Wednesday, December 03, 2014

Today’s Autumn Statement tells us something about the way in which the government sees the economy moving over the next few years, and rather less about how it plans further to reduce the budget deficit.

After peaking at 3% this year, GDP growth is expected to fall to 2.4% in 2015. That is no surprise – indeed I have been predicting a slowdown next year for some time, and the sluggish performance of the UK’s major trading partners in recent months reinforces the view that broader economic conditions do not offer a favourable wind. The longer term projections for growth are for it to stabilise at between 2.2 and 2.4 per cent each year to the end of the decade. This probably has more to do with the structure of the econometric models used in forecasting – which tend to revert to a mean – than any serious assessment of the economics. We might be so fortunate, but equally we might, post-recession, be in a new world in which the secular rate of growth is slower than it was before.

The public finances are forecast to improve dramatically beyond the current year. Last year’s outturn was a deficit of £97.5 billion. This year’s is expected to be slightly lower, at £91.3 billion (down from £133.9 in 2010-11). But by 2016-17 it is expected to be only £40.9 billion, and the following year just £14.5 billion. In percentage terms – as a percentage of GDP, that is – the deficit is expected to be 5.0% in the current year compared with 8.4% in 2010-11. It is coming down, but slowly. If the recent strength of the economy were to be maintained, there may be scope for tightening the belt – but many indicators suggest that this year’s strong performance has been a blip, and the Prime Minister may well be right to suggest that ‘red warning lights are once again flashing’ in the economies of some of our major partners. In any event, the Autumn Statement provides little information about how the turnaround that is still sought in the public finances is to be achieved, not least because the changes in planned expenditures and revenues announced today imply only a small net gain.

Big money changes include an increase in personal tax allowances, a major reform of stamp duty (moving to a marginal rate system), a restriction on tax relief that banks can claim on losses made in the aftermath of the financial crisis, and new employer contribution rates for public sector pensions. Moreover, a scheme will be introduced to tax multinational enterprises that seek to declare profits overseas rather than face UK tax; how this will be implemented is unclear.

Certain items of specific public sector investment are worthy of note – the Sir Henry Royce Institute for advanced materials will attract £235m in Manchester, and a Big Data centre at Daresbury will attract £113m. These are significant investments in the North West – though the Alan Turing Centre on Big Data will be located in London (which some may see as perverse given his connection with Manchester). Further investment in the Northern Powerhouse includes infrastructure improvement, including road improvements in Merseyside and on trans-Pennine routes, HS3, and investment in other rail services.

While the Chancellor announced several public investment projects, the Statement is disappointingly thin on measures to promote business investment. There are minor changes to R&D credits, and proposals to extend the work of the British Business Bank, notably through an extra £400m under the Enterprise Capital Funds programme.

On the labour market, there are proposals to extend the National Insurance break for firms employing young workers to cover all workers under the age of 25 on apprenticeship schemes. While it is good to see the importance of youth training acknowledged, it is not clear that this is the best way to achieve progress in this area. The quality of many apprenticeship schemes remains an issue, and it is in any event not clear that incentives of this kind are efficient in view of the deadweight associated with providing a break to employers that would in any event have provided the training.

A particularly welcome innovation is the proposal for a loan scheme to finance taught postgraduate education. This will help end the current inequity that has made tuition at this level affordable (more or less) only to those with private resources.

Overall, the Statement is one with much detail to be pored over, but lacking a clear vision of the route ahead. The cuts that remain to be made in public spending are severe, and we still await information on where the axe is intended to fall.

Monday, November 03, 2014

The Chancellor of the Exchequer has announced that new powers are to be devolved to the Greater Manchester Combined Authority (GMCA). The GMCA will gain powers in the areas of policing, planning, transport and housing, and will be required to introduce the post of a directly elected mayor.

These powers are modest and do not offer the promise of any real capability to stimulate economic development. If the north of England is to be able to position itself as more power is devolved to Scotland and other regions, it will itself need further discretionary powers.

But the absence of such powers in the current proposals might in fact be a blessing.

For while this move is being portrayed as progress in the development of the Northern Powerhouse, it is not at all clear that it represents a positive development in that context. The Northern Powerhouse is intended to create a single urban area stretching across the Pennines, bringing in Leeds and Sheffield as well as Manchester - and reaching out further in both directions along the M62 corridor. Creation of a nexus of political authority in Manchester may well hinder economic integration of the north rather than aid it.

Northern cities face a drain of human capital to London and they lack the capital's levels of business investment. The disadvantage faced by the north thus amounts to much more than the lack of a high speed rail link over the Pennines. Integration requires a unified political purpose that is not well served by creating divisions now between Greater Manchester and weaker local authorities elsewhere.

Creating new jurisdictions in a UK that is characterised by devolved government requires careful thought. It should not come about purely as a consequence of 10 local authorities deciding to work together. Wider interests are at stake, and central government has a duty to take those fully into consideration. Should Manchester be a metro in its own right? What then of the Northern Powerhouse? So should the metro include Liverpool, Leeds and Sheffield? Maybe. But what then of Newcastle? And what of the rural areas in between? These are questions worthy of debate. Computable general equilibrium models are used to evaluate such issues elsewhere. Serious research is needed in the UK too.

Today's first step is not altogether promising.

Tuesday, October 07, 2014

Data on output in the production industries indicate a slowing of the recovery. As recently as March of this year, year-on-year growth in this sector was healthy at well above 3%. The latest figures show this measure slowing down to a little over 1% - and the seasonally adjusted figures show no month-on-month growth.

Further, applying my neural network forecaster to these data suggests that the next year or so will see a decline (albeit short lived) in industrial output. This may well be a pessimistic forecast - it does not take into account the surge in business investment that we have seen over recent months. But it does serve as a warning that some aspects of the current recovery are still rather more fragile than might be desirable.

Thursday, September 25, 2014

The cost of living has become a major concern in public debate on the UK economy. While unemployment data reflect an economic recovery, the continued decline in real wages points the other way, painting a confused picture of the state of the labour market.

The recent publication, by the Institute of Economic Affairs (IEA), of a book on the cost of living is therefore welcome. The main thrust of this contribution is to emphasise the role that can be played by the market in bringing down prices. Hence, relaxing planning controls can bring down the price of housing. EU policies such as the Common Agricultural Policy could be relaxed to bring down food prices. Environmental policies based on old technologies could be updated to bring down energy prices.

The IEA notes also that many policies being promoted by other participants in the debate would involve increased government intervention - raising the minimum wage, imposing controls on fuel prices etc. - and that these can be damaging. For sure.

But this is where the book arrives at its limits. In pursuing the free market agenda so aggressively, the IEA misses the primary cause of the problem, and hence misses also the primary remedies. That primary cause is the loss of productivity. Until productivity growth is restored, the cost of living will remain a problem - regardless of how much tinkering (be it liberation or intervention) is done at the edges. That requires investment - barely mentioned in the IEA report. We have, over the last few months, seen the first signs of renewed business investment; sustaining this through maintaining low interest rates and facilitating access to finance has to be the top policy priority.

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.

Tuesday, April 29, 2014

The latest data indicate that, in the first quarter of this year, GDP grew by 0.8%. This implies a very healthy 3.1% growth over the course of the last year.

The performance across sectors is uneven, with particularly strong growth in manufacturing and in distribution. Manufacturing grew by 1.3% over the quarter, and by 3.5% over the year. This is clearly good news in that it addresses concerns that the UK had, before the recession, become over-reliant on services. Strong growth in manufacturing helps raises incomes, but with developments in technology making this sector increasingly capital-intensive, the progress of the sector may not be reflected in such strong employment growth. The extent to which this concern is well founded will require monitoring as the recovery progresses. The strength of recovery in the distribution sector (which includes, amongst other things, retail and wholesale industries) reinforces the extent to which this has, at least until very recently, been a recovery led by consumer spending. Recent forecasts from, amongst others, the EY ITEM group, suggest that investment is set to rise significantly this year. If it does - and there is still surely a question mark surrounding their precise forecasts - then that will strengthen the underpinnings of a recovery that has, till now, been built on rather fragile foundations.

Other metrics of the recovery, including house price changes, suggest that experience across the regions is very patchy. Data on output growth by region are produced with long lags and are not considered to be terribly reliable, but the evidence that this recovery is spatially uneven suggests that the very encouraging aggregate statistics may serve to conceal what is, in reality, a much more nuanced picture. The data on underemployment released by the Work Foundation likewise suggest that the impact of output growth on the labour market is very different to – and less comforting than - what we have experienced in the past.

Nevertheless these most recent data offer much hope that the economy is indeed recovering.

Wednesday, April 16, 2014

This morning's release of the latest labour market statistics provides a dose of good news all around. The unemployment rate has fallen below 7%, and earnings are rising at 1.9% over the year. The rate of earnings growth is particularly pronounced in manufacturing, where it is 2.8%, possibly reflecting the onset of skills shortages. In finance and business services, meanwhile, earnings have grown at only 0.3%, possibly reflecting in part the decline of bonuses.

The detailed data still paint a more nuanced picture. Take productivity as an example. Output per job rose by 1.3% over the year to quarter 4 in 2013. This is a marked improvement on the 0.5% achieved the previous quarter, and certainly better than the declining productivity that was still being experienced in the first quarter of last year. However, improvement in output per hour has been considerably less impressive. This was still falling as recently as the third quarter of last year. The final quarter figures are a little more encouraging (suggesting 0.7% growth on a year earlier), but remain fairly muted.

Another aspect of the labour market which has been interesting in recent years is the dramatic rise of self-employment. Between December-February and the previous quarter, self-employment rose by some 146000, and the total now stands at more than 4.5 million. The latest figure represents a 7.1% change over the year. Self-employed workers now comprise 14.8% of the workforce. We know that much of the increase in self-employment has taken place amongst older demographic groups, and it remains unclear how much of the rise is due to entrepreneurial development as opposed to people running out of labour market options. Clearly more research is needed on this.

In sum, therefore, the statistics are encouraging. But the labour market is clearly changing rapidly, and an exclusive focus on the headline metrics risks being more than usually misleading.

Tuesday, April 15, 2014

The rate of growth of consumer prices in the UK has again slowed - to an annual rate of 1.6% in March. This has raised hopes that real wages, which have fallen and then stagnated over recent years, may finally have turned a corner. Earnings data become available tomorrow, but - since they are produced with a longer lag than the price data - will cover the three months to February. But clearly, if real wages do turn out to be on the rise, a major component of any explanation will be the slow increase in prices.

The low rate of price inflation thus merits some consideration. Since August of last year, the value of the pound relative to other major currencies has increased. Against the euro, it has risen over 5%, while against the US dollar it has risen by well over 20%. This has led to cheaper imports, putting downward pressure on price inflation. The fundamental basis for this appreciation is unclear - while confidence in the economy's ability to deliver growth has clearly increased, the current account balance has deteriorated sharply over the last two years.

If nominal earnings do indeed soon rise faster than prices, then that would suggest a turnaround in productivity - and that would of course be welcome. But the growth rate of productivity looks set to remain slow, well shy of its trend, for some time to come. The supply side issues underpinning low productivity still need to be addressed urgently. The labour market is still some way off returning to normal.

Tuesday, April 08, 2014

The latest figures for industrial production (up to February) have been released today. These allow me to report the latest forecast from my neural network model. The forecast is now for a less dramatic (but still pronounced) spike in output than previously predicted. The forecasts in the graph below cover a 24 month period, and suggest that, from early 2015, the rate of growth of output will slow down sharply. While the recent run of good news on the economy is cause for some celebration, caution about the medium term is still warranted.

Tuesday, April 01, 2014

The latest data on labour productivity show some positive movement. In the fourth quarter of last year, productivity grew by 0.3%, representing a 0.7% change over the course of the year.

A positive outcome on productivity is, of course, welcome following the dismal performance over the last few years. Nevertheless, this rate of growth remains below half of the long run trend.

The news coincides with the release of an important report from the Institute for Public Policy Research. This shows (Fig. 8.9, p.104) that British investment in training over the last few years has lagged way behind that of competitors. Without addressing the shortfall in human capital, productivity will remain a challenging feature of the UK economy, and will continue to pose a threat to the recovery.

Friday, March 28, 2014

The Bank of England’s Financial Policy Committee has sounded a warning about conditions in the housing market. It notes a rise in mortgage approvals of some 40% over the last year, and a record level of mortgages for which the loan is more than four times the borrower’s annual income. This warning reflects more widespread concern about the emergence of a housing market bubble.

The latest data on house prices do indeed show a rapid acceleration, with average house prices across the country growing by some 6.8% over the year January (with the Bank’s data suggesting a further sharp rise since). But this figure conceals some very substantial variations across the regions. In London, house prices are growing at a rate of 13.2%, surely unsustainable. In the South East, the increase is 7.1%. In other regions the rate of growth is much more modest – in the North East, house prices have grown by just 0.6%, and in Scotland by just 1.4%.

Regional unemployment disparities remain wide, with rates varying from 5.2% in the South East to 9.5% in the North East. Moreover, while unemployment is falling quite rapidly in the South East, the latest data record a rise in the North West, Yorkshire and Humberside, the East of England, and the East Midlands.

The latest available data on regional growth rates of gross value added – though somewhat out of date - likewise indicate a very uneven recovery. These show the South East growing at 2.5%, but most other regions growing at less than 1% per year, and with the East Midlands actually contracting.

In sum, these data indicate a considerable measure of spatial disparity. Recovery is proceeding apace in the South East, but has barely begun in some other regions. Past experience suggests that the improvement in the state of the economy will transmit across regions eventually – though it appears to be doing so more slowly this time than it has done in the past.

The extent of the disparities at this juncture is, however, a little worrying. The boom in the South East needs to be checked, but without stalling growth elsewhere. Monetary tools represent the mainstay of macroeconomic stabilisation policy, but a hike in the interest rate could not check growth in one region without causing profound damage in others. Different conditions across space call for policies that have different impacts across space. The solution to the South East housing bubble is not, therefore, to be found in macroeconomic policies – rather it is to address the supply side constraints. That means, quite simply, building more homes.

Wednesday, March 19, 2014

The latest report of the Office for Budget Responsibility (OBR), released to coincide with today's Budget Statement, raises the forecast for GDP growth to 2.7% for the current year. Since no forecaster has performed well in recent times, this news, in itself, is not terribly interesting. What is more interesting is the fact that the OBR forecast remains so far below that of the Bank of England - 3.4% - though the Bank does expect a somewhat more severe downward adjustment in the growth rate in 2015 than does the OBR. The discrepancy between the short term forecasts that drive judgements about fiscal and monetary policies is somewhat disconcerting; one might hope that, over time, each forecaster should learn from the other. And as things stand, the Bank of England appears to be closer in forecasting the growth spike than does the OBR.

The OBR report also provides a measure of the output gap, and this is now, at 1.4% of GDP in 2014, much closer to being in line with the Bank's assessment of the extent of spare capacity in the economy. Both measures remain low in comparison with most independent estimates, and hence support the view that a considerable portion of the government's budget deficit remains structural.

This last observation, of course, explains the continued caution of the government in producing a Budget that takes with one hand as much as it gives with the other. Work remains to be done to bring the public finances back into balance - views may differ about how much needs to be done, but it is clear that there is still some way to go. In any event, an expansionary Budget would, of course, have been inappropriate at a stage of the cycle at which growth appears to be surging ahead of trend.

Monday, March 17, 2014

The latest data from EEF (formerly the Engineering Employers' Federation) provide some very encouraging news. Much of the current recovery in the UK economy has come from increased consumer spending, and this has raised doubts about the sustainability of the upturn. But the new EEF data suggest that manufacturers are experiencing a substantial increase in orders for export - and that this increase is expected to accelerate into the next quarter. While the forecasts necessarily have an element of guesswork about them, if the export picture turns out to be close to the mark then it provides real cause for optimism.

Wednesday, March 12, 2014

There has, for some months, been some concern that the full cost of the new regime of tuition fees for undergraduate education in the UK was underestimated by the government at the time that it was introduced. The new regime raised the cap on tuition fees from a little over £3000 per year to £9000, and was designed to compensate universities for a severe fall in public funding - hence reducing the government's budget deficit.

On the surface, it seems obvious that such a change in policy would indeed reduce the deficit. Scratch beneath the surface, however, and things are not so clear. This is because student loans are repaid through the income tax system as a proportion of graduates' incomes. And if, 30 years after graduation, a graduate has not paid off the loan in full, the remainder gets written off. This means that some proportion of the total value of the loan book will never get repaid, and the burden of financing this will fall back onto the taxpayer.

This proportion has come to be known as the Resource Account and Budgeting (or RAB) charge. The RAB is an important figure, partly because it tells us how much of a discount needs to be offered when the government sells parts of the loan book off to the private sector. Estimates of the RAB have risen over time - in 2011, the government estimated a RAB charge of 30%, but the most recent official estimate is 40%.

The most recent estimates are uncomfortably high. The Higher Education Policy Institute has estimated that, if the RAB were to reach 47%, the new fees regime would be no more favourable to the government's finances than was the old. More recent research, published this month by London Economics, suggests a similar figure - between 48 and 49%.

If the RAB turns out to be in the high forties, then clearly the new fees regime will have missed in terms of its goal of bringing down the budget deficit. Even if turns out to be slightly lower, doubts must be raised about whether the current model of undergraduate financing is sustainable beyond the short term. Sadly we are a long way from realising Vince Cable's hope that the 'imaginary black hole will very soon disappear'.

The Confederation of British Industry (CBI) has put forward a set of proposals to strengthen the skills base in Science, Technology, Engineering and Maths (STEM) subjects. It notes that the UK is facing a skills shortage in these areas. One of its proposals is to reduce university tuition fees on some courses in STEM subjects.

Clearly it is important that players in the market for education should be aware of impending skills shortages, and that they should respond to them. Typically this is achieved through the market by employers raising wages for jobs where they face a shortage of labour - thereby attracting more workers into those jobs. Such a market mechanism bypasses the problems that might arise under a system of 'manpower planning' - where government tries to play the role of an omniscient planner, but often seems to lack the requisite information.

The proposal to reduce university tuition fees is problematic for a number of reasons. Not least, the current funding system for undergraduate education in the UK is one where loans are repaid out of future income streams - and crucially involves the writing off of any part of the loan that remains unpaid after 30 years. This means that students do not know how much of their loan they will end up repaying, and are therefore likely to be insensitive even to quite large fee discounts. There is evidence that students are responsive to the award of bursaries, but that is quite a different thing.

The devil is in the detail, and, while the aim of the CBI's proposal is worthy enough, the detail would frustrate that aim if it were ever to be put into practice.

Friday, March 07, 2014

Spring is in the air, and the economy is recovering. How far it will recover after the major shock it has suffered is still open to question. A generation ago, many economists spoke of 'hysteresis' - the tendency for blips in unemployment to become long-lasting owing to the depreciation of skills and the increased potential therefore for unemployed workers' attributes not to match well with those required by firms.

Alfonso Arpaia and Alessandro Turrini have evaluated a measure of such mismatch for some 22 European countries. These results show that the efficiency with which unemployed workers are matched with jobs fell in most of these countries quite soon after the economic crisis hit.

There are some interesting exceptions - efficiency has risen inexorably in Denmark. This may be the result of the 'flexicurity' of the labour market in that country - a system where extremely high degrees of job mobility are accompanied by a robust system of social security and active labour market policies. In Romania, too, matching efficiency has risen with just a bit of a flattening out in recent years. In many countries - especially those in Eastern Europe - the fall in matching efficiency followed a sharp peak, itself probably the result of introducing more liberal labour market policies following transition.

In the UK, the efficiency of matching fell sharply with the recession, and has not recovered since. Arpaia and Turrini's findings suggest that a high incidence of long term unemployment is one of the major factors underpinning this fall in efficiency. And in the UK, long term unemployment has risen markedly since the recession. At the end of 2007, there were 383000 workers who had been unemployed for over a year; although the number fell markedly in the last quarter of last year, there are now some 845000.

It would be easy, but facile, to contend that, with the unemployment rate falling rapidly, the labour market is functioning well. (It is in some respects, and is not in others.) For the market to maintain the flexibility that is needed, the matching of workers to jobs should be as efficient as possible. While long term unemployment rates remain high, this will not happen. Just as in the 1980s - when Richard Layard and others argued in favour of helping the long term unemployed back to work because doing so would not add to inflationary pressure - helping these workers now is an imperative. There is more to Denmark than good TV.

Wednesday, March 05, 2014

The size of the output gap is critical for determining the appropriate stance of fiscal policy, yet it has been the subject of considerable debate amongst economists. Some new data from the Office for National Statistics provide some instructive information.

On most measures the extent of spare capacity in the UK economy has narrowed over the last year. Measures based on qualitative survey data from firms tend to suggest a narrower gap than do quantitative measures such as employment data. The qualitative data are, by their very nature, harder to interpret; while they likely reflect practitioner perceptions quite accurately, it is difficult to explain why they should differ so much from the quantitative indicators.

Of the latter, it is particularly noticeable that the proportion of part-time workers who are unable to find full-time work remains high - as does youth unemployment. To the extent that such indicators reflect spare capacity in the labour market, the constraints (such as they are) appear more likely to be related to capital. Given the low levels of investment in the UK economy in recent years, this should hardly be surprising. As, with the recovery, investment picks up, so should capacity - this means that the potential level of output that is used in calculating the output gap is something of a movable feast.

In a nutshell, the capacity constraints faced by the UK economy are much softer than some observers would have us believe.

Tuesday, March 04, 2014

Redistributive government policies are widely assumed to be costly in terms of their effect on growth. The argument is that redistribution blunts incentives, so that most innovative and diligent people become less so.

That might well be the case, but it is far from being obviously true. The taxes and benefits that are used to redistribute income have both substitution and income effects - they change the return to each hour of work, thus tending to make work less attractive; but they also change the length of time that people need to work in order to achieve a given income, thus tending to make work more attractive. This means that their impact on how hard people work can go either way. While some economists hold doctrinal positions on this matter, in reality it is an empirical issue.

Recent work by Jonathan Ostry, Andrew Berg and Charalambos Tsangarides provides the empirical evidence. They find that, while in extreme cases, redistribution can be harmful (unsurprisingly enough), for the most part 'redistribution appears generally benign in terms of its impact on growth'. In statistical terms, they struggle pretty hard to get any significant results at all on their redistribution variable.

Incentives are no doubt extremely important. But to imagine that they work in only one direction is to ignore some pretty basic lessons from introductory economics courses. Oh, and the evidence.

Friday, February 28, 2014

The output gap has long been the focus of debate amongst economists, with estimates of the magnitude of this key policy-relevant figure varying widely. Sadly, one of the more useful sources of information on this, the English Business Survey, will shortly stop being collected. But the latest data from the survey are out today, and offer some interesting reading.

Across the whole of England, some 7% of firms report their capital as being underutilised. But this figure varies from just 4% in London to 10% in the South West. In two other regions, the North East and the West Midlands, the figure is 9%.

The present recovery is clearly one that has begun in the South East, and its spread to other parts of the country remains slow. The benefits of the upturn should be expected to spread more widely over the coming months. In the meantime, the output gap in large parts of the country remains substantial.

The TUC has released results from an analysis of unpaid overtime. This shows that some 10% more workers are working overtime on an unpaid basis than was the case in 2007. Partly (but only partly) this is the consequence of the recent increase in employment.

Other factors include the severity of the recession, and the aftermath that that has had on behaviours in the labour market. The increase is coincident with a rise in self-employment - much of which appears to be involuntary, since earnings of the self-employed have been falling. Despite the recent signs of recovery, fear appears to be an important factor, with people feeling they must demonstrate that they are working harder in order to keep their jobs.

An important implication of the figures released by the TUC is that, since the extent to which hours worked are underreported has risen over time, the stagnation of productivity (which is calculated as output divided by hours worked) has been even more pronounced than we had thought heretofore.

Monday, February 24, 2014

The Office for Fair Trading is calling for a full inquiry into competition in the university sector. It has legitimate concerns about applicants to undergraduate programmes being able to apply for only five universities and about the bar on them applying both to Oxford and Cambridge.

A further concern is the level of tuition fees, which are set by most institutions at the maximum of £9000. The OFT considers this to be evidence that universities are operating in collusion with one another. That, however, reflects a lamentable misunderstanding of the way the funding mechanism works.

Students take out loans to pay their fees, and these loans are repaid on an income-contingent basis once the students graduate. Any part of the loan that is not repaid after 30 years gets written off, and is paid by the taxpayer. This means that students do not know how much they will ultimately pay for their tuition - a rise in the 'ticket price' of that tuition is not tantamount to an increase in the amount that they will ultimately pay. Consequently, students prefer the certainty offered by bursaries that they might be offered while they are studying. This means that the best way for universities to attract students is to charge the full fee, and spend as much as they can of the revenues on bursaries. This being so, the fact that universities almost always charge (home undergraduates) £9000 is a million miles away from being evidence of collusion - it is simply the logical outcome of the funding mechanism that is in place.

None of the above is rocket science. If - as newspaper reports suggest - the OFT has indeed failed to grasp it, one wonders whether it is has the competence to advise on the inquiry.

Tuesday, February 11, 2014

Economic forecasters have received a rough ride in the media, often for good reason. The Great Recession was not well predicted by many economists - though there are some notable exceptions. In general GDP growth was overestimated both at the onset of the recession and over subsequent years - only more recently, in the UK, have the forecasts (very markedly) underestimated the extent of growth.

The OECD has produced an evaluation of their own forecasts over this period. Two findings are of particular note. First, forecasts for economies that were particularly open to external shocks were relatively prone to large errors. The impact of contagion of the financial crisis was underestimated. The global interlinkage of financial markets is a feature of the microeconomy that macroeconomic models - even those (maybe particularly those) with strong microfoundations - were not particularly well equipped to handle. This implies that forecasters need to learn a lesson about this aspect of their models (and to some extent they have already done so).

Secondly, forecasts were unusually error prone in economies that, before the recession, had more rigid regulation in their product and labour markets. In such economies, rigidities generate more extreme variations in employment and output than in economies where prices can bear the brunt of economic fluctuations. The modelling of such impediments to the free movement of prices calls for quite detailed understanding of institutional arrangments within the economies under study, and it is clear that this understanding needs to be improved if forecasters are to better their performance.

It should, however, be borne in mind that - while many observers like to judge economists on the basis of their forecasting ability - forecasting is far from the be all and end all of economics. Understanding the past and present is arguably more instructive (and - given the uncertainties that the future inevitably brings - more achievable) than accurately reading the statistical tea leaves.

Friday, February 07, 2014

The latest forecasts from my neural network model, using data to December of last year and forecasts for the next 2 years, are shown below.

The current recovery is starting to look a lot like the recovery of the late 1960s, with a sharp spike in growth followed by more moderate growth over an extended period. In the 1960s, the spike was stimulated by the November 1967 devaluation of the pound. The current increase in output has not been stimulated by such a discrete policy intervention - but the acceleration in consumer spending (that started in the last quarter of 2012 and which has continued since) has been remarkable.

Wednesday, February 05, 2014

The Institute of Fiscal Studies and Oxford Economics document to which I have referred in an earlier post contains an estimate of the magnitude of the output gap - the gap between current levels of output and the levels that would obtain were the economy working at full capacity. This estimate suggests that currently output is running at 5% short of its potential level.

This figure may be contrasted with that produced by the Office for Budget Responsibility - which is just 2.2%. The difference is important. If the output gap is, as the OBR suggests, small, then the economy is already operating near capacity and the bulk of the government's budget deficit is structural. If, on the other hand, the output gap is relatively large, relatively little of the deficit is structural, and so there is less need for austerity to reduce it.

The danger of excessive retrenchment is a theme that I have alluded to frequently in this blog over recent years. Fortunately policy has followed a rather more pragmatic course than the rhetoric would suggest. While the government may still claim that there is no plan B, the speed of austerity has, for the most part, suggested otherwise - and that it has been pursued. Good.

Falling real wages have been the topic of much debate in recent months, but forecasts recently produced by Oxford Economics and the Institute of Fiscal Studies suggest that the corner will soon be turned. Their prediction is that 'the combination of strengthening earnings growth and low inflation should be sufficient to ensure that real wages begin to increase again by the middle of this year'.

There are good reasons to suppose that this forecast is close to the mark - to be sure inflationary pressure is currently low. Moreover the sharp upturn in the economy has brought about increased employment in relatively high wage sectors such as finance.

However, stagnant productivity continues to present a challenge. Structural change was not a primary cause of the collapse of productivity in the first place - it fell in some industries (notably finance and pharmaceuticals) more than others, but it's these falls within industries rather than switching activity between industries that have proved problematic. A lasting cure will require us to address the innovation deficit - exemplified by a startling decline in patents issued in the UK in several key industries over recent years. Successful innovation requires a little luck, but also a lot of design. It is crucial to strike the right balance between beneficial regulation (such as patent protection) and harmful regulation (stifling creativity - might high marginal tax rates be an example?). Successful innovation also requires a context within which thinking big, and capturing the public imagination, is encouraged. In that, there is a role to be played by both private and public sectors.

Wednesday, January 22, 2014

The unemployment rate has been falling fairly steadily since its peak in the last quarter of 2011. Until the last three months of last year, this fall was unspectacular; at its peak the unemployment rate was 8.4%, and as recently as the three month period to last September it was still as high as 7.6%. The latest figures released today show that, in the three month period to November, the rate fell to 7.1%.

The latest data on GDP growth pertain to the third quarter of last year, and suggest a quarter-on-quarter growth of 0.8%. This is high - it suggests an annualised growth rate of 3.2%, well above the consensus forecast. In that quarter, growth within the construction sector was particularly striking. With GDP growth now apparently above the trend rate, it is not altogether surprising that unemployment should fall.

Yet questions remain about the source of this growth. Business investment grew in the third quarter of last year, but this only partially made up for a fall in the previous quarter, and the total level of such investment remained below the figure realised a year earlier. Investments in dwellings and other buildings likewise accelerated in the third quarter, but this only partially made up for recent falls. Consumer expenditure, meanwhile, has been rising steadily since the depths of the recession in 2008, and has accelerated sharply since the beginning of 2013.

The fall in unemployment and rise in output both represent very welcome news. As more people find jobs, the increase in consumption becomes more sustainable and the recovery becomes more secure. A key challenge that remains, however, is to raise productivity back to pre-recession levels and hence to restore real wage growth.

Monday, January 20, 2014

The ITEM (Independent Treasury Economic Model) club (supported by Enrst and Young) have issued their latest forecast for the UK economy. They conclude that growth in 2014 will accelerate to 2.7%, but caution that the recovery is very much led by consumer spending and that, until real wages rise, interest rates should be held at their current low level.

It would be hard to disagree with the ITEM club - at least as a short term forecast. Their predictions for the years beyond 2014 show the reversion to a steady state growth rate of around 2.5% that is characteristic of models of the type that they use - and recent experience suggests that we should be sceptical of that.

But the note of caution that is sounded here, suggesting that the recovery is fragile while it remains so heavily dependent on consumer spending, is well made. If growth does indeed accelerate to 2.7% this year, an outcome in 2015 of 2.4% (which is what the ITEM club is currently predicting) would be a rather better outcome than I would expect.