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.