Tempers are fraying at the highest levels of economic policy-making in the UK.
Theresa May, at the Conservative Party conference, emphasised the “bad side effects” for savers of the Bank of England’s policy of near-zero interest rates, a position reinforced by former Tory leader William Hague in the Telegraph this week. A few days ago, Mark Carney, the governor of the Bank, hit back by saying he would not take instructions from politicians.
He went on to discuss inflation. The fall in sterling puts up the price of imports, and some economists predict that inflation will hit 3 per cent next year, up from its current (still low) level of 1 per cent. The Bank’s Monetary Policy Committee (MPC) has an official remit of maintaining inflation at 2 per cent. Carney stated that he would allow inflation to run “a bit” above this to protect growth and employment.
Just how much power does the MPC have to control inflation in such a precise way? At first glance, the work of the MPC has been brilliant. Some years the inflation rate has been higher than the 2 per cent target, like in 2011 when it was above 4 per cent, and some years lower, as last year when it was zero. But over the past 15 years, inflation in the UK has averaged 2 per cent a year, almost exactly in line with the target.
But the average inflation rate has been very close to 2 per cent averaged across the 28 member states of the European Union. And the United States also registered the same average of around 2 per cent over the past 15 years.
The fact that inflation has averaged more or less the same rate across the major economies for well over a decade – only in Japan has it been substantially different – strongly suggests that there is a common factor at work. It could be the collective skills of central bankers, or it could be the effect of plain, old fashioned competition.
Competition in markets for goods and services means that it is hard to make price rises stick, and competition for labour means it is difficult to secure substantial wage increases. Competition in the global economy is the main reason inflation has both been low and very similar across the developed world.
The MPC controls the short-term rate of interest, and the theory is that a rate increase, say, reduces demand in the economy as a whole. This in turn has a stable and predictable impact on inflation, with lower demand leading to lower inflation. The trouble is that the facts do not fit the theory. Inflation dropped to zero after peaking in 2011, but unemployment has effectively halved and the economy has grown at a decent rate.
We do owe central bankers in the UK and the US a massive vote of thanks for preventing the crisis of the late 2000s from becoming a repeat of the Great Depression of the 1930s. But even they do not have magic powers. Inflation is low because of competition, not central bankers.
As published in CITY AM on Wednesday 18th October 2016
It had been an article of faith among economists and policy-makers that free trade is a Good Thing. Trade liberalisation was a key feature of the world economic order enforced by the United States after the Second World War. For decades, the trend of removing trade barriers led to world trade growing around twice as rapidly as world GDP.
All this now seems under threat. Calls for greater protectionism have been a feature of the US presidential race, emanating from both Donald Trump and the Democrat hopeful, ultimately defeated by Hillary Clinton, Bernie Sanders. In Britain, the Brexit vote puts the spotlight on trade policy for the first time for many years. Even the International Monetary Fund (IMF), the high priest of economic orthodoxy, has joined in the debate, with a warning at the end of September that free trade is increasingly seen as benefiting only the well off.
The economic principles which support free trade go back over 200 years, almost to the beginning of economic theory itself. Adam Smith, in his great book the Wealth of Nations, set out the basic arguments in the late eighteenth century. Trade enabled countries to take advantage of specialisation. If Portugal produced, say, wine more efficiently than Britain, and we made cloth better, by concentrating resources on what each were good at and trading the outputs, both benefited. Production of both commodities would be concentrated in the country which was most efficient at each.
David Ricardo, writing in the early nineteenth century, was not just an economist but a self-made multi-millionaire – at a time when a million pounds was a million pounds – and a Member of Parliament. He took Smith’s arguments further, and showed that trade was beneficial even if one country could literally make everything more efficiently than everyone else. Countries should specialise in what they were comparatively best at.
This, the so-called principle of comparative advantage, remains at the heart of the economic theory of trade to this day. Ricardo’s theory was tremendously influential. It was used by the Lancashire politicians John Bright and Richard Cobden to secure the repeal of the Corn Laws. These put high tariffs on the import of corn into the UK. Their abolition meant cheap food for the industrial working class, and was the most important social reform of the entire nineteenth century.
But all theories make assumptions. Ricardo made it clear that he was assuming that capital did not move across borders. It stayed put in its country of origin. In the early nineteenth century, this was a reasonable assumption to make: international capital flows did exist, but not on a massive scale.
If capital can flow freely, Ricardo’s theory needs to be heavily qualified. So, when the Berlin Wall fell, German companies built factories in Poland and the Czech Republic, destroying German jobs. In the long run, trade may still be beneficial, but there will be many losers along the way. Next year sees the two hundredth anniversary of Ricardo’s great book. The IMF has just rediscovered something which good economists knew all along.
As Published in CITY AM on Wednesday 12th October 2016
The economic data on post-Brexit Britain is beginning to emerge. We discovered last month that employment in May to July grew by 174,000 compared to the previous three months. Last week, the Office for National Statistics published its estimate for the output of the service sector of the economy in July. This shows a 0.4 per cent rise on June, and a growth of 2.9 per cent since July last year. Both are very good figures.
Official data, even for employment, is notoriously prone to subsequent revisions. Is there any harder evidence that the economy is prospering and that Project Fear, so prominent in the referendum campaign, was wrong?
The key to a growing economy is of course confidence. This was the great insight of Keynes. The economy is driven much more by psychological factors – by his memorable phrase “animal spirits” – than by objective economic ones. If confidence becomes depressed, no amount of stimulus will persuade businesses to spend on their investment plans or hire more people.
My colleague Rickard Nyman has been analysing tweets in the London area every day from the beginning of June. Now, there is an awful lot of rubbish on Twitter, but the latest machine learning algorithms enable you to dive into the mud and come up with pretty polished estimates of overall sentiment. The day after the vote, 24 June, stands out as one huge hangover. The balance of London sentiment went very sharply negative. Yet by the end of June, it was back to where it stood at the start of the month. Sentiment wobbles along for the rest of the summer, but since the start of September a strong positive upward trend has set in.
Most tweets of course are about the fortunes of Arsenal, going on holiday, what was on TV, and not directly about the economy. But the overall mood of Londoners has become much more positive over the last few weeks.
More evidence of positive feelings was provided at a seminar organised last week by the law firm Linklaters and the property outfit Strutt and Parker. The focus was on commercial property, which is notoriously sensitive to the state of the economy. There is no doubt that the sector took a hit immediately after the Brexit vote. But every speaker, from quite different backgrounds, struck a decidedly optimistic note about both commercial property in particular and the UK in general.
Andy Martin of Strutts noted that the value of deals in 2016 is on track to be close to the levels of 2007, the pre-recession peak year for the economy, despite the sharp pause in the summer. Both Zach Vaughan from Brookfield, one of the largest investors in global real estate, and Chris Morrish, recently retired as head of European real estate for Singapore’s sovereign wealth fund GIC, confirmed the continued strong attraction of the UK for overseas investors.
A coherent picture emerges from this diverse mix of official statistics, social media conversations and global commercial property perspectives. The UK economy is thriving.
As Published in City AM on Wednesday 5th October 2016
Image: Twitter by Christopher is licensed under CC by 2.0
It’s an exciting time of the year for many young people, with some setting off to university for the first time and others starting to polish their applications for next year.
Good news if you have been accepted to read economics at Cambridge, say, or business studies at Oxford. A survey by the Sunday Times shows that the average salary, just six months after graduating, is over £40,000. If instead you are off to Worcester to do drama and dance or Liverpool Hope for psychology, you can expect around £13,000, just under half the value of average earnings across the workforce as a whole.
Figures like these raise the question of whether it is worthwhile studying many of the courses which are on offer. It is a question which is increasingly pressing. Last year, a report commissioned by the Chartered Institute of Personnel and Development (CIPD) claimed that no fewer than 58 per cent of the UK’s graduates are in non-graduate jobs compared to only 10 per cent in Germany. The growth in graduates is outstripping the growth in high skilled jobs across the EU, but especially in Britain.
Successive governments have made a fetish of higher education. The Conservatives elevated a whole raft of polytechnics to university status in 1992, followed by a second wave under New Labour in the 2000s. Tony Blair was insistent that his target be met of 50 per cent of each year group of young people going to university.
The mismatch between the supply of and demand for graduates is not something new. It was already well known when Blair invented his mantra of “education, education, education”. Peter Dolton and Anna Vignoles, both then at Newcastle University, published a famous paper 20 years ago on over-education in the graduate labour market. Scientists measure the value of an academic paper by the number of citations it receives from other scholars. On this criterion, this one is a star.
They looked at a very large sample of graduates and their conclusion was stark. “We find that 38 per cent of graduates were overeducated for their first job and, even six years later 30 per cent of the sample were overeducated.” So the current estimate of 58 per cent by the CIPD, 20 years later, startling though it may seem, may not be too far off the mark. To be fair, other studies do come up with lower numbers. But they all demonstrate the same point. Lots of graduates end up in jobs which do not require a degree.
This is bad news for economic theory, which predicts that even if over-education is observed, it will only be a temporary phenomenon. Companies are assumed to adapt their production techniques to fully utilise the increased supply of skills.
Is it bad news for the students? A quantitative degree from a good university still commands a huge premium in terms of lifetime earnings. But estimates of the average amount extra that a graduate will earn conceal massive differences in outcomes. Increasingly, studying weak courses at weak institutions is simply not worthwhile.
As published in CITY AM on Wednesday 29th September 2016
Image:Graduation by Amy is licensed under CC BY 2.0
Natalie Twisleton-Wykeham-Fiennes: don’t you just love her? One of the Black Lives Matter campaigners, our Nat caused chaos by occupying the runway at London City Airport, on the grounds that climate change is racist.
She and eight others, including a former member of the Oxford University Croquet Club, were sentenced by the courts last week. For many, their punishments were derisory: token fines and suspended prison sentences.
Would harsher treatment deter future protests like this and the one which disrupted Heathrow last month? Anecdotal evidence suggests it would.
In the town where I grew up, nestling in the foothills of the Pennines, the police would often drive miscreant youths late at night to remote hamlets up on the moors and make them walk home. It helped if it was raining, which it usually was. The more recalcitrant were likely to discover that the damp made the steps of the local police station unusually slippery. Compared to today, crime was low.
But this is mere causal empiricism, and there is a vast academic literature on whether or not harsher punishments deter crime. As a broad approximation, criminologists themselves tend to be sceptical about the impact of punishment as a deterrent.
A few years ago, I was at a seminar on the topic in which a criminology professor at Middlesex University asserted, without a trace of irony, that crime was caused by capitalism. In contrast, economists, who believe that agents respond to incentives, often claim that deterrence works.
Economists base their conclusions not just on theory, but on statistical analysis of detailed databases. Even so, the results might not be straightforward to interpret. For example, if prison sentences are increased and we see a fall in crime, is this because potential criminals are deterred, or because prolific criminals are in jail and can’t commit crimes?
Francesco Drago and colleagues published an influential paper in the Journal of Political Economy in 2009. They exploited the natural experiment provided by the Collective Clemency Bill passed by the Italian Parliament in July 2006. This provided for an immediate reduction of three years in the sentences of existing inmates, and as a result 22,000 of them were released. But if they re-offended, they had to serve all the suspended time, plus whatever extra they were given.
The study showed decisively that an additional month in expected sentence reduced the propensity to re-commit a crime by 1.24 per cent. Steve Levitt, in his bestseller Freakonomics, described similar results obtained by smart analysis of American data.
Perhaps the way forward is to experiment with another fundamental concept in economics, that of externalities. Twisleton-Wykeham-Fiennes believes that flying, while convenient for the individual, imposes costs on others through its negative impact on the climate. Other people bear these costs, which are external to the benefits to the person flying.
The airport protests inconvenienced many others. So the fines should be in proportion to the external costs created by the crime. The assets of the well-heeled protestors would vanish in a trice. Anyone for this natural experiment? Future Twisleton-Wykeham-Fienneses might prefer croquet instead.
As Published in CITY AM on Wednesday 21st September 2016
Who will win the US presidency?
Opinion polls have got a bad name in Britain, at least. During the 2010 general election campaign, many suggested that Gordon Brown could still continue in power in a minority government or coalition. The polling record in the 2015 campaign was even worse. Most polls showed the two main parties neck and neck, and even the exit poll on the day did not predict the overall majority achieved by David Cameron.
Conventional, survey-based polling is encountering fundamental problems, and they’re not confined to the narrow area of trying to discover political opinions. They are much more general. Household surveys are the source of a wide range of statistics which guide policy, such as official rates of poverty, inflation, and, in the United States, unemployment rates and health insurance coverage. They are also a primary source of data for a lot of economic research.
But an article on their accuracy by Bruce Meyer of the University of Chicago and his colleagues in the Fall 2015 issue of the prestigious Journal of Economic Perspectives concludes starkly that “the quality of data from household surveys is in decline”. The title of the paper says it all: “Household surveys in crisis”. Households have become less likely to answer surveys at all, those that do respond are less likely to answer all the questions, and their answers are becoming less accurate.
In the US government’s consumer expenditure survey, for example, non-response rates have risen from 15 per cent in the mid-1980s to 35 per cent now. In surveys designed to measure poverty, 25 years ago between 10 and 20 per cent of respondents failed to answer all the questions, but this “item non-response” rate is now as high as 40 per cent.
In a lengthy discussion, the authors point out that it is difficult to pinpoint exactly why these things have happened, precisely because any survey designed to answer the question would itself be unreliable! But they suspect that an important reason is because “talking with interviewers, once a rare chance to tell someone about your life, is now crowded out”. People have so many opportunities to give feedback via email and social media that they just cannot be bothered with conventional surveys.
These trends create formidable problems for polling organisations in trying to correct for any biases which might exist in any particular survey or sample. Adjustments to a sample which might have worked 20 years ago to give an accurate picture of the population as a whole no longer have the same validity. This is exactly the problem that the political pollsters in the UK have encountered.
Against this background, what are we to make of the opinion polls in the run up to the American presidential election?
On the face of it, Hillary Clinton does seem to have a small lead over Donald Trump, but her margin is narrowing. Perhaps the most scientific prediction would be to just toss a coin.
As published in CITY AM on wednesday 14th September 2016
Image: Hillary Clinton by Roger H. Goun is licensed under CC BY 2.0
Sports fans will all be familiar with the commentator who almost always gets things wrong. “Arsenal are very much on top here” he – it is invariably a “he” – will pronounce, or “Root is looking very settled”, only for the opposition to score a goal immediately and for the Yorkshireman to be clean bowled. In economics, a similar role is played by the International Monetary Fund (IMF).
In the middle of July, Remain fanatics had a field day. “The IMF has slashed its forecasts for the UK economy for next year after Brexit”, crowed the Financial Times. Maurice Obstfeld, the Fund’s chief economist, claimed that Brexit “has thrown a spanner in the works”. Global growth projections for 2017 were cut back, but most of all for the UK.
But on the first day of September, the IMF was forced to admit that growth in Britain had, in a splendidly bureaucratic phrase, “surprised on the upside”. On the same day came the news that manufacturing activity in August had posted its biggest monthly rise in 25 years. On Monday this week, the Markit purchasing managers’ index for the service sector registered the biggest monthly increase in its 20 year history.
The IMF has real form. In 1998, East Asia was experiencing a major economic crisis. Yet in May 1997, the IMF was predicting a continuation of very strong growth in most countries for the year ahead: 7 per cent for Thailand, 8 per cent for Indonesia and 8 per cent for Malaysia. They revised the projections down by December, but even these proved wildly optimistic, as the economies collapsed during 1998, registering a fall in output of over 15 per cent in Indonesia, for example, worse than America in the Great Depression of the 1930s.
Macroeconomics is the study of variables such as GDP which describe the economy at the aggregate level. Since the 1980s, it has been dominated by the concept of equilibrium. Highly mathematical models have been developed, resting on the premise that the economy can correct itself and absorb any shocks. Olivier Blanchard, the IMF’s previous chief economist, was a great enthusiast for this project. In August 2008, he published a paper which concluded with the claim “the state of macroeconomics is good”. Three weeks later, Lehman Brothers collapsed.
Apart from the European Commission itself, the IMF has been probably the biggest cheerleader for the euro. Since the inception of the single currency in 1999, a whole series of statements and technical articles from the IMF has eulogised its mystical benefits. At the end of July this year, the IMF’s own Independent Evaluation Office (IEO) was totally scathing of the Fund’s record on this. The top staff became impervious to other points of view and ignored warning signs of the financial crisis. In their view of the world, it simply could not happen.
The IMF exercises enormous influence and power. Yet its persistent ineptness makes England football managers look like world beaters. To add insult to injury, its staff enjoy tax free salaries. It’s time to close the Fund down and go back to the drawing board.
As published in CITY AM on Wednesday 7th September 2016
Following the Brexit vote, normal service seems to have resumed. A key question in economic policy since the General Election of 2010 has moved centre stage once again: should the government abandon austerity?
At one level, the question has an easy answer. Interest rates are now so low that the UK government can borrow for 30 years at a rate of not much more than 1 per cent, so some relaxation in terms of infrastructure spending does seem sensible. It is essential that the projects are not motivated by purely short-term political expediency, but in principle they are a good idea.
For Jeremy Corbyn, the answer is even easier. He would carry out no less than £500bn of extra public spending. How would this be paid for? Even easier, just grow the economy, stupid! Extra taxes generated by economic growth will fund whatever we like.
This is not a spoof, it is what Corbyn and his shadow chancellor John McDonnell actually believe. Taxes are currently about 40 per cent of the economy, so to pay for £500bn of extra spending, the economy needs to grow by something like £1.25 trillion. Its total size at the moment is just under £2 trillion. This stupendous growth will take place like something out of Harry Potter, once Jeremy waves his wand.
The real task of political economy facing the chancellor is a much more difficult one. At one level, there is no need to relax the policy of austerity and the simple reason is that the UK is at full employment. The unemployment rate from April to June, the latest data available, was just 4.9 per cent. This is well below the average of 7.3 per cent during the period since the major oil price shock in 1973. Record numbers of people are in work, no less than 31.75m of them, up by 600,000 on the same period a year ago. The labour market is essentially in equilibrium, and almost anyone who wants a job can get one.
But a key reason for full employment is that labour has priced itself back into work. Following the recession in 2008, earnings after allowing for inflation fell every single year until 2014. Only last year was this trend halted and a modest increase registered. Workers have become cheaper to employ.
The downside is that many people in work have experienced falling living standards. If real earnings rose by 5 to 10 per cent to make up the lost ground, on the one hand there would be less incentive for an individual employer to hire someone. But on the other hand, the “price” of labour is the wage, and higher wages mean more money to spend, and higher demand for goods and services. So more workers would be needed by firms to satisfy this demand.
In principle, full employment can exist with higher earnings. The risk, however, is that we become trapped in a relatively low wage full employment situation.
If the government were to relax austerity to do something about this, it would be a very difficult balancing act to pull off. But the political rewards could be huge.
As published in City AM on Wednesday 31st August 2016
The A-Level results released last week confirm the dominance of schools in London and the South East. Provisional league tables have only appeared so far for state schools, but these two regions have two-thirds of the top 100. South Yorkshire, Tyne and Wear, and Wales did not have a single school between them in the top 100.
State schools in London and the South have many of their potentially brightest pupils creamed off by high-powered public schools. Yet they consistently produce much better results than their counterparts elsewhere in the country.
An article in the latest issue of the American Economic Association’s top Journal of Economic Perspectives sheds light on this persistent regional discrepancy in school performance. The paper, by Ludger Woessmann of Munich University, is an in-depth, meticulous statistical analysis of differences in the average achievement levels of school students in different countries across the world. There are of course formidable conceptual issues in comparing performances in, say, Ghana and Germany. But building on the pioneering work of the OECD and its Programme for International Student Assessment, the International Association for the Evaluation of Educational Achievement has made great progress in dealing with them.
An advantage of using such a disparate data set is precisely that there are large variations in both inputs and outputs in different countries. This means that, somewhat paradoxically, provided that the right analytical framework is used, the variability makes it easier to identify exactly what factors are important in determining outcomes. Even within the developed world, substantial differences exist. So we can usefully learn some lessons for inside the UK from Woessmann’s work.
The analysis confirms that resource inputs such as expenditure per student or class size appear to have limited effects on student achievement. Spending more money in itself is a very inefficient way of improving outcomes. This has been clear in general across the public sector as a whole since Gordon Brown’s experiments with massive increases in public spending.
Interestingly, “competition from privately operated schools positively affects achievement levels”. This implies that the strength of state schools in the South is in part due to the fact that they have to compete to attract good pupils. It is no coincidence that there is a cluster of very good state schools in South Manchester/North Cheshire, because Manchester, unlike anywhere else in the North, has a number of excellent private schools.
Given current debates here about devolving power within the educational system, Woessmann reports that school autonomy has positive effects on performance.
Finally, the values and attitudes of teachers and management matter. King David, a state school in an insalubrious part of North Manchester, promotes “traditional Jewish values of respect, self-discipline and the pursuit of excellence”. It came forty-ninth in the national tables.
Michael Gove described the UK educational establishment as “the blob”. The opinions and values of the blob are contradicted almost in their entirety by the scientific evidence. Competition, both within and between schools, and autonomy are key determinants of success.
As published in City AM on Tuesday 23rd August
The total number of working days lost through labour disputes last year was, at just 170,000, the second lowest annual total since records began in 1891.
What a difference a year can make. Southern Rail commuters have endured months of misery due to the prolonged series of strikes called by the RMT. Union members on Eurostar walked out in the past week and have threatened to do so once again over the Bank Holiday weekend. Before it was suspended yesterday, Virgin East Coast staff were planning industrial action.
We are also experiencing the long-running dispute between the government and junior doctors, who in April carried out their first full walkout in the history of the NHS. They are now threatening the “trade union dispute of the century”, with rolling strikes from September onwards.
Traditionally, strike activity rose as the economy picked up. And labour market statistics for 2016 do show that the UK economy is very close to full employment. Pockets of unemployment may be scattered in some of the regions, but the latest economy-wide figures show a rate of just 4.9 per cent, the lowest for 11 years. There are a record 31.7m people in employment, and the proportion of people aged between 16 and 64 who are in work is also at a peace time high of 74.4 per cent.
Despite the buoyancy of the labour market, however, disputes remain very rare in most sectors of the economy. The current spate of strikes is essentially confined to the public sector, broadly defined. Private companies operate the rail franchises, but Network Rail is responsible for the maintenance of the network as a whole.
The connection between the strength of the economy and the number of strikes still holds in transport and health. The innovative polices of the rail operating companies mean that passenger numbers have boomed, doubling over the past decade. And the demand for health services continues to grow rapidly.
The unions shed crocodile tears and claim the disputes arise out of concerns for the safety of the public. In one sense, the strikes are nothing more than good, old fashioned examples of the workers putting their hands in taxpayers’ and consumers’ pockets when the opportunity arises.
But we might reasonably ask why the same things are not happening elsewhere in the economy. There does in fact appear to be a more sinister aspect to these disputes. Many of the strike activists are supporters of Jeremy Corbyn. The Labour leader and his acolytes scorn the possibility of reform through representative parliamentary democracy. Building a so-called social movement is far more important to these true believers than is winning elections.
The Black Lives Matter campaign, another social movement, earlier this month closed access to Heathrow from the M4 and disrupted transport across the UK. Just as with the junior doctors and the rail workers, the same sanctimonious regret was expressed at any inconvenience caused to the public.
Unfortunately, Corbyn’s position as Labour leader and his advocacy of “social movements” gives comfort to the growing number of strikes, sit downs and general disruptions which we are currently witnessing. And if he wins the party’s leadership contest, we can expect them to continue.
As published in CITY AM on Wednesday 16th August