the mid-70s. That said, while the smart money continues to be on an interest rate hike over the summer months, it is not altogether clear that that is the way to go either. The interest rate increases in the Eurozone and the US appear to be having an effect in dampening demand, and that - migrated into the UK through foreign trade - might be enough to take the heat out of the domestic economy.

The signals are clear enough that we can rule out an imminent cut in rates. Whether the interest rate needs to rise or not then depends on wage pressures. If expectations of wage increases build up, then the one-shot blip of inflation due to the rise in energy prices will threated to turn into sustained inflation. An interest rate hike would be needed to fix that. If the authorities can manipulate expectations successfully so that union pressure for increased wages does not mount up, then increased interest rates may not be needed after all.

Spin gets a bad press. But, now more than ever, outcomes in the real economy depend on how convincing the politicians can be in urging wage restraint.

Friday, June 09, 2006

The recent announcement of the loss of 900 jobs at the Vauxhall car production facility at Ellesmere Port has raised issues about the UK's competitiveness. For sure, much manufacturing capacity in the vehicle production industry is being transferred to countries such as the Czech Republic and the eastern part of Germany where labour costs are lower than in the UK. But this is not the only issue being debated.

Union leaders have claimed that job losses in the UK are particularly severe because labour laws in this country are less tough than elsewhere, making it relatively easy for firms to lay workers off. While doubtless this does explain in part why the 900 jobs at Ellesmere Port have gone (or, at least, why they've gone now rather than later), the claim of the union leaders tells at most only part of the story. There is plenty of evidence to suggest that tighter labour market regulation leads to firms hiring less labour. The harder it is to fire workers, the less likely firms are to hire them.

So while job losses may be due in part to slack labour market legislation, many of these jobs may not have existed in the first place if it weren't for that same slackness. Britain's recent record of employment growth compares very favourably to that of our European partners, and our institutional and legal framework has to take a good bit of the credit for that. At the level of the individual, of course any job loss is terrible news. But that doesn't mean that our labour laws aren't performing well across the piece. The evidence suggests that they are.

Wednesday, June 07, 2006

Chancellor of the Exchequer, Gordon Brown, has been speaking out against protectionism. He is right to do so. While many interest groups see protection against foreign competition as desirable, it is in fact a thoroughly discredited policy; indeed it is as doomed to failure as Knut's efforts to hold back the tide.

Some things are better produced in some places than others. Climate, natural resources, skills are all unevenly distributed across countries. It is therefore efficient for countries to specialise, concentrating on producing the things that (relative to other countries) they are best at. This principle, known to economists as 'comparative advantage', is closely related to the division of labour; the advantages of specialisation are so strong that they constitute the strongest of market forces. While workers in heavy manufacturing industries in Britain or America may want to protect their jobs by lobbying for restrictions on the level of imports, such policies can offer only short term relief, making the inevitable outcome more sudden and unmanageable when it comes.

If producers in other countries can produce certain types of goods more cheaply than we can, then let them. Let's enjoy the cheap imports. And let's concentrate our resources on producing the things that producers elsewhere are not so efficient at producing. That way they can enjoy our cheap exports. Everyone gains. This freedom of trade is something that the European Union and other trading blocs were created to foster, and we should ensure that it is a freedom that applies not only within but also between blocs. It means we have to have a flexibile labour market, with people willing to retrain as they progress through their careers. The alternative is sclerosis.

Free trade does, of course, mean that goods need to be moved around the planet more than would be the case if we did not trade freely. But efficient movement of goods is cheap and - with the exception of a very few highly perishable goods such as cut flowers - involves a negligible environmental cost. On the flip side of the coin, the damage done by not trading freely is measured by the poverty to which rich countries - by imposing protectionist tariffs, quotas and regulations - condemn people in the developing world. That is appalling.

Good call, Mr Brown.

Friday, May 12, 2006

A fascinating and very instructive new article by Nicholas Bloom and John van Reenen compares productivity and managerial competence across four countries. They find that managerial competence is a key determinant of productivity (and of other key performance indicators for firms). Managerial competence in the UK lags behind that in Germany and the US.

The authors argue that a major reason underpinning this is the system of primo geniture, under which family firms are passed down generation to generation, with management of the firms being carried out by people who are chosen for who they are rather than what they can do.

If the authors are right - and their study is indeed a very careful one - then there are obvious implications for policy, ranging from inheritance tax, through support for business schools, to a requirement that senior appointments in privately owned businesses should be advertised and demonstrably made on the basis of merit.

Thursday, May 04, 2006

Which way now for UK interest rates? Interest rates have risen of late in other major markets, including the Eurozone and the US. Oil prices have risen dramatically, and the fear is that this reflects a rise in fundamentals, not just a blip. This leads some observers to worry about a rise in inflation; although the oil price hike will surely affect prices in a one-off manner, if people start to build price rises into their expectations of inflation this could lead to a prolonged inflationary episode similar to the experience of the 1970s. So that makes a case for a hike in interest rates in order to defuse inflationary pressure.

Other observers are more cautious, citing levels of business confidence that are still low. Indeed some are calling for a cut in interest rates.

The clever betting has to be on interest rates remaining constant when the Monetary Policy Committee makes its decision later today. But, given the signs of economic renaissence in the UK's trading partners, I would suspect that the next move in interest rates - if there is to be one anytime over the next six months - is more likely to be up than down.

Tuesday, April 25, 2006

A recently published report by New Philanthropy Capital challenges the government's claim that City Academies offer donors an attractive investment in education. The City Academies have been particularly controversial in recent weeks because they lie at the heart of the 'cash for honours' allegations.

Only 27 academies have been set up so far. Of these, 10 are currently in their first year of operation. Of the remainder some are new schools, while some are replacements for pre-exisiting schools. In their most recent review of the programme, Price Waterhouse Coopers analysed this latter group, and found that GCSE grades (as measured by the percentage of pupils achieving 5 or more GCSE qualifications at grades A*-C) have risen in half of the schools following their conversion into Academies, and that grades have fallen in the other half of schools. While it's still early days for the programme, this is not a ringing endorsement.

Other measures are more positive. Stakeholders - pupils, parents - comment favourably on the learning culture, the attitudes of staff, and the quality of leadership in the Academies. If these qualities can, over time, translate into higher grades, then the Academies may yet turn out to be a good investment.

The running costs of Academies are comparable to those faced by conventional schools. Set-up costs are about £7m higher (because Academy buildings are often designed specifically to meet specialised pedagogical objectives). We know, from research by Gavan Conlon, that people who achieve 5 A*-C grades at GCSE typically earn around 11% more than those who don't (holding other things equal, and assuming that getting the GCSEs doesn't lead to getting further qualifications). Aggregated (and discounted) over a lifetime, that's worth around £50000. If, by changing from a school into an Academy, around 7 more pupils per year could achieve 5 A*-C grades at GCSE, then - over time - the investment could pay off. In year groups of 100, that means a 7% improvement in the performance measure. That's quite a demanding target to meet, albeit not an impossible one.

More interesting questions concern exactly what characteristics of Academies might deliver these benefits - and can these characteristics be obtained more cheaply than at present? Is it expensive new buildings that do the trick, or is it good leadership, or is it motivated teaching staff, or is it subject specialisation, or is it freedom from regulation?

Those philanthropists who are considering backing an Academy should bear all of this in mind. The Academies are not a sure-fire bet in the quest to improve educational standards. New Philanthropy Capital suggests that providing support for out-of-hours school activities, tackling bullying, and supporting special educational needs can all represent safer investments. The benefits of these alternative programmes - which are certainly less glamourous than Academies - have not been quantified in a way that makes it possible to compare them with the benefits of Academies, and without further evidence it would be difficult to concur completely with the New Philanthropy Capital view. But their report certainly poses the right questions.

Tuesday, April 04, 2006

Labour market rigidities cause unemployment. Rigidities are themselves often caused by institutions - those institutions may be unions, regulations, standards... or even, perversely enough, employment protection legislation.

There is ample and unambiguous evidence that employment protection legislation serves only to reduce employment. This evidence comes from many different countries, and over many different time periods. The reason is easy to surmise - the tougher is employment protection legislation, the more reluctant are employers to hire labour in the first place, because once hired it can't (easily) be fired.

The demonstrations in France are aimed at a relaxation of employment protection for young people. The policy is proposed specifically to attack a problem of high youth unemployment - and it's a policy that should work. The winners from the policy will be currently unemployed youths. The losers (and there will be some) will be young people who are currently in work, and who will lose out in terms of their job security.

The protests began with students - young people who most likely will find work and who up till now have been beneficiaries of excessive employment protection. We should not forget that - they are not being altruistic. They are not thinking of their less fortunate contemporaries. The latter need the new legislation in order to raise their probability of finding work.

One hopes that the French government will not capitulate in the face of protests by a curious coalition of privileged rent-seekers and the poor misguided and uninformed.

Friday, March 17, 2006

The 2006 UK Education and Inspections Bill recently passed its second reading in the House of Commons. The bill has been controversial, relying on support from opposition members of parliament for its passage to this stage. It comprises a number of major elements:

Schools may opt to become trust schools, owning their own assets, employing their own staff, and setting their own admissions criteria - independent of local authorities.

The local authorities, meanwhile, will develop a strategic role which will promote quality in all schools within their jurisdiction. They will also be required to play an active role in promoting parental choice.

Admissions procedures will be tightened up, so that schools have to abide by their policies (not merely have regard of them). Interviewing of pupils will be banned, and the ban on selection by academic ability will be reaffirmed - except for the 164 grammar schools that are still in existence.

There are a number of other provisions, which include such things as school meals, the right for staff to discipline pupils, and the creation of specialised vocational diplomas.

The main reason for Labour revolt over this bill would appear to be the creation of the trust schools - which are similar to the grant maintained schools introduced by the last Conservative administration. By removing many schools from direct control of the local authorities, this effectively separates the schools from the political process. Many people other than the Labour rebels might regard that as a rather good thing.

A little discussed aspect of the bill, however, concerns the creation of specialised diplomas. The role of the state in creating qualifications has not in the past been a distinguished one. Think of the NVQs. Unfortunately this part of the bill has all the hallmarks of an accident waiting to happen. There are two aspects of the proposal with which I am uncomfortable. First, the diplomas are intended to be vocational in nature. There is, however, no evidence to suggest that education at this level should be take the form of vocational training. In a fast changing economy, general education, providing as it does the skills with which people can become adaptable and amenable to lifelong learning, provides much higher returns. Secondly, any new qualifications would stand the best chance of success if they were to be created and validated by a private sector body. This would ensure that market pressure is brought to bear that should guarantee the usefulness of the qualifications.

Thursday, March 16, 2006

Gary Becker provides an interesting defence of capital punishment. His argument hinges on the deterrence effect. While the strength of this effect is a matter of some debate, he argues that even where less than one innocent life is saved as a result of killing a guilty murderer, society may benefit from capital punishment, since the positive value to society of the murderer is likely to be less than that of the innocent victim. "A comparison of the qualities of individual lives has to be part of any reasonable social policy."

This statement is, of course, far from innocuous - especially so if we remove it from the emotive context of capital punishment. It is particularly controversial because it begs the question of who should make the decision about the qualities of individual lives. If different people are to carry different weights in society's welfare function, how should democracy work? Do currently installed governments have a mandate to make decisions on this? Should the governments now in place therefore allocate variable numbers of votes to members of their populations in time for the next elections? Should these be based on criminal records, access to welfare payments, education, gross income, or contributions to party funds? Under such conditions, democratic government would amount to little other than a one party state. So should it be a dictator that decides on the weights? That would be convenient, to be sure, but one dictator's tea is another dictator's coffee.

Unless Becker can tell us how and by whom the comparison of the qualities of individual lives should be made, his argument is no more than subjective opinion - in his view, we should count some people's lives as worth more than others. In the context of capital punishment, his opinion may have a lot of public support. More generally in the construction of social policy his would be one voice amongst many, and each of those voices would like to be able to dictate.

All this is not to suggest that economists can, or should, refrain from making comparisons of the qualities of individual lives. Indeed we cannot avoid doing so, for assigning an equal weight to each individual involves making comparisons just as does the assignment of unequal weights. But reaching a judgement that at the margin one life is worth more or less than another is something that we should do only in the most exceptional of circumstances, and in full cognisance of the implications. For amongst those implications is the undermining of much of our discipline as we know it. Utilitarianism would be out, and with it much of welfare economics would go. Even the invisible hand, which provides the intellectual foundation stone of free market economies, and which assumes that one agent’s welfare is worth the same as another’s, would be seriously compromised.

Now that's a funny thing to come out of Chicago!

Thursday, March 09, 2006

Energy prices have been rising very dramatically of late. Those with long memories will be reminded of the 1970s. At that time, oil price hikes led to general price increases, and many governments (notably the UK) sought to accommodate these by increasing the money supply. The result was rampant inflation.

Is inflation likely now? Certainly a one-shot increase in prices is likely and that will cause a blip in inflation. A major difference between the current situation and that of the 1970s, however, is that the central bank has autonomy to determine monetary policy. Its reaction to an inflationary blip is likely to be a temporary rise in interest rates which will serve to reduce inflationary pressure. This is the opposite of the policy mistake that was made in the 1970s.

So while the increase in energy prices hurts, it is reassuring to know that it is unlikely this time to be translated into a sustained and high rate of inflation. And, who knows, it might even have a beneficial impact on the environment.
Britain's big supermarkets - Tesco, Asda, Sainsburys and Morrisons - are under investigation. The charge is that they are dominating the market and crowding out smaller providers. This is seen as being detrimental to local communities.

There are advantages and disadvantages associated with big stores. They exist because they can take advantage of economies of scale. These include, most obviously: spreading out advertising costs amongst many stores within the chain; the ability to arrange for the production of discounted 'own brand' goods; human resource management; a rationalised distribution network; administrative and other overhead savings. These economies of scale are likely to be substantial, and advantage should be taken of the savings that they allow.

There are other advantages that the supermarkets have in the market, however. With such a high degree of concentration of market power, they can use their weight in the market as a means of exploiting their suppliers. In economists' parlance, they can abuse their monopsony power. This means that small suppliers - including many farmers - find their profit margins squeezed to the point that they go out of business. This is not welfare-enhancing.

Moreover, the increased dominance of large, often out of town, superstores has implications for the car useage and the transport infrastructure more generally. The environmental and social cost of superstores - compared with the availability of local shopping - needs to be borne in mind in any assessment of welfare.

So the supermarkets do indeed need investigating. Striking the right balance between exploiting scale economies, on the one hand, and preventing the anti-competitive exploitation of suppliers, on the other, will be a challenge. That the authorities should at last have risen to meet the challenge is welcome news.