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There’s substance to the Trump team’s trade critique of Germany and the Eurozone

Posted by on March 22, 2017 in Blog, Euro-zone, GDP | 0 comments

There’s substance to the Trump team’s trade critique of Germany and the Eurozone

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.

As published in City AM Wednesday 22th March 2017
Image: Shipping VW Cars by Jordi Bernabeu Farrús is licensed under CC by 2.0

Need a reason to cut public sector pay and pensions? Look at Jeremy Corbyn

Posted by on March 15, 2017 in Blog, Pensions, Politics, Taxation | 0 comments

Need a reason to cut public sector pay and pensions? Look at Jeremy Corbyn

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

Image: Seesaw by Rwendland is licensed under CC by 2.0

Kenneth Arrow proved economists needn’t be loud to make a difference

Posted by on March 8, 2017 in Blog, Economic Theory, Macro Economics, Micro Ecomonics | 0 comments

Kenneth Arrow proved economists needn’t be loud to make a difference

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

Claims that a low tax, low regulation UK would be a disaster are rubbish

Posted by on March 1, 2017 in Brexit, Economic Theory, Employment, GDP, Immigration | 0 comments

Claims that a low tax, low regulation UK would be a disaster are rubbish

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

Blame restrictions on the supply of land for new homes for rising wealth inequality

Posted by on February 22, 2017 in Land, London, New homes, Property | 0 comments

Blame restrictions on the supply of land for new homes for rising wealth inequality

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.

 

Image: Fields of Gold by PaulPierce is licensed under CC by 2.0

A tale of two Eurozones: Greater Germany and Club Med are drifting ever further apart

Posted by on February 15, 2017 in Economic Theory, Euro-zone | 0 comments

A tale of two Eurozones: Greater Germany and Club Med are drifting ever further apart

At the end of last week Federica Mogherini met leading members of the Trump administration.

Mogherini, yet another Italian politician turned Euro-bureaucrat, is in fact the foreign policy chief of the European Union. She stood on her dignity, or rather the dignity of the European Commission, issuing a warning to America not to interfere with politics in Europe.

We might reasonably wonder what American armed forces have been doing for the past 70 years, effectively providing the defence of Continental Europe and so sparing local politicians the need to raise taxes to pay for it themselves. But this free riding by Europe is apparently an acceptable form of interference. On anything else, America has to be “warned”.

Mogherini went on to surpass herself, claiming that “the strength of the EU and the unity of the EU I believe is more evident today than it was”. Certainly, this “strength” and “unity” are on full display in the latest instalment of the Greek debt crisis. Output in Greece is over 20 per cent lower than it was in 2007, 10 years ago. And the Germans are showing the greatest reluctance to put their hands in their pockets yet again to bail out the Greeks.

More generally, the data on output – GDP – reveal an absolutely fundamental split between the economies of the EU. What we can think of as Greater Germany has performed far better since the financial crisis than the Club Med.

In the former group, to Germany itself we can plausibly add economies such as Austria, Poland, the Czech Republic, the Netherlands and Belgium. The Club Med is represented by France, Spain, Portugal, Italy and Greece.

To put it starkly, Greater Germany has recovered since the financial crisis and Club Med has not. In every individual year since 2009, Greater Germany has grown faster than Club Med.

Output in the former is just over 14 per cent higher than it was in 2009, the year of deep recession with output shrinking almost everywhere in the Western economies. In the latter, it has also risen, but only by 2 per cent. And growth of 2 per cent was typical for just a single year in the decades prior to the crisis.

In 2009, the two blocs were of very similar overall size. Total output in each was around €5 trillion, with the Club Med group being slightly the larger of the two. Stripping out inflation, output in Greater Germany is now around €700bn higher than it was in 2009, and Club Med has registered an increase of only €100bn. Even removing Greece from the latter makes little difference, given that the Greek economy makes up less than 5 per cent of the Club Med group as a whole.

A massive gap has opened up between two groups of economies within the EU in the space of less than a decade. One has grown almost as much as the dynamic UK. The other languishes with growth close to zero. Strength? Unity? It’s just the way Mrs Mogherini tells them!

Image: European and Greek flags by Reithose is licensed under CC by 2.0

It’s fanciful to think China’s economy will overtake the US’s anytime soon

Posted by on February 8, 2017 in Economic Theory, Inflation, Politics, Uncategorized | 0 comments

It’s fanciful to think China’s economy will overtake the US’s anytime soon

Possibly the single most important of the tensions stoked up by President Trump is the rivalry between the United States and China. Economic strength will be the ultimate determinant of this struggle for the position of Top Nation.

Comparisons of the size of economies, particularly ones at very different levels of income per head, are fraught with difficulties. Taking a deep breath, annual output in China is currently around $10 trillion a year, compared to $17 trillion in America.

Over the past 30 years, the US has grown at an annual average rate, after allowing for inflation, of 2.4 per cent, and China by 9.3 per cent. If we project these rates forward, the Chinese economy will be as big as the American by 2024. By 2037, it will be more than twice the size.

We can allow for some slowdown in China’s growth, to, say, 7 per cent a year, and a bit faster expansion in the US, to take account of the fact that the average over recent decades is influenced by the impact of the financial crisis. Even so, we soon reach a situation where the two are of comparable size.

But a paper in the latest issue of the world-class Journal of Economic Perspectives argues persuasively that the sustainable Chinese growth rate in the medium and longer term is much lower, in the range of 3 to 4 per cent a year.

Hongbin Li and colleagues, based both in Stanford and top universities in China, note that Chinese growth since the start of the economic reforms in 1978 has been the fastest that any large country has sustained for such a long period of time. But much of this is due to the rapid transition from a centrally planned to a market oriented economy. Forty years ago, virtually no-one operated in the private sector. Now, well over 80 per cent of workers do so. This shift obviously cannot be repeated.

 

Closely intermingled with this has been the massive move of population from the countryside to the cities – or more precisely, from low productivity agriculture to higher productivity urban economic activities. But the annual growth rate of rural-to-urban migration has fallen from over 11 per cent in the 15 years before 2000 to only 3 per cent since. And the authors argue that the growth of migration almost certainly will decline further given that “rural-based surveys are finding that less than 10 per cent of young able-bodied rural individuals are now living (and working on farms) in rural areas”.

Until 2011, the authors point out that China enjoyed what they call a “demographic dividend”. The age group of the working population was unusually high as a share of the population as a whole. But because of what the authors tactfully refer to as “the fall in fertility” since the early 1980s, this is now declining fast. The One Child Policy was mainly responsible, but higher incomes also reduce birth rates.

China remains a huge and growing economy. But projections that it will overtake the US within readers’ lifetimes seem fanciful.

Image: Chinese Lanterns by Suloke Mathal is licensed under CC by 2.0

Why the economics profession remains blind to the benefits of Brexit

Posted by on February 2, 2017 in Brexit, Economic Theory, Euro-zone, Markets, Networks, Politics | 0 comments

Why the economics profession remains blind to the benefits of Brexit

The office for National Statistics last week estimated that the UK economy grew at an annual rate of 2.4 per cent in the final quarter of last year. This is slightly above the long-term average growth of the past three decades.

But a Financial Times survey this month showed that the majority of economists remain just as pessimistic about Brexit’s likely effect on Britain’s economic prospects as they were a year ago.

Most have not changed their minds. But of those who have, the more pessimistic outweigh the more optimistic by three to one. Almost incredibly, economists do not generally feel they were proven wrong by events following the vote.

How can this be? Why is the economics profession so overwhelmingly opposed to Brexit?

The reasons rest on two important underpinnings of the discipline. First is a belief in the benefits to society of free trade. There is substantial empirical evidence which backs up economists’ views on this matter.

The majority opinion among economists, however, is that the UK leaving the EU will necessarily lead to our trade becoming less free. This is a judgement about political economy, on which standard economic theory is silent. Simply put, they agree with Remainers that we cannot negotiate better trade deals on our own than we can from within the European Union.

As the referendum showed, this is a contested issue. The Cambridge economist Bob Rowthorn has pointed out that “there has already been a sharp fall in the size of the Euro-area economy as a proportion of the world economy, and it is hard to see how this trend will not continue”. The deals we need are with fast-growing countries like India and China, and with enormous and innovative markets like the United States. Whether we can get a better deal in or out of the EU is a matter of judgement, not theory.

But the more important reason is that economic theory is in essence about equilibrium. It is about how best to allocate a fixed amount of resources in a static world. Economics has relatively little to say about dynamic processes, about change, about disruption, evolution, innovation, about behaviour out of equilibrium.

This emphasis on a static world leaves many economists unable to see the serious failings of the EU, both actual and potential. In the 1970s and into the 1980s, before the impact of the Thatcher reforms had been felt, it was indeed sensible to look to Europe for inspiration. The UK was plagued by high inflation and low growth.

But now we have had nearly two decades of the euro, one of the most efficient job destruction machines ever created. The combined impact of the euro and their own internal corruption has led output in Italy, Portugal, Spain and Greece to be much lower now than it was 10 years ago. This is a recession without parallel in economic history in its length and severity.

The ability to innovate is the key to long-term growth, as America has shown with Microsoft, Google, Facebook and others. Economic theory has very little to say about innovation. And this blinds the economics profession to the failings of the EU.

As published in CITY AM on Wednesday 1st February 2016

Economic Research Council talk: why are so many economists opposed to Brexit?

Posted by on January 31, 2017 in Brexit, Economic Policy, Economic Theory | 0 comments

Economic Research Council talk: why are so many economists opposed to Brexit?

Economic Research Council talk on Monday 20th February 18.30 – 20.00: I will be discussing why so many economists are opposed to Brexit. 

Book your ticket here. A limited number of Early Bird tickets are available for £15 each.

Following a Financial Times survey in January that showed that nine times as many economists are opposed to Brexit as are in favour. I will explain why the thought processes of economists traps them in the past, and makes it difficult for them to appreciate the importance of change and innovation, expanding on how Brexit opposition has intensified over the past year, despite the strong post-Brexit performance of the UK economy.

The Economic Research Council, Britain’s oldest economics-based think tank, is dedicated to extending the reach of economic education, debate and leadership. In support of this, the ERC raises the profile of economic conversations; we host events to cultivate wider accessibility, inclusion and civic participation.

Image: Tread Upon Now What? by John Eisenschenk is licensed under CC by 2.0

The NHS will never have enough cash: the English religion needs reformation

Posted by on January 26, 2017 in Economic Theory, Euro-zone, Politics, Uncategorized | 0 comments

The NHS will never have enough cash: the English religion needs reformation

We British like traditions. A well-established one which comes round every year is the “winter crisis” in the NHS. Health provision is a political hot potato not just for this government, or indeed for any particular UK government, but for governments across the developed world.

One of the key assumptions made by economists about human behaviour is that there is no limit to the amount of things that people want. In the splendid jargon of economic theory, this is referred to as “non-satiation”.

But regardless of what name we give to the concept, health is an excellent practical example of it. When the NHS was founded in the late 1940s, many thought that the demands on its services would dwindle over time. As the new system gradually improved the health of the population, fewer would require the NHS.

 On the contrary, the demand for health provision has expanded across the West much faster than the overall economy has grown. As people get wealthier, they want more and more healthcare.

Nigel – now Lord – Lawson once pronounced that “the NHS is the closest thing the English people have now to a religion”. Certainly, any politician tampering with it too much risks his or her career. A striking illustration was provided in the General Election of 2001. The Labour government proposed closing the hospital in Kidderminster on the grounds that it was just very bad. This provoked fury, and a local doctor stood and won as an Independent, destroying the incumbent Labour rising star and holding on until 2010. A subsequent independent inquiry carried out for the NHS showed unequivocally that the hospital was even worse than had been initially thought.

An Institute of Economic Affairs monograph by Dr Kristian Niemietz shows how things could be run much better. The intriguing title summarises the contents: “Universal Healthcare without the NHS”. Niemietz begins with a simple point to debunk the popular view that the NHS is the envy of the world: its structure has never been copied anywhere outside the UK.

In fact, in international comparisons of health system outcomes, the NHS almost always ranks in the bottom third of developed world countries, sitting with places such as the Czech Republic and Slovenia. If the UK’s breast, prostate, lung and bowel cancer patients were treated as in Germany, 12,000 lives a year would be saved.

Most European countries use a social health insurance (SHI) system, in which even homeless people have health coverage. Essentially, these systems are based upon means-tested insurance. Niemietz regards each individual one as having its own particular flaws and irritations, but they routinely achieve much better outcomes for patients, while preserving the concept of universal access.

Their experience shows that, for example, charging for GP appointments does not damage health, and that ordinary people can be trusted to make sensible choices from a range of health insurance plans. The alternative to the NHS is not American, but European health care.

We are, quite rightly, steaming ahead with Brexit, but Europe still has valuable things to teach us in the case of health provision.

As published by CITY AM on Wednesday 25th January

Image: Accident & Emergency Sign by Lydia is licensed under CC by 2.0