Tag Archive for: Economy

A stunning diplomatic achievement

The EU and UK agreement could ignite a dramatic economic recovery, as long as we rediscover timeless and useful principles

As somebody who always refused to accept the false “No Deal v 2nd Referendum” narrative which somehow took hold in the last four years, I am personally delighted by the new Trade and Co-Operation Agreement between Britain and the European Union.

It is a stunning diplomatic achievement and of great credit to the negotiators on both sides. This is especially so when you consider their difficult remit, the complexity of the issues and the dispiriting backdrop of the last few years. Boris Johnson and Lord Frost, Britain’s chief negotiator, are right when they say, “it should be a moment for national renewal.”

That said, whether it is or not depends on how things work and evolve in practice – the agreement is governed by some 19 committees – and what we as a country choose to do with our new found, sovereign freedom. I have to confess to being more ambivalent about that point and I am not alone. A recent poll by IPSOS Mori found that only 11% of Brits think the economy will have recovered next year, the lowest of any OECD economy. Thank goodness that we have such a productive and innovative private sector, capable of getting things moving.

In structure, ETCA loosely emulates the Norwegian pillar of the European Economic Agreement: collaborative access to the single market on a zero quota, zero tariff basis as long as we go along, broadly, with the rules, including in relation to the environment, labour relations and state aid. If we don’t and there is a disagreement, there will be an arbitration procedure which may culminate in that area of the agreement being “rebalanced” and tariffs imposed.

The situation is vaguer for financial services. By March 2021, the two sides intend to negotiate a memorandum of understanding for regulatory co-operation in financial services to be accompanied by, “equivalence decisions” with the EU. In the meantime, most City firms have set up branches or subsidiaries in the EU to enable business to flow.

In return for these looser arrangements, including an end to freedom of movement, we have given up certain things. The first is to participate in EU rule-making and the second, the superior protection of the Court of the European Free Trade Association, where judges are nominated exclusively by the EFTA members like Norway and Iceland. The EU-UK tribunal is more ad-hoc, as in a traditional international agreement. The tribunal’s members will be split into three with a third comprising  EU judges or equivalent, some of whom will no doubt be connected to the European Court of Justice; the second third will be from the UK and the final third will be independent.

However, these and other flaws, such as the uncertainty about Gibraltar’s status, are mere details compared to the really big point: we have a comprehensive agreement with the EU which should give us amicable access to each other’s markets and engender a spirit of co-operation and mutuality, while also disembarking us from the runaway train of “ever closer Union” enshrined in the Treaty of Rome. Businesses and individuals are inventive and adaptable. Goodwill, workarounds, technology and good custom and practice should help mitigate or overcome any shortcomings.

The UK Parliament will ratify the deal in the next few days. The EU process will take until mid-February. That might prove to be more difficult as the explicit purpose of the European Parliament is to replace a “Europe of nations” with something new. It is a draft treaty and MEPs and EU member states might demand additional clauses, perhaps in relation to governance, to be re-presented to the British.

Assuming that the ratification process goes according to plan, the resulting certainty over the biggest legal and commercial issue facing the British economy for several decades, should finally enable investors and businesses to put substantial amounts of money to work here. For nearly five years, business investment has been flatlining, even retail investors (many of whom presumably voted for Brexit) have been withdrawing money and investing in global opportunities. The FTSE 100 has been the worst performing global stock index.

The amount of money that may potentially be deployed into the UK is truly gargantuan. According to Bank of America, global fund managers are a record “underweight” of the UK in their portfolios. Vast sums of money have been printed and borrowed by Central Banks and Governments, including by our own. Much of it is sitting in bank accounts, earning pitiful interest or held in cash or near cash of one kind or another by both businesses and households in the UK and elsewhere.

Before we get too carried away, what are the risks to this rosy scenario? Leaving aside the ongoing virus (where we must hope the vaccines work their magic), there are two.

The first is our old friend inflation, dormant since the 1980s. It stands to reason that when large parts of the economy are subject to legal restrictions and are idled, turning on the money geyser will cause a surge in prices. Unless the Government can move fast to get Covid under control, to open up the economy and also to create the appropriate structures for money to be invested by the private sector into new assets and opportunities (such as infrastructure and flotations of companies on the London Stock Exchange) the great flood of money will be wasted in pointless speculation in, say, house prices and consumption.

The consequent inflation could only be arrested by a sudden rise in interest rates, turning the Brexit boom to bust.

The second risk is something more subtle: the need for a process of economic and institutional reform which restores orderly, reasonable law and decision-making and efficiency to the British state. The worry is that, despite all the rhetoric about “global Britain” and trade secretary Liz Truss signing free trade deals at a heroic pace, the Conservative Party has apparently lost the moderate, practical, business-minded, Scottish Enlightenment mindset of Pitt, Peel, Thatcher and Blair and instead embraced a sort of madcap nationalist and socialist thinking, which I (ironically) call “NatSoc economics”.  Let us hope this is temporary.

If our future is really to be found not in the stars, but in ourselves, we must, as a country, start by rediscovering established commercial principles.



We need more than Caractacus Potts

We cannot take the suspense. Philip Hammond labours like Caractacus Potts in the Treasury shed. Creak, bang, curse, he tinkers away into the night, preparing to unveil his latest Budget contraption on November 23rd.
There is a sense of foreboding too. Will it fly beautifully, like Chitty, Chitty Bang? Or send him careering dangerously around Westminster, like the malfunctioning rocket pack?

Judging by the speculation in the press, it would be well to stand clear. First, (hammering noise) an income tax cut for young people was mooted and then dropped. Now it is being suggested that a temporary cut in stamp duty for first time buyers is a possibility.

I am no fan of stamp duty – the worst tax on the statute book, amidst stiff competition – but we should be suspicious of such a fiscal Toot Sweet. Prices for first time buyers would simply rise to take account of the cut. They have already been artificially lifted by the subsidised loans in the Help to Buy scheme.

The benefits would similarly accrue to the vendors, largely housebuilders, whose profit margins, share prices and executive remuneration are already at record levels. A recent study by Morgan Stanley found that Help to Buy had contributed to a 15% premium in new house prices, matching almost pound for pound the cheap 20% equity loan provided by the government. (Wait till the initial 5-year period runs out and the interest rate goes through the roof, but that is another story).

As the stamp cut would be temporary, it would be unlikely to stimulate investment in further construction of new homes.

The losers would be existing homeowners hoping to move house, perhaps to start a family, as they would be outbid on properties by first time buyers.

This stamp duty idea exemplifies a paucity of economic thinking by the current Government. If you are interested in the reform of property taxation, far better to remove the distorting effects of stamp duty altogether by cutting it to a flat 1% for both buyers and sellers. Any loss in revenue would be offset by rising revenues from new construction, VAT and higher volumes in the housing market (which remain below pre-crisis levels). A reforming chancellor might also examine the council tax bands, to ensure that those in large expensive houses pay their fair share.

Property taxation is a classic example of how, somewhere along the way, the Conservative party has lost both its market nous and its understanding of economics. The consequence is that the Government has no economic strategy to speak of and short term fix has been piled upon political gimmick.

Let us start with market nous. Unnoticed in Westminster, economic growth is accelerating. Yes, you read that right. The National Institute of Economic and Social Research – which has as good a track record as any – has said growth recovered to 0.5% in the three months to October. However, in all likelihood, inflation will remain a problem due to the rapid rise in the oil price to around $65 a barrel.

What this means is the tax revenue forecasts are probably too pessimistic and the chancellor does not immediately have to worry too much about the deficit. The deficit would be even less of a problem if the chancellor took a more long-term approach to taxation, and set taxes at levels which maximised incentives, economic growth, productivity and revenue.

If that is the good news, there is plenty of bad news. A combination of the change in the political context, exemplified by the rise of Jeremy Corbyn, the exhaustion of austerity as a political narrative, and decades of underinvestment mean that the demand for increased public spending is fierce. According to IMF data, gross fixed capital formation in the UK, at 17.2% of GDP has been substantially below the G7 average of 20.2% for 25 years.

This is mostly due to cuts in public investment, which at 2% of GDP remains below the level before the financial crisis. Indeed, one of the big contributors to deficit reduction under the Conservatives has been large cuts in capital expenditure by the Government, as opposed to cuts in current spending. Evidence of this is everywhere: traffic jams, full commuter trains, insufficient A&E facilities, a shortage of social housing, etc.

The anchor of economic policy is the so-called fiscal rule, that the Government should reduce its cyclically adjusted net borrowing to 2% of GDP. As Ed Balls explained when he was shadow chancellor, that fails to distinguish between current spending and capital investment. Controlling current spending on day-to-day items is sensible. But if the Government borrowed for capital investment, on which it made a return, who cares if it adds to the deficit at a time when its cost of borrowing is the lowest since the Victorian era?

A better option than simply raising public investment would be to revive public/private partnerships in a new form to invest in infrastructure. These could borrow via a new, properly regulated, project bond market, partly underwritten by the Government. Not only would these be kept off the public balance sheet, they would have an independent life of their own and so not be micro-managed by Whitehall. Victorians built railways, canals, hospitals and the like by tapping their own deep and liquid capital markets, and we should do the same.

Another idea which ought to be given serious consideration is using the State’s remaining stake in RBS and other assets to seed a sovereign wealth fund, which could co-invest alongside the private sector in infrastructure and innovation.
This is the sort of strategic thinking which one hopes for in the Budget and indeed from the Conservative party more widely, but with a few honourable exceptions, there is little sign of it. If we are to make a success of Brexit, we are going to need more than tinkering in the Treasury shed.

The public finances are in rude health

I know these are unfashionable things to say, but not only is the British economy in much ruder health than many commentators admit, but we all owe a debt of thanks to George Osborne. The excellent public sector finance figures published today are a dramatic demonstration of these truths.

What a pleasant surprise for the chancellor Philip Hammond on the eve of the Budget.

The great financial crisis. The deficit, the great lode star of economic policy for nearly a decade. Living beyond our means. Remember them? Well, they are sorted. Ancient history. Job done. In the year to March 2017 public sector net borrowing was £45.7bn or 2.3% of GDP. That is down massively from £152.5bn, or 9.9% of GDP in the worst year of 2010.

If anything, even that number is an exaggeration. It has been revised steadily down in the past few months by £6bn, from an initial £52bn. The Office for Budget Responsibility – which the Treasury relies upon – had originally forecast a deficit of that level too, so it has been far too gloomy, as usual.

In my opinion, judging by the trajectory of the deficit in the past few months, the picture continues to improve and my guess is we are on course for a deficit of circa £42bn in 2017/18, or 2.0% of GDP this financial year. Incidentally, the OBR is forecasting a deficit of £58.3bn for this year. That looks too pessimistic. Let’s see who is right.

The critical point about a deficit of less than 3% to GDP is it is roughly in line with the underlying growth rate of the economy. That means, relative to the size of the economy, it is stable. To draw an analogy, it is like having a mortgage which may have risen in size in cash terms, but only in line with the value of your house. So your loan to value ratio hasn’t budged.

Ideally, you want your mortgage to be gradually paid off. But the fact it is stable is very far from a disaster.

Furthermore, half of the deficit run up since March, or £19.2bn is actually made up of capital spending. Arguably, we should worry less about capital spending. It only costs the Government about 2% to borrow. If it is investing in an asset which makes, say, a 7% return (such as a new road), it can actually make sense to borrow. This is the equivalent of adding to your mortgage to dig a basement or build an extension. It can be a good thing.

What about the absolute level of debt? Well, two economists called Carmen Reinhart and Kenneth Rogoff have long advocated that countries with national debt levels of more than 90% of GDP tip into crisis. Other economists have said this rule is far too strict. But let’s, assume it is correct.

Britain’s top-line national debt to GDP is £1.8 trillion, or 87.2% of GDP. That looks scary. But on closer inspection, a big chunk of this is offset by assets held by the Bank of England and the residual stakes the Treasury owns in banks like RBS. Strip those out and our debt to GDP is tolerable 79.6%.

That is more than Germany but substantially lower than our competitors, such as France, United States and Japan and China. It really isn’t anything to worry about.

Whichever way you look at it, the performance of the British public sector finances continues to surprise positively. It is another example, like the earnings data, of how economics commentators are simply, in their very nature, too gloomy. What, I wonder could be their motive? Are they all secret Corbyn supporters? Or howling Remainers determined to do the country down?

The implications for public policy of the robust public finances are huge and nearly all good. Gone are the days where the Treasury should be squeezing spending and raising daft taxes here and there. We now have the room to take a strategic view about the future size and role of the state, without panicking about short term cash flow issues.

It means we can set tax rates to maximise growth and productivity in the medium term; we can afford to borrow to invest; and we can fix the problems which have built up in the recent past, such as the criminal 6.1% interest rate on student loans, and the punitive and distorted levels of stamp duty. We can even afford an unfairly expensive bill to leave the European Union. Sadly, there is no evidence the Treasury itself sees things that way.


It is not true we are getting poorer or that our incomes are falling

Given the economics profession’s delight in gloom, sifting out the good news from that which is actually bad requires constant vigilance.

This week is a classic example, over the average earnings data. The Office for National Statistics said that average earnings grew at an annual rate of 2.2% in August, below inflation. In other words, in real terms, average wages are declining. This overshadowed the more positive news that unemployment was at a 42-year low.

Frances O’Grady, the ever-cheerful secretary general of the TUC, proclaimed that “Pay packets are taking a hammering. This is the sixth month in a row that prices have risen faster than wages.”

But is this really true? Er, not quite. It omits the rise in self-employment. Add that back in and incomes are on average, rising, as is personal wealth.

The ONS average earnings number is based on a survey of around 9000 employers who employ 20 people or more on their payroll, not freelancers or consultants. It doesn’t capture, and nor is it intended to, the growth in self-employment, especially those who set up a new company. Many of these are actually in lower paid trades, such as construction. Such people now amount to 4.8m. or 15% of the workforce and they typically receive dividends, not just salaries.

Last month, the ONS revised up substantially the level of household incomes in the latest National Accounts. Due to the growth in self-employment and small companies, it said, households actually received £61.7bn of dividends last year, not £12.2bn as previously thought.

Not all of these dividends were spent, instead many were saved. With the result the savings ratio (the proportion of incomes being saved) was revised up to 5.4% from 3.8%. This was good news.
Some people, of course, are both employed and have companies or professions from which they earn income on the side. The growth in mini-corporate buy-to-lets is explosive, for instance, but the statisticians are only just adapting to this phenomenon.

There is a second problem with the average weekly earnings data as a proxy for our prosperity: it is before tax. So, it does not reflect the rising personal tax threshold, which has reduced income tax for millions of people, or the impact of tax credits.

A better number than average weekly earnings which picks up all the income of households, including wages, self-employed income, investment income and pensions, and which also takes account of tax change, benefits and inflation, is the so-called “real disposable household income per head” number in the revised National Accounts. This shows that actual money in people’s pockets has risen steadily in the last few years, ahead of inflation.

Real disposable income surged by 4.8% in 2015, as company owners paid themselves bumper dividends in advance of a tax change. Last year, real household disposable income per head shrank by 0.7%, mostly because dividends dropped after those bumper payouts in 2015.

This year, from what we know so far, it shrank by 1.2% in the first quarter, but then accelerated to plus 1.5% in the second quarter. So, it is not true, that on average, our incomes are falling.

Incidentally, mean real household wealth per head also rose by 3.3% last year, driven by the rising stock market and house prices. Though clearly those with the most assets benefited the most.

Even the real disposable income number has its limitations. In particular, it is difficult for the ONS to break out the impact of the rising minimum wage and the National Living Wage. We do know that, at the lower end, this has benefited some 1.3m people. As a matter of logic, for the average to be growing slowly when the lower half is rising, it must be those further up the wage scale who have been held back.

If those on lower incomes have had rising wage packets and company owners are doing okay too, it means that it is predominantly the middle classes in paid employment but without self-employed earnings who have seen their incomes fall in real terms.

Many of these work in the public sector, where we know there is a soon-to-be-dropped 1% pay cap. (That in turn does not reflect the generous future pension contributions to which the public sector is entitled). Alternatively, those who work in the private sector are exposed to both technological disruption and Brexit-related uncertainty (undoubtedly a factor in, say, universities or parts of the City).

However, the situation could be about to flip round. The Government is theoretically planning some big cuts to benefits and tax credits, which would obviously hit those on lower incomes, and the outlook for middle class salaries is improving.

The labour market is incredibly tight. According to the survey data published in the Bank of England’s August Inflation Report, companies are reporting greater difficulties in recruitment and filling vacancies. Unfilled vacancies, as a percentage of the entire labour force, are 2.31%. That is the highest ratio for about 20 years. If you ask employers, they will tell you finding the right people is their number one difficulty. In order to do so, they now have to offer new recruits substantial pay rises.

In other words, the recent lull in middle class wages is likely to be offset by rising earnings for new recruits spreading across the labour force. Unless, of course, either the Conservatives or an incoming Labour Government tip the economy into recession with their bad policies (always possible), or inflation goes through the roof, or our jobs are suddenly replaced by robots.

Next time somebody says to you “it is a disaster, we are all getting poorer.” You can say “No, that it is not true, it is middle class employees who have been temporarily squeezed, and their wealth has anyway risen strongly due to the rising value of their savings, pensions and houses”.

The squeezing of middle class wages helps explain noisy bourgeois political phenomena, such as the rise of Jeremy Corbyn or Remainers agitating about Brexit. One reason they are so cross is that many of them have indeed seen their wages stall. Hopefully it is already passing.

A bigger problem is the barriers to wealth accumulation for young people caused by the dysfunctional housing market and the student loan system.

Life in Britain is not perfect – and I am glad I am not myself wrestling with universal credit or a student loan – but we are definitely not all getting poorer. Not yet, anyway.

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