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Britain is more optimistic about Brexit than gloomy forecasts suggest

Britain is more optimistic about Brexit than gloomy forecasts suggest

The International Monetary Fund (IMF) is up to its usual tricks. Last week, it predicted a two-year recession in the UK in the event of a no-deal Brexit.

Even in the main forecast, involving a mild Brexit, GDP was projected to grow by only 1.2 per cent this year and 1.4 per cent in 2020.

These are very gloomy numbers. If they were correct, it would be the weakest period of growth since the financial crisis itself in 2008 and 2009.

The IMF has form on this matter. Six years ago, in the spring of 2013, mainstream economists were full of doubt that the government’s policy of austerity would work. In January that year, the IMF projected only one per cent growth, which in April it slashed to just 0.6 per cent.

In fact, economic growth accelerated from 1.4 per cent in 2012 to 2.0 per cent in 2013 and 3.0 per cent in 2014.   In line with the thinking of Project Fear, in the middle of June 2016 the IMF predicted an immediate recession if the UK voted to leave.

Exactly the opposite happened. The economy continued to grow, and unemployment to decline.   To be fair, this time around there does seem to be evidence of a slow-down. The Office for National Statistics (ONS) suggests only modest growth at an annual rate of around one per cent in the last three months of last year.

A recent Deloitte’s survey of chief financial officers found only 13 per cent of them more optimistic about prospects than they were three months ago. Does the online world tell us anything different?

The ONS is making progress here. The agency is starting to use so-called big data to try to get faster and more accurate fixes on what is happening to economic activity. Online information such as value added tax returns and road traffic is being analysed.

Given that this is the first time it has ventured into this field, the ONS is understandably cautious about its initial estimates. It says, rather cryptically, that the indicators they are using are broadly in line with their long-term averages and paint a mixed picture.

Since 2016, with my UCL colleague Rickard Nyman, I have been monitoring on a daily basis how people in London are feeling.

The conventional measurement of wellbeing is based on responses to surveys. In contrast, the Feel Good Factor (FGF) extracts the sentiments which people reveal, knowingly or unknowingly, in their online posts, using advanced machine learning algorithms.

There were big drops immediately after Brexit and after Donald Trump’s election. But the FGF recovered in a matter of days.

Averaging the data over each quarter, optimism peaked at the start of 2017. By early 2018, a sharp drop took place, but sentiment was still around its 2016-19 average. During early 2019, the FGF is down again, but only slightly, and the past few weeks show no change compared to the same period last year.

Uncertainty over Brexit does seem to be having a negative impact on sentiment in the short term. But the overall trend offers some sunny perspective on the IMF’s dismal economic forecasts.

As published in City AM Wednesday 17th April 2019

Image: British Weather by Wikimedia is licensed under CC BY 2.0
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This Nobel-winning economist can tell you why there’s no Brexit consensus

This Nobel-winning economist can tell you why there’s no Brexit consensus

Should pure blue sky research be funded?

Certainly, the answer from government-backed research councils seems to be “no”. The emphasis is increasingly on research which has immediate practical applications.

Yet seemingly esoteric research can shed light in quite unexpected areas. For example, a PhD thesis written by a then obscure research student 70 years ago helps us understand the difficulties encountered today in resolving the current Brexit problem with a series of votes.

The number of alternatives suggested as the outcome of the Brexit process has been bewildering.

During the past week alone there has been: Theresa May’s deal; her deal plus a customs union; her deal plus a customs union and the Single Market; a Canada-style free trade agreement; another referendum; revoking Article 50 and cancelling Brexit; and leaving without a deal at all.

Little wonder that MPs have struggled to produce an overall majority in favour of any particular option.

So now we come to the idea of so-called “indicative votes”. MPs are due to vote on each of a large range of options to see which, if any, command a majority.

A variant would be to get MPs – or the electorate as a whole if there were another referendum – to rank explicitly the alternatives in order of preference. When we elect the London mayor, we have to express our preferences rather than just cast one vote, as we do in a General Election.

All of these approaches seem plausible. They share the same basic idea: test the options with a voting system based in some way on preferences among the alternatives, and see which comes out top.

It seems common sense. But unfortunately, as is often the case, common sense is not a very good thing to rely on.

The PhD thesis mentioned above was written by Kenneth Arrow, who went on to win the Nobel Prize in economics. He demonstrated the inherent problems of preference-based voting systems.

Arrow, who died in early 2017 at the age of 95, is virtually unknown to the general public. He spent his life in the sheltered groves of American Ivy League universities. But he made some of the most profound contributions to economic theory in the whole of the second half of the 20th century.

One of these was his so-called Impossibility Theorem. He proved that, whenever voters have three or more alternatives, no system of ranked voting can convert the ranked preferences of individuals into a set of preferences at the aggregate level which is guaranteed to be consistent.

Arrow’s result applies not just to a given practical example, but to all systems of this kind. Paradoxes abound. For example, even if all voters prefer X to Y, it is entirely possible that at the group level the result may not reflect this.

When once asked about the practical implications, Arrow himself said: “Most systems are not going to work badly all of the time. All I proved is that all can work badly at times.”

Brexit is an excellent example not just of this, but of the value of high quality, blue sky research.

As published in City AM Wednesday 27th March 2019

Image: Brexit via Pixabay

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Europe has suffered from the euro – just ask the Greeks

Europe has suffered from the euro – just ask the Greeks

One of the entertainments of the holiday period was reading Adults In The Room, the book by Yanis Varoufakis.

It describes his time as finance minister of Greece, and his negotiations with the IMF, the European Central Bank, and the European Commission.

Varoufakis was only in the job between January and July 2015. He had the unenviable task of trying to renegotiate the massive debts of the Greek government.

Reading between the lines, Varoufakis cannot have been an easy person to deal with. Indeed, he was effectively forced out of his position by the far-left Prime Minister Alexis Tsipras.

Still, the academic-turned-politician had many bright ideas. But he could get no traction.

Some of Jeremy Corbyn’s shadow cabinet will undoubtedly have read the book. The more reflective among them will realise that negotiating with international bodies when you have a large burden of public sector debt is not exactly fun. In the end, exactly like the Greeks, you will be forced to adopt policies of austerity which you have spent your political life criticising.

But many of our more ardent Remainers would also benefit from reading the former Greek finance minister’s analysis and descriptions of events.

To them, the EU represents a kind of Garden of Eden, where milk and honey (as well, of course, as sweetness and light) flow in abundance.

The harsh reality is that, in their fanaticism for greater European integration and its crowning symbol of the euro, Europe’s elite are quite unable to get to grips with the fundamental problems which the continent faces.

The financial crisis of the late 2000s began to take hold of the wider economy during the winter of 2007/08. The year 2007 represented for most countries the peak level of output before the crash.

Over the past decade, western European countries in the Eurozone have grown much more slowly than comparable ones which have their own currencies.

Greece, of course, has experienced one of the deepest and longest recessions in the entire history of capitalism. Greek output in 2017 was 22 per cent lower than it was in 2007.

Even leaving Greece out of the calculations, the growth performance of western European economies in the Eurozone has been poor. Their average growth over an entire decade has been just 5.6 per cent.

In contrast, average growth in a group made of the US, Canada, Japan, Australia, the UK, and smaller non-Eurozone countries like Norway and Switzerland has been 16.2 per cent. The UK itself is below the average for this set at 11.4 per cent – still, a lot higher than the Eurozone average.

Towards the end of last year, much was made of the fact the growth in the Eurozone as a whole had slowed from 0.4 per cent in the second quarter of 2018 to just 0.2 per cent in the third quarter.

But Europe’s problems are much deeper-seated. The evidence of an entire decade shows the stultifying impact of the euro. The best decision that Gordon Brown ever made was to keep us out of it. If only Greece had done the same.

As published in City AM Wednesday 9th January 2019

Image: Street Art by Aesthetics of Crisis under CC BY 2.0

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The Ghost of Christmas Past could tell us where the negotiations all went wrong

The Ghost of Christmas Past could tell us where the negotiations all went wrong

In Charles Dickens’ A Christmas Carol, Scrooge finds being haunted by the Ghost of Christmas Past unbearable.

He begs it to stop. The Ghost replies: “These are the shadows of things that have been. That they are what they are, do not blame me.”

It might almost be the Prime Minister speaking about the whole Brexit process.

How might things have been different? And are there any pointers about our future dealings with the countries of the EU?

A fundamental concept in game theory is that of the non-credible threat. This means making a threat in a sequential game – one in which there is a sequence of moves by each side – which a rational player would not carry out because it is not in their interest to do so.

But in order to be effective, the other side has to believe that you will in fact carry it out if necessary.

Donald Trump is a master of making such threats. China and North Korea both respect and fear him precisely because he conveys the impression that he might indeed do something completely irrational.

The UK held – and still holds – two major bargaining chips in the Brexit negotiations: our armed forces (specifically the nuclear deterrent) and GCHQ. But at an early stage, Theresa May ruled out using either of these in the negotiations.

At the moment, for example, British troops are stationed on the border of Estonia and Russia. They have taken part in war games to offer deterrence to Vladimir Putin.

The Baltic states live in fear of a Russian invasion. They all have sizeable Russian-speaking minorities. In 1940, they were taken over by the then Soviet Union, and only regained their independence in 1991.

They may not count for much in EU circles. But Britain could have made it clear that, unless these countries supported us, they would have to rely on, say, the Germans to defend them, and not the UK.

Similarly, GCHQ is acknowledged to be the best cyber intelligence organisation in the EU. The head of the agency said in June that it had played a critical role in thwarting terror attacks in four other European countries in the past year. Letting just one of these attacks go ahead would have brought instant credibility to Britain’s leverage – though it would of course have come with a significant cost.

On a more positive note, a number of EU governments are openly critical, and almost actively hostile, to the European Commission.

Poland, Slovakia, Hungary, and the Czech Republic all have major concerns over migration. Matteo Salvini in Italy has never made a secret of his dislike of Brussels, and since his election has had a fierce argument with the EU over the Italian budget.

But the Prime Minister seems not to have tried to build an alliance with him, nor with these other eurosceptic nations.

Some may argue that these governments are not necessarily in the liberal tradition. They are, however, potential allies. And as the great nineteenth century Prime Minister Viscount Palmerston said: “Britain has no eternal allies, and we have no perpetual enemies. Our interests are eternal and perpetual, and those interests it is our duty to follow.”

If May had heeded this, how differently things might have turned out.

 

As published in City AM Wednesday 19th December 2018

Image: Theresa May by Arno Mikkor under CC BY 2.0

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Economies of the future will have to engage with the world, not just the EU

Economies of the future will have to engage with the world, not just the EU

The fire and the fury rage from day to day around the outcome of the Brexit process.

The discussion has lost sight of the longer-term context in which both the UK and the EU will operate, regardless of the precise deal which is or is not struck.

In the 1960s, the countries which are now in the EU-bloc represented just under 30 per cent of world output. This has already fallen to less than 15 per cent.

And on any reasonable extrapolation of trends, it will dip under 10 per cent at some point in the next two decades.

This does not mean that Europe is getting poorer. Far from it. It means that the rest of the world, especially Asia, has been becoming richer much faster.

The Brookings Institute calculations released last week were a marvellous piece of news.

For the first time in human history, just over 50 per cent of the world’s population, or some 3.8bn people, live in households with enough discretionary expenditure to be considered either “middle-class” or “rich”.

This has been achieved by capitalism. Until the 1980s, for example, in their own ways both India and China were centrally planned economies. Once they shifted to the principles of market-based economies, they have boomed.

The Brookings authors estimate that in 2030 – just a decade and a bit away – the middle-class markets in China and India will account for $14.1 trillion and $12.3 trillion, respectively.

This compares to their projection of the US middle-class market at that time of $15.9 trillion.

Okay, so their decimal points give an air of spurious accuracy to the forecasts – but the general point is clear. Whether Europe likes it or not, the vast majority of world trade will take place outside the EU.

The second key point to note is that Europe has hardly been a major economic success story. The narrative peddled by Remainers seems stuck in the past.

If we travel back in time to, say, 1970, it becomes easy to believe that the European economies are so dynamic that it is essential for us to have the closest possible links with them.

In the 1950s and 1960s, annual real GDP growth in the economies which then made up the EU averaged over seven per cent. In contrast, the UK barely scraped above three per cent.

Since then, the long-term average growth rate of the original EU countries has fallen more or less continuously to less than two per cent a year.

The UK’s has also dropped, but not by much. Over the past 20 years, our GDP has risen by 2.1 per cent a year. France registers 1.6 per cent, Germany 1.5 per cent, and Italy a mere 0.6 per cent.

Regardless of the eventual Brexit terms, successful economies in the future will simply have to engage with the rest of the world, rather than depend upon the EU.

As published in City AM Wednesday 10th October 2018

Image: Chinese Girls by David Stanley licensed under CC-BY_2.0

 

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The Bank of England’s own data negates Carney’s overhyped house price warning

The Bank of England’s own data negates Carney’s overhyped house price warning

No one can tell them quite like Mark Carney, the governor of the Bank of England.

He appears to have briefed the cabinet last week that house prices could fall by 35 per cent in the event of a no-deal Brexit.

To be fair, the Bank did try to qualify this figure by saying that it was just the worst of several scenarios which analysts had produced in order to stress test the balance sheets of the commercial banks.

But the 35 per cent house price drop has now become embedded in the public narrative about Brexit.

Just how likely is such a massive drop to take place?

We do not know exactly how the Bank did its stress tests. But, typically, the worst-case scenario in such tests is either one which is judged to have a one in 20 chance of happening, or, if you are setting really demanding standards for the test, just a one in 100 chance.

When trying to assess these odds, an important input is what has happened in the past. The past may of course not be a reliable guide to the future, but it is all we have to go on.

An analogy from the sporting world might help. Every year, three clubs from the Championship are promoted to the Premier League. What are the chances of one of them being relegated after their first season in the top league?

We can look at the historical record since the Premier League began in 1992/93, which helps us form an initial view. We might then qualify it, and set the benchmark – a 44 per cent chance of relegation, since you ask.

With house prices, we can go much further back in time, as far back as 1845 to be exact. And the source of this information on nearly two centuries of house prices data is none other than the Bank of England itself.

Over all this time, there has never been a cumulative fall in the Bank’s house price series of as much as 35 per cent.

The closest we have seen was in the opening decade of the twentieth century in the run-up to the First World War. The UK economy was pretty much in the doldrums, and between 1902 and 1909, prices fell by a total of 33 per cent.

Nothing else remotely compares to this drop.

There have been two global financial crises over this period. In the 1930s, house prices fell by only seven per cent between 1929 and 1934.

And following the most recent crash, the reduction between 2007 and 2009 was 13 per cent.

In America, the Case Shiller house price index was 21 per cent lower in 2011 than it was in 2006, but this is the largest fall in that particular database.

The governor is therefore inviting us to believe that, in the event of a no-deal Brexit, house prices may fall by more than they have ever fallen since the Bank’s own data began in 1845.

How did the Bank arrive at this figure? I think we should be told.

As published in City AM Wednesday 19th September 2018

Image: Mark Carney by Bank of England on Flickr licensed under CC-BY-ND 2.0
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