Elections create uncertainty. But we can be sure of one thing. Regardless of the result, during the course of the next Parliament, stealth taxes will rise. This week, we have a sharp rise in speeding fines. Even doing between 31 and 40mph in a 30mph zone can now land you with a penalty of 50 per cent of your weekly income.
Governments across the West are running out of ways to pay for the spending levels which the electorates appear to demand.
A key way in which public spending has been financed over the past 40 years has been through debt. Almost everywhere, the level of public sector debt relative to GDP has risen sharply.
A few years ago, the International Monetary Fund (IMF) published long runs of historical data on the public debt to GDP ratio for countries across the globe. The Bank of International Settlements (BIS) updates the ratio regularly.
In 1977, gross public debt in the United States was 39 per cent of GDP. In 2016, it was 98 per cent. Over the same period, the UK, using the IMF and BIS definitions, the rise was from 49 to 115 per cent of GDP. In France, the ratio went up from 15 to 115 per cent. Even in debt-wary Germany, there was an increase from 27 per cent in 1977, to 78 per cent in 2016.
There are different ways of defining public debt, and no two measures are the same. But regardless of how we put the figures together, the conclusion is clear.
Public sector debt has risen massively. The simple fact is that most governments in most years now routinely spend more than they dare raise in taxes. The resulting deficit has to be financed by issuing debt. But the limits are now being reached, a lesson the Greeks have learned so harshly in recent years.
Over the course of history, public sector debt, relative to the size of the economy, has been at much higher levels than it is now, with no apparent serious consequences. In 1946, for example, UK public debt was 270 per cent of GDP.
But in the past, governments with high debt levels typically did one of two things. They either defaulted, or they tried to pay it off. The left wing Labour government of Clement Attlee ran huge budget surpluses in the late 1940s, peaking at around £100bn a year in today’s terms.
Most debt used to be incurred as a result of war. In 1861, US public debt was less than 2 per cent of GDP. The Civil War bumped this up to 30 per cent. In the late 1810s, as a result of the Napoleonic Wars, the first truly global conflict, British debt was 260 per cent of GDP. It took decades to get it down to sustainable levels, but governments did succeed and pay it off.
In stark contrast, debt has been built up in the late twentieth and early twenty-first century to finance the services provided to voters. It is simply unsustainable.
As published in City AM Wednesday 26th April 2017
Image: Speed Trap by Peter Holmes is licensed under CC by 2.0
Is setting up a micro brewery a licence to print money? This month, a private equity company acquired 22 per cent of BrewDog for just over £200 million, netting a neat £100 million for the founders. Last year, the owners of Budweiser, AB InBev, bought Camden Town Brewery for a reported £85 million. This follows the sale of Meantime Brewery in 2015 to the global giant SAB Miller for an undisclosed amount.
There has been an explosion in the number of craft beer start ups. The number of micro breweries in the UK has grown from 1026 to around 1700.
But far from replicating the BrewDogs of this world, most of these will fail.
The same thing happens in every innovative market where new products are developed. Between 1900 and 1920 there were almost 2000 firms involved in automobile production in the US. Over 99 per cent of them disappeared. Before the First World War, the European film industry operated on a global scale, supplying half the American market. By 1920, European films had virtually disappeared from the US and had become marginal in Europe itself. Hollywood had taken over.
Being big offers no guarantee against failure. Only this month for example, we have seen the reputation of United Airlines seriously damaged, and Toshiba has projected that is losses this year could be as much as $9 billion. Between 2005 and 2009, MySpace was the largest social networking site in the world. NewsCorp bought it for $580 million in 2005, but sold it in 2011 for just $35 million.
These firms, including MySpace, remain in business for the moment, but many giant companies go under eventually. The failure rate of small businesses is high in the first 2 or 3 years of life, because of elementary mistakes such as, for example, not making provision to pay the tax authorities. But, after that, the probabilities of failure in any given year of small and large firms become very similar.
The basic reason is that there is an inherent level of uncertainty about the future, which no amount of cleverness can reduce. In 1914 Briansk Rail and Engineering in Russia was one of the largest industrial companies in the world. But it disappeared in 1917 after the seizure of power by the then tiny Bolshevik Party. This itself became the giant Communist Party of the Soviet Union until it, too, eventually collapsed.
In the economics textbooks, running a business is easy. One of the basic things which students learn is how to maximise the profits of a firm. Even the more advanced material is set in an essentially static world.
The distinguishing features of capitalism are innovation and evolution, but economics has very little to say about these. Things do not just stand still. Last year, for example, Ford had a global income of $151 billion and Tesla had $7 billion. Yet this month, Tesla’s market capitalisation has overtaken Ford’s.
By all means take early retirement to brew the beer you have always wanted. But don’t expect to get rich.
As published in City AM Wednesday 20th April 2017
Image: Micro Brewery by Bernt Rostad is licensed under CC by 2.0
The Bank of England Financial Policy Committee (FPC) has signalled that it has become worried again about debt. Its specific focus is households. Consumer credit, for example, grew by 10 per cent during 2016, far faster than the economy as a whole. A lot of household debt is in the form of a mortgage, so there is at least an asset which might support the loan. The particular concern of the FPC is unsecured loans, such as credit card balances, personal loans and the like. If someone becomes unemployed, he or she will no longer have the income to repay the money. And if a shock were to hit the economy as a whole, defaults on loans would rise sharply.The intense competition in personal finance markets is making credit much easier to obtain. The Halifax, for example, is offering up to 41 months interest free if you switch your credit card balance to them. In the laconic words of the FPC minutes, the recent rapid growth in consumer credit “could principally represent a risk to lenders if accompanied by weaker underwriting standards”. In other words, the risk to lenders could become too high.
How justified are these fears? The Bank for International Settlements publishes data on the stocks of debt held by consumers, companies and governments as a percentage of the economy. There is a bit of delay before its data comes out, so we only have it to the end of September 2016.
In the first quarter of 2007, just prior to the financial crisis bursting onto the scene, the debt of UK households was 90.7 per cent of GDP. In the third quarter of 2016 it was 87.6 per cent, and the FPC indicates that it has risen since then. So in terms of household debt, we are back to pre-crisis levels.
The German economy is in a much more comfortable position in this respect. In early 2007, household debt was 63.7 per cent of GDP, much lower than in the UK, and it has since fallen to 53 per cent. Germany’s problem is the loans its banks issued to both the personal and public sectors in economies like Greece and Spain.
The FPC is in something of a dilemma. In the late twentieth and early twenty-first centuries, consumer credit boomed. In 1977, household debt was only 29.6 per cent of GDP, compared to the 90-plus in the late 2000s. Even in Germany, the percentage rose from 40 to 64 over this period. A substantial amount of the increase in spending over the past 40 years was financed not by income but by debt.
Loans are denominated in money terms, so high inflation erodes their value. But in our current low inflation economy, these debts are for real. They are a genuine burden. Yet if consumers suddenly started to pay them off big time, spending would collapse and we would be in a major recession.
Getting consumers to manage their debt is the baby bear’s porridge problem facing the FPC. Not too little, not too much, but just right.
Leading Welsh politicians seem to be getting ideas above their station. Fifty years ago, Labour held all but four of the Parliamentary seats, and had over 60 per cent of the vote. Now, the Conservatives are by a large margin the second party in terms of votes, and are within hailing distance of Labour. They gained 3 seats in the 2015 general election, and hold 11 compared to Labour’s 25.
Yet in the media, it is the Labour First Minister in the Welsh Assembly, Carwyn Jones, and the Plaid Cymru leader, Leanne Woods, who grab all the attention. They are highly critical of the Prime Minister over Brexit.
Jones in particular keeps insisting that Wales should not lose a “penny of subsidy”, despite the fact the Principality voted strongly for Leave. Readers in London and the South East will be only too well aware of just exactly who is meant to keep handing over the monies.
Labour and Plaid Cymru together have controlled the Welsh Assembly since its inception in 1999. But just how well have they served the interests of Britain’s poorest region?
The Welsh government is opposed to fracking, for example, despite the considerable potential which exists.
A paper in the latest American Economic Review by a team from the Ivy League Dartmouth College examines the local economic impacts of fracking in the Unites States. Using detailed data from the Bureau of Labor Statistics and the Internal Revenue Service, they assess not just the overall impact, but how much of any benefits are retained locally.
Their geographic unit of analysis is the US county, which broadly corresponds in British terms to the local authority in terms of their respective average populations. The authors, Feyrer, Mansur and Sacerdote obtain two main findings.
First, the counties where extraction occurs enjoy significant economic benefits. Second, the effects grow larger as they widen the geographic area being examined. The regional impact on jobs and income is approximately three times as large as the immediate county effect with most of the impact happening within 100 miles of the drilling sites.
Around 20 per cent of all the total value of gas and oil extracted remains within the specific county where the drilling takes place. Each million dollars of new oil and gas production is associated with a $80,000 increase in wage income and 0.85 new jobs within the county in that year. Roughly 40 percent of the income increase is in industries not directly related to oil and gas extraction such as construction, hospitality, and local government.
The academics point out that if a region is at full employment, this additional activity will simply displace rather than add to the total. But during the Great Recession, the US was far from full employment. Fracking added a total of 640,000 extra jobs.
Wales is a long way from being at full employment. Here is a real chance to boost the region economically. But the politicians put their own right-on images above the interests of the people of Wales.
As published in City AM Wednesday 5th April 2017
Robots and artificial intelligence (AI) seem to be in the news all the time, and breakthroughs are announced regularly.
Last year, it was an AI programme which beat the world champion at Go, a game immensely more complex than chess. Now, in the austere American journal the Proceedings of the National Academy of Sciences, comes news of a big step forward in the task of getting AI programmes to think like humans.
Once we have learned to ride a bike or swim, we can remember how to do it, even after a lapse of many years. In the meantime, we will have learned many other skills as well.
This is straightforward for humans. But it has proved to be extremely difficult for AI. When an algorithm such as a neural network learns a new task, the challenge is to prevent it from “forgetting” how it solved previous ones, how to stop its knowledge from being overridden. A big team from Google’s Deep Mind and Imperial College London claims to have solved the problem.
Scientific progress such as this is uplifting and inspiring to read about. Yet there always seems to be a downside. On almost the same day as the Deep Mind paper was publicised, the latest in a series of gloomy reports about the impact of robots and AI in general on jobs was released by PwC.
“Up to around” 30 per cent of existing UK jobs are susceptible to automation by the early 2030s, intones the firm’s blog on the report. Many others have come up with similar sorts of numbers.
For economists, the question of the impact of AI on the labour market is not so much about the eventual impact on jobs. It is about the level of real wages at which jobs will continue to exist.
We have seen massive technological progress for over 200 years. Huge numbers of jobs have been destroyed, but many others have been created. Professor Len Shackleton of Buckingham University points out that, in the census of 1841, domestic servants made up one quarter of all jobs. Lots more were in what he calls the “horse economy”, for railways had scarcely begun. Almost all of these disappeared long ago. Now, we have behavioural pet therapists instead.
Bob Rowthorn at Cambridge and Stephen DeCanio at the University of California have both separately extended the standard model of economic growth to include a robot (AI) sector. DeCanio’s summary is almost a popular caricature of economists: “an increase in robotic labour can have either a positive or a negative effect on wages”. But both of these highly technical papers are serious attempts to grapple with trying to understand the circumstances in which AI will either raise or depress real wages. The answer is not obvious.
Apart from a brief surge of interest in the 1990s, the mainstream model of economic growth has not really been worked on since its inception in the 1950s. But it offers a powerful framework for understanding the impact of AI. Economists should start to focus on it again.
As published in City AM Wednesday 29th March 2017
President Trump’s administration has made many criticisms of Germany. One of the more important was by his top trade advisor, Peter Nabarro. He accused the Germans of using a “grossly undervalued” Euro to “exploit” its trading relationship with America.
The complaint that when the Euro was formed the Deutschmark was too low relative to the other European currencies is a longstanding one within Europe itself.
The Trump administration has raised the stakes. The Euro was described as an “implicit Deutschmark”, whose value is manipulated to be artificially low. This gives Germany, and the rest of the Euro zone, an unfair advantage both in direct trade with the US and in other export markets such as China.
Certainly, the Germans have run a large trade surplus for years. But this was not always the case. Between 1991, when Germany was re-unified and 1998, their average annual balance of payments deficit was around $20 billion, according to OECD data.
The Euro came into existence on 1 January 1999. Germany took a bit of time to adjust, with their deficit in 1999 and 2000 being just over $30 billion. This fell sharply to $7 billion in 2001. Germany has subsequently run a surplus in every single year. Indeed, since 2010, their average annual balance of payments surplus has been a massive $250 billion.
So the timing of the switch from deficit to surplus lends plausibility to the accusations of the US government.
The balance of payments is calculated in current price terms, reflecting the values of both imports and exports. These in turn are influenced by a wide range of factors, including both domestic costs and exchange rate changes. Another perspective is to strip these out, and look at changes in the volumes of exports and imports rather than their values. The difference between the volumes makes up part of the calculation of GDP, the total output of an economy.
The recession caused by the financial crisis had bottomed out in many economies by the middle of 2009. Output stopped falling, and began a tentative rise.
Since then, the pattern of recovery in terms of the component parts of GDP has been quite different in the Euro zone to both the US and the UK. The increase in the net trade balance in volume terms has been by far the biggest single contributor to the rise in output in the Euro zone as a whole. Just over 40 per cent of the total increase in GDP is accounted for by exports rising faster than imports.
GDP has grown by a lot more in the US and the UK, up 17 and 16 per cent respectively since mid-2009 than the 8 per cent increase in the Euro zone. But in both the Anglo Saxon countries, imports have risen more than exports. Their recoveries have been driven by the domestic private sector, by personal consumption and by strong increases in investment by companies.
From both these perspectives, there is substance in the attacks which Trump has made on Germany and the Euro zone.
The shambles over the treatment of National Insurance has dominated the media’s reporting of the recent Budget. But only the previous week, Jeremy Corbyn made a complete horlicks of his tax return for the second year running.
The Bearded One makes a saintly fuss over making his tax affairs transparent. In 2016, he forgot to include his pensions in his return. This year, he seems to have entered his allowance as leader of the opposition as a benefit rather than as income.
The real scandal is not his gross incompetence. It is the amount he already earns in pensions and is set to receive in the coming years. It is not necessary to be an educational success to earn a lot of money. There are many prominent examples of this point. But, taking the population as a whole, there is a pretty good relationship between how well you do when in education and how much you earn in your career.
Corbyn left school with two grade Es at A level, and left what was then the North London Polytechnic without finishing his degree. His pensions, including his state pension and a pension from the Unison union, already amount to nearly £10,000 a year. When he retires as an MP, he is entitled to a further gold-plated pension which will pay out almost £50,000 annually, which analysis last year estimated would cost £1.6m to buy on the open market.
The leader of the opposition has spent his entire adult life outside the wealth creating sectors of the economy, insulated from market forces. And he will draw a pension which is more than the amount which the vast majority of full time employees are paid by actually working.
It is the continuing problem of public sector pay and pensions which the chancellor should be addressing, rather than fiddling around with the technicalities of National Insurance rates. The howls of anguish should not be from builders and plumbers, but from bureaucrats who find their gold-plated pensions and salaries cut. The public sector pay bill makes up around half of all total public spending, so this is the place to look to reduce the government’s deficit.
A new report by the Institute for Fiscal Studies (IFS) out this week acknowledged that, in raw terms, average hourly wages were about 14 per cent higher in the public sector than that in the private in 2015-16.
The IFS mounted the classic defence of high public sector pay, however, arguing that “after accounting for differences in education, age and experience, this gap falls to about 4 per cent”. In other words, public sector workers are more highly qualified, so their higher pay is justified.
But this takes no account of the outputs of the two sectors. In the old Soviet Union, value was measured solely on the basis of inputs such as the skills of the labour force, and we know what happened there.
A European Central Bank paper from 2011 illustrates the dangers. In Germany, public and private sector pay was more or less equal. In Portugal, Italy, Greece and Spain, public pay was between 20 and 50 per cent higher. Sharpen your axe Mr Hammond!
As published in City AM Wednesday 15th March 2017
Does winning the Nobel Prize in economics cause longevity? We might be forgiven for thinking so. Thomas Schelling died last year aged 95. The author of the famous textbook, Paul Samuelson, passed away at 94, whilst his colleague, Bob Solow, is still going strong at 92. The British Laureate Ronald Coase reached the age of 102. Kenneth Arrow was a mere whippersnapper in comparison, dying a couple of weeks ago at 95.
The metropolitan liberal elite in America represent an aristocracy every bit as interwoven by family connections as the grandees of 18th century England. Forget the Clintons and their daughter. Arrow was Samuelson’s brother in law. He was the uncle of Larry Summers, former Treasury Secretary and President of Harvard.
In terms of his contribution to science, Arrow was possibly the most important economist of the second half of the 20th century. But he is essentially unknown to the general public, spending his career in the sheltered groves of American Ivy League universities.
This illustrates a fundamental feature of economics. In the media, it appears to be solely about the big features of an economy, the macro variables in the jargon, such as GDP, unemployment and inflation. In the public perception, economists seem to spend most of their time having furious arguments with each other.
But this is just the tip of the iceberg, the bit that is seen. Where Arrow worked, under the surface, is where most economics is done. And it is where economists are far more often in agreement than in dispute. It is the territory of micro economics, the study of how individuals behave and take decisions.
Arrow made a massive contribution to the crown jewel of this world, so-called general equilibrium theory. The idea that markets are a Good Thing goes back at least as far as Adam Smith, as does the insight that supply and demand can be brought into balance by changes in the price of the product.
The role of price in any particular market is easy to understand. For many decades economists wrestled with a problem which is straightforward to state but fiendishly difficult to solve. Price can equalise demand and supply in a single market. How can we establish whether a complete set of prices can exist which ensures that all markets clear in this way, so that supply is the same as demand?
An analogy with quadratic equations might help. Most readers will recall struggling to solve these at school. But there is a formula which guarantees to find the solutions to any such equation. Simply plug in the relevant numbers, and the answer pops out. Arrow’s mathematical work was not to find a set of prices for any particular economy. It was to establish the conditions, to find the formula, under which a solution could be found for any economy.
This may sound, and indeed it is, highly esoteric. But general equilibrium models, thanks to Arrow, are now, for better or for worse, part of the everyday practical tool kit of modern day economists.
Image: Seesaw by Antony Mayfield is licensed under CC by 2.0
Dame Minouche Shafik, Deputy Governor of the Bank of England, is leaving to become Director of the London School of Economics. Last weekend, she gave her final interview wearing her Bank hat.
Shafik issued what was described in the media as a “thinly veiled warning” to the Chancellor, Phillip Hammond. She stated that it was an “illusion” to believe that transforming the UK into a low tax, low regulation economy would give it a competitive advantage. Indeed, Shafik went further and offered the opinion that such polices risked “hugely disastrous consequences for the economy”.
We have heard such prognostications before. In the run up to Brexit, the Treasury claimed that unemployment would rise by 500,000 by the end of 2016 in the event of a leave vote. It actually fell. The Bank signalled a similar opinion, that Brexit would be bad. Doom and gloom was prophesised by the OECD and the IMF.
These institutions seem permeated by what we might call “Davos liberalism”, the sorts of opinions which would be congenial to George Clooney. Of course clever, well meaning people can design policies and regulations which will benefit ordinary people, who after all cannot be expected to understand these things and might hold incorrect views!
Shafik claimed that the UK economy has lost 16 per cent of GDP relative to trend because of the financial crisis. Looser regulation would run the risk of an even bigger loss in future. But the French economy is much more highly regulated than that of the UK. It has lost at least 20 per cent of GDP relative to trend, some £80 billion more than the UK. And France has at least 1 million more people who are unemployed.
Shortly after the Shafik statement, the government announced a major review of how the UK can become the world leader in artificial intelligence (AI) and robotics. We can take with a pinch of salt the unnervingly precise estimate that £654 billion can be added to the British economy by 2035 if the growth potential of AI is achieved. But we are clearly already a world leader in this area and, equally clearly, if we succeed in capitalising on this, GDP will be boosted by a very big number.
An essential ingredient for success is to attract the innovative thinkers who will push out the frontiers of the science, and the entrepreneurs who will help turn the ideas into practical tools. It is of course possible that a system of high personal and corporate tax rates could succeed in attracting such people. But it seems plausible that low tax rates are more likely to do the trick.
The high taxes imposed by President Hollande in France illustrate the point. Young French people have flocked to the UK. London is now the sixth largest French city in the world in terms of the population of native French speakers.
Our borders need to remain open to highly skilled individuals. But we need policies which continue to attract them rather than drive them away.
Image: French President François Hollande by Foreign And Commonwealth Office is licensed under CC by 2.0
Official data released last week on London house price increases in 2016 generated a lot of interest. Given that housing represents by far the most important component of wealth for most people, it is not surprising that stories like this are read avidly.
There is a feeling that the current situation regarding the affordability of housing, or rather the lack of it, is without precedent. This seems to be the case if we look at, say, the Halifax House Price Index, the UK’s longest running monthly house price series. But this only goes back to 1983.
A very thorough and impressive study of house prices going back to 1870 has just been published in the American Economic Review. Katharina Knoll and other German economists have gathered an immense amount of primary source data to produce series for house prices for nearly 150 years in 14 developed economies, including both the UK and the US. The authors strip out the general level of inflation, so their series show how house prices have changed in terms of affordability. Their work extends in time and space a path-breaking paper by MIT’s Matthew Rognlie, which came out in 2015.
There are two striking features of the data, which are common across all 14 countries examined. From the late 19th century to the middle of the 20th century, house prices in real terms were effectively flat. There were fluctuations during this period, but overall, houses were more or less just as affordable in 1950 as they had been in the decades before the First World War.
Since then, house prices have risen considerably faster in all countries than prices in general. In most countries, the trend has been accelerating. As the authors put it: “in the final decades of the 20th century, house price growth outpaced income growth by a substantial margin”.
Knoll and her colleagues go on to analyse why this has been the case, bringing together estimates of both the cost of construction and land prices. They find that about 80 per cent of the total increase in real house prices in advanced economies since 1950 is due to higher land prices.
Almost incredibly, the great English economist David Ricardo predicted in the early 19th century that this would happen in the long run. In practical terms we might, for example, be able to increase the supply of land in the short term by relaxing green belt regulations. But, eventually, the inherent scarcity of land will resurrect itself and prices will rise in a growing economy.
The results also have important implications for the ongoing debate about inequalities in wealth. Most of the rise in the inequality of wealth which has taken place in recent decades is due to the housing market, which in turn is driven by land prices.
Thomas Piketty generated a commotion with his book Capital in the 21st Century, which essentially argued that wealth inequality was driven by the greed of capitalists. Detailed empirical work by economists such as Knoll and Rognlie refute this view decisively.