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.