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The UK’s capacity to innovate matters far more than panic over consumer spending

The UK’s capacity to innovate matters far more than panic over consumer spending

The debate about Brexit has become mired in a virtually incomprehensible quagmire of detailed and technical negotiations between the UK and the rest of the EU.

Yet the campaign itself in 2016 was dominated by broader questions of political economy.

In addition to the hurly burly of claims about extra NHS spending or Project Fear, both sides took a serious, longer-term view of what was needed to sustain Britain’s prosperity. All this has been lost sight of, but the fundamental issue has not gone away. So does Britain have an economy which is fit for purpose in the twenty-first century?

At one level, the evidence seems to side with the Remain camp. Growth in the UK since the depth of the recession in 2009 has been decidedly unbalanced compared to much of the rest of the EU.

We can break down the growth of the total economy – GDP – into categories defined by who is doing the spending: how much is done by individuals as consumers, how much by firms in terms of capital investment, and how much by the public sector. We also have the net balance between our exports and imports.

Looked at this way, Britain’s growth since 2009 has been concentrated in a seemingly unhealthy fashion on consumer spending. This accounts for no less than 58 per cent of the total growth in the economy 2009-18. Investment by companies takes up another 29 per cent, and there has been a slight deterioration, amounting to just three per cent of GDP, in our net exports.

This is in sharp contrast to Germany. The increase in investment is similar, making up 27 per cent of the total increase in GDP. But consumption is just 32 per cent, and net exports have boomed, accounting for 22 per cent of the increase in German GDP. No wonder President Trump has concerns about German trade surpluses.

This pattern is similar in countries closely connected to Germany. Compared to the UK, increases in consumer spending are only a relatively small part of the total expansion of the economy since 2009 in Austria, Belgium, Denmark, France, the Netherlands, and Sweden.

Surely an economy which relies less on spending by individuals is better placed than one in which they splurge every last penny?

Well, up to a point. For one thing, public spending accounts for a larger proportion of total growth in the Greater Germany group than it does in the UK. The rise in public spending in Britain makes up just eight per cent of total growth. In France, it is 25 per cent.

But the key evidence comes from the US. Here, spending by individuals makes up no less than 75 per cent of the total expansion of the economy since 2009. Yet America remains the most dynamic and innovative economy in the world.

Economic theory has long identified the capacity to innovate as being the key determinant of long-term growth, not who spends what. The debate over post-Brexit Britain should be about how to boost innovation, and whether the European Commission is a help or a hindrance to this.

As published in City AM Wednesday 25th July 2018

Image: Regent Street & Oxford Street by Tony Webster is licensed under CC-BY-2.0
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Mark Carney has bigger things to worry about than meaningless Brexit forecasts

Mark Carney has bigger things to worry about than meaningless Brexit forecasts

The governor of the Bank of England, Mark Carney, is up to his usual tricks.

Last week, he claimed in front of the Treasury Committee of the House of Commons that British households are now more than £900 worse off after the vote to leave the EU.

The figure was obtained by comparing a forecast made by the Bank in May 2016 on the assumption of a Remain victory with the situation as it actually is today.

In other words, the so-called evidence cited by the governor consists of the difference between where the economy stands right now, and a forecast made by the Bank two years ago.

It is no exaggeration to say that this has no scientific standing at all.

Predictions of the economy are notoriously unreliable. The Survey of Professional Forecasters in the US publishes a 50-year track record of one-year-ahead predictions of the growth of the economy. The correlation between the forecasts and what actually happened is – literally – zero, with no sign of it improving during the course of the five decades. And this is just looking one year ahead, not two.

The UK does not have such an impressive body of evidence to assess forecasting accuracy, but the studies which have been published show that the track record of our economists is no better than that of the Americans.

It is worth pointing out time and again that the Project Fear forecasts, also made in May 2016 like the Bank’s ones referred to by the governor, were for the next six months, not the next two years. Yet they were shown to be completely wrong.

Far from the predicted rise in unemployment of half a million by the end of 2016 on a Leave vote, unemployment has fallen almost continuously ever since, and now is lower than it has been since the mid-1970s.

We might usefully recall one of Carney’s first public pronouncements after taking up the post of governor in July 2013.

Interest rates, he said, would not be raised until unemployment fell from its level of 7.8 per cent to below seven per cent. He stated that this process would take three years. In fact, unemployment dropped to below seven per cent just six months later, at the start of 2014.

Rather than grandstanding about Brexit and currying favour with the global liberal elite, there are more pressing issues to occupy Carney’s time.

The primary concern of the Bank of England should be the stability of the financial system. Yet there has been a worrying rise in the amount of debt in the economy.

Figures from the Bank of International Settlements show that total credit to the private non-financial sector – the debts of households and companies in everyday language – peaked at 196 per cent of GDP in 2008, the year of the crash. This had fallen to 163 per cent by 2015. But it has now risen to 170 per cent.

This is by no means yet another crisis, but this – not Brexit – is where the governor’s mind should be focused.

As published in City AM Wednesday 30th May 2018

Image: Mark Carney by Bank of England is licensed under CC2.0
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Master the art of brinkmanship to run Brexit rings around Barnier

Master the art of brinkmanship to run Brexit rings around Barnier

Michel Barnier invokes a wide range of emotions this side of the Channel.

To his credit, the EU’s chief Brexit negotiator appears to have a stronger grasp of the insights of game theory than his UK counterparts.

Thomas Schelling, the polymath winner of the Nobel Prize in economics, advanced the science of game theory in many ways. Funded by the US security forces at the height of the Cold War, Schelling formalised the concept of credible threats.

How could America convince the Soviet Union that, if necessary, it would launch a nuclear strike? This would have been a highly irrational act, and game theory is meant to be played by entirely rational people.

One way to do this is by brinkmanship, defined by Schelling as “the tactic of deliberately letting the situation get somewhat out of hand, just because it being out of hand may be intolerable to the other party and force his accommodation”.

This seems to be exactly what Barnier is doing. His draft document published last week includes a so-called punishment clause that would allow Brussels to ground aircraft and block trade if the UK failed to obey EU rules during the transition period.

The counter ploy to such an irrational move – which would harm the EU as well as the UK – is not to cower and capitulate. It is to play brinkmanship yourself.

A threat to, say, drop a tactical nuclear device on Hamburg would not work. This would be unbelievable.

But we could threaten to walk out of the talks all together. Several European countries such as Poland appear to be seriously concerned about this prospect.

But we need back-up material for this to seem like a real threat; Barnier has to think that we would really do this.

Much of the doom and gloom from the Remain camp is all about short-term economic prospects if we leave. Our negotiating team should make it clear that in the longer run the UK would be better off outside the grip of the central planning mentality of the European Commission, even if there were transitional costs.

The Markets in Financial Instruments Directive II (Mifid II), designed to offer greater protection to investors, is a perfect illustration.

Introduced at the start of this year, and at least seven years in the making, Mifid already runs to several thousand pages of regulatory requirements. In this mindset, both bureaucracy and rules can eliminate risk.

But it is so complicated that it is virtually beyond the powers of a human to grasp. Certainly, experts like Phil Treleaven at University College London believe that it is riddled with contradictions.

We do not need the madness of Mifid II. The EU is frightened of an innovative, lightly taxed UK, which embraces, rather than resists, the rapid pace of change in the world economy.

If the government really believed this itself, we could play brinkmanship to our heart’s content and run rings round Barnier and his cronies.

As published in City AM Wednesday 14th February 2018

Image: Regulatory Documents via Max Pixel is licensed under CC by 0.0
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How European commissioners really allocate EU funding

How European commissioners really allocate EU funding

“Pork barrel” has been a theme in American politics for almost as long as the United States has existed.

Many members of Congress work hard to secure public works projects, agricultural subsidies and the like for their own districts, almost regardless of the economic arguments for and against.

Surely the European commissioners would rise above such petty behaviour? After all, the European Union claims that they “represent the interests of the EU as a whole”.

It turns out that many of them have had their noses in the trough, both literally and metaphorically. A new scientific study shows that the agricultural commissioners have systematically over the years ensured that their own country receives more than its fair share of funding.

This cannot be dismissed as the product of some swivel-eyed Brexiteer. The findings are published in a paper in the latest issue of the American Economic Review (AER), probably the most prestigious academic economics journal in the world.

Kai Gehring of Zurich University and Stefan Schneider of Heidelberg find that “there is a significant positive relationship between the commissioners’ country of origin and the agricultural fund spending these countries receive during their terms in office”. Their highly sophisticated statistical analysis concludes that “this translates on average into about €850m per year for the country of origin of the respective commissioner”.

There are many anecdotes along the same lines. One which is very relevant in the light of the current Volkswagen emissions scandal is how, in 2007 and 2008, the German commissioner for enterprise and industry, Gunter Verheugen, repeatedly opposed a planned commission proposal to reduce new cars’ carbon dioxide emissions.

As Gehring and Schneider state, “his success in weakening the initial proposal was widely perceived as support for the German car industry”.

The current study is the first in-depth scientific analysis of the allocation of funds by the commissioners.

In economic terms, the Commission structure is a principal-agent one. The national government which makes the nomination is the principal, and the commissioner is the agent of the government. It would be surprising if their interests were not aligned to some extent, particularly since many commissioners want to return to political life in their own countries.

Tellingly, the authors note that they had to restrict their investigation to agriculture because “a lack of data and transparency” did not allow them to quantify the effects for the other directorates general. But it does not seem unreasonable to believe that they operate in a similar way to agriculture. The overall effect is to divert some €1.5bn a year to a few select countries, those which hold the big-spending portfolios.

The AER paper analyses almost three decades’ worth of data. So we might plausibly conclude that this has been going on ever since we joined the EU in 1973.

If we add back in the interest on the extra monies we have had to hand over as a result, even though the cost to us may be difficult to estimate, the study gives plenty of scope to come up with a big number.

As published in City AM Wednesday 7th February 2018

Image: EU Flags by Thijs ter Haar is licensed under CC by 2.0
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The UK could teach the Eurozone a thing or two about successful monetary unions

The UK could teach the Eurozone a thing or two about successful monetary unions

The Office for National Statistics (ONS) published last week some figures which show how a successful monetary union works in practice.

It is not obvious at first sight, from the dry heading: “regional public sector finances”.

The ONS collects information on the amounts of public spending and money raised in taxes across the regions of the UK. The difference is the so-called fiscal balance of the region.

Only three regions generate a surplus. In London, the South East and the East of England, total tax receipts exceed public spending. The capital has a healthy positive balance of £3,070 per head, followed by the South East at £1,667 per head.

Essentially, these two regions subsidise the rest of the UK. Public spending in the North East, for example, is £3,827 per person above the level of taxes raised in that region. In Wales, it is even higher at £4,545. No wonder that one of the first things Carwyn Jones, leader of the Welsh Assembly, said after the Brexit vote was: “Wales must not lose a penny of subsidy”.

The region which benefits most is Northern Ireland, which gets £5,437 per head more than it generates in tax. Scotland, to complete the picture, receives around half of that, at £2,824 per person.

There is a lot of debate around Brexit and the border between the North and the Republic of Ireland. There is even talk of reunification, but on these numbers the Republic would be mad to want it.

Essentially, the regions receive these subsidies because they are running deficits on their trade balance of payments. The exports of goods and services from the North East, for example, to the rest of the UK are much less than it imports. In balance of payments jargon, the subsidy it receives is a monetary transfer from the rest of the country, principally from London and the South East.

The ONS does not actually produce regional balance of payments statistics. But the fact that most regions receive these large transfers implies that they are just not productive enough to sustain their living standards by their own efforts.

All the regions are in the sterling monetary union. Those running trade deficits cannot devalue to try to improve their position. They must instead rely on subsidy.

Exactly the same principles apply in the Eurozone. The massive difference of course is that there is no central Eurozone government to make sure the weaker performing regions receive the necessary funding.

This is why President Macron and Chancellor Merkel announced they will examine changes to treaties to allow for further Eurozone integration. Even the hardline German finance minister, Wolfgang Schauble, said: “a community cannot exist without the strong vouching for the weaker ones”.

To be sustainable, a monetary union needs large transfers between its regions. London and the South East already put their hands deep into their pockets for the rest of the UK. Gordon Brown did get one thing spectacularly right. He kept us out of the Euro.

As published in City AM Wednesday 31th May 2017

Image: Euro sign by Alex Guibord is licensed under CC by 2.0
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Anti-growth Welsh leaders are denying their voters prosperity by opposing shale

Anti-growth Welsh leaders are denying their voters prosperity by opposing shale

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

Image: Fracking Rig by David Burr is licensed under CC by 2.0
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