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The economic impact of Brexit tariffs only tells us half the story

The economic impact of Brexit tariffs only tells us half the story

Brexit is about much more than the economic costs and benefits, but the idea that the former dramatically outweigh the latter has become the received wisdom in much of the media.

Report after report emerges which purports to show that, under any of the various trade arrangements envisaged, the UK will be worse off as a result of Brexit.

These studies are not wrong. They all use perfectly standard economic theory to arrive at their conclusions. But they are misleading.

The real problem is that they miss out key bits of the story. We can think of the classic tale of the person dropping his car keys in the street at night. He only looks for them under the street lamp, where the light is.

In the same way, standard economic analysis of Brexit only illuminates part of the landscape.

The explanation of why trade occurs between countries was given 200 years ago by the great English economist David Ricardo. It is still the basis of the modern economist’s understanding of trade.

Ricardo imagined, to illustrate his theory, a world with just two countries and two products. His examples were England and Portugal, and cloth and wine – but they could have been any countries and any products.

Ricardo asked a simple but profound question. If England could produce both cloth and wine more efficiently than Portugal, why would trade take place at all? How could the more efficient country, England, benefit from trade?

His answer introduced the fundamental concept of comparative advantage. England had an absolute advantage in producing both cloth and wine, but the country should choose to specialise in producing the one in which its advantage compared to Portugal was bigger.  Both would benefit if England produced only cloth and Portugal only wine, and they traded.

Economics has moved on in the past two centuries, but the concept of comparative advantage, modified by factors such as the distance between countries, is still seen as a key determinant of trade patterns.

In terms of Brexit, introducing complexities like tariffs into the picture essentially affects the amount which is traded, and not the structure of trade in terms of who sells what to who.

If the basic pattern of trade is fixed by comparative advantage, then if Brexit means higher tariffs for the UK, as a country we will lose out. In a nutshell, this is what lies behind all the negative assessments of the impact of Brexit.

However, the key word in the last paragraph is “if”.  Like almost all economic theory, these models are static. They assume that the network of trade is fixed, and analyse the consequences of changing prices through tariffs.

The EU has become mired in regulation and the level of innovation is low. Outside the EU, the UK could alter the patterns of trade by innovating in, say, biotech or AI-related products and services. It is this dynamic response, and not the static one, which will determine whether or not Brexit is a success.

Economic models which claim to analyse the impact of Brexit are true – but only up to a point, Lord Copper, as the saying goes.

As published in City AM Wednesday 30th October 2019 
Image: Dover by Oast House Archive via Geograph licensed for use CC BY-SA 2.0
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Until Scotland’s currency puzzle is solved, independence is economically delusional

Until Scotland’s currency puzzle is solved, independence is economically delusional

The possibility of Scottish independence is back on the political agenda once again. And one question – which currency would an independent Scotland use? – that was crucial in the 2014 referendum has still not been resolved.

The informal use of the pound is a very risky option.

To see why, the Scottish National Party (SNP) might look at the problems which Facebook is having in getting its proposed digital currency libra off the ground. Already, companies like PayPal, Visa, Mastercard and Ebay have withdrawn as potential sponsors.

While Facebook is a company and Scotland is a country, the issue is how the currencies are backed.

Facebook proposes to back the libra by its accumulated profits held in a portfolio of “low volatility assets”. But as Barry Eichengreen of the University of California points out, “anyone who lived through the 2008 global financial crisis will know that low volatility is more a state of mind than an intrinsic attribute of an asset”.

In the face of an unexpected adverse shock to the values of these assets, Eichengreen notes that these will be subject to the equivalent of a bank run. But there is no lender of last resort able to simply print money.

By simply using sterling, as many Latin American countries do with the US dollar, the Scots would have no means of printing money if their banks were attacked in a financial crisis. Taxes would have to rise massively to support the banks.

The Scots could instead apply to join the euro. An immediate problem with this would be the rule in the Stability and Growth pact that countries in the Eurozone should keep their budget deficits below three per cent of GDP.

The UK spends only 1.1 per cent of GDP more than it raises in taxes.  Ironically, this would make us a shoo-in for euro membership, if Britain as a whole wanted to join.

In contrast, the latest figures produced for Government Expenditure and Revenue for Scotland show the nation running a public sector deficit of seven per cent of GDP.

This is obviously much higher than would be allowed in terms of membership of the euro.  It is, in fact, the highest in the whole of Europe, the next highest being Cyprus at 4.8 per cent. So to join the euro, the Scots would have to make large cuts in public spending.

If instead they decided to set up their own currency, the markets would almost certainly force similar public spending reductions on them. After all, small countries running large public deficits tend not to be viewed kindly.

This problem has been magnified dramatically by the statement by Derek Mackay, the Scottish government finance secretary, that an SNP government in an independent Scotland would refuse to repay its share of outstanding UK debt.

A massive public sector deficit and defaulting on government debt is hardly a very sound basis on which to launch any new currency.

The desire for independence is often driven by emotion rather than rational calculation. But unless the currency question is addressed and solved, an independent Scotland would live to rue the day.

As published in City AM Wednesday 23rd October 2019
Image: Scottish Independence March by Christine McIntosh via Flickr licensed CC BY-ND 2.0
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Forget ‘reparations’, scrapping subsidies is the way to help get Wales back on its feet

Forget ‘reparations’, scrapping subsidies is the way to help get Wales back on its feet

Get ready to put your hands deep into your pockets for the boyos and girlos of the Welsh Valleys.  Adam Price, the leader of Plaid Cymru, called last week for the UK to pay “reparations” to Wales for the crime of reducing the country to poverty. For centuries, Wales has (apparently) been stripped of its natural resources and “deprived of its inheritance”.

Price’s demands are almost beyond parody. But they could become a frightening reality if a coalition government led by Jeremy Corbyn and various nationalist and green parties wins the next election.

The then-Labour leader of the Welsh Assembly, Carwyn Jones, set the new tone of Welsh whingeing the day after the Brexit vote in 2016.  “Wales,” he declared, “must not lose a penny of subsidy”. Wales, of course, had voted Leave.

There, in a sentence, was the economic policy of the Welsh government: hold out the begging bowl.

Wales is the poorest of the economic regions of the UK. Household income per head in 2017 – the latest date for which figures are available – was only £15,754, compared to the UK average of £19,514. The gap with the wealthiest regions is massive – the south east has an income per head 43 per cent higher, and London is no less than 77 per cent ahead.

It has not always been like this. In the early decades of the Industrial Revolution, the valley towns were probably the richest in the world.

Merthyr Tydfil, now a byword for poverty even by the standards of Wales, led the way. It was the first genuinely industrialised town in the history of humanity. In 1831, 96 per cent of its labour force worked in manufacturing and mining.

Many forces are at work in the story of Wales’ decline, but in modern times, it has often not exactly helped itself. The key to a successful economy is a skilled labour force, but in 2001, the Welsh government scrapped the publication of league tables for the performance of schools. This both deprived parents of information, and reduced the incentive for poor schools to improve.

The outcome was predictable. A Bristol University study estimated that it led to a fall of 1.92 GCSE grades per pupil. In 2015, the Welsh Assembly reversed the decision, but a lot of damage had been done to the human capital of Wales. For over a decade, students were less well educated than they could have been.

This lack of a skilled talent base inevitably holds back enterprise. This, along with other counter-productive decisions, may be why Wales is increasingly dependent on public sector jobs. Overall, Wales raises £14bn a year less in taxes than it spends on public services.

Might Wales be able to turn its fortunes around if it were forced to consider its economic decisions more carefully? After all, the policy of subsidising underperforming regions has been tried for decades. It has made no difference.

So instead of paying reparations, perhaps we should consider withdrawing subsides, as New Zealand did with great effect. By removing the handouts which are distorting Welsh decision-making and causing a vicious cycle of subsidy demands, we can give Wales the chance to restore the enterprise which used to flourish in the nation.

As published in City AM Wednesday 9th October 2019
Image: Welsh Assembly by Anne Siegel via Wikimedia Commons licensed under CC by 2.0
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Relax, the UK (probably) isn’t heading for recession

Relax, the UK (probably) isn’t heading for recession

Immediate fears of a recession in the UK economy were eased last week with the latest Office for National Statistics (ONS) estimate of monthly GDP.

The economy had shrunk in April, but growth resumed in May.

This has not prevented widespread conjecture that a recession is imminent. The Resolution Foundation claimed last weekend that the risk of a recession is at its highest since 2007, the year immediately before the financial crisis.

The most serious recessions are caused by the debts of the private sector – households and firms – growing too big. Repayments become challenging, and fears grow among lenders that the debt will not be repaid.

At the end of 2007, for example, household debt in the UK was 93 per cent of GDP. Two decades previously, in 1987, the ratio of debt to GDP was only 49 per cent. This crept up to 57 per cent at the end of 1997. But the opening years of the twenty-first century saw a surge in debt levels.

The same is true of corporate debt. This was 95 per cent of GDP at the end of 2007, having been only 39 per cent 20 years previously.

Debt remained high at the end of 2018, the latest date for which the Bank for International Settlements data is available. Household debt was 87 per cent of GDP and corporate debt 84 per cent.

But the ratios are lower than they were at the start of the financial crisis of the late 2000s. The trend over the past five years is broadly flat. There is no sign of the rapid accumulation of debt which characterised the 2000s.

With my UCL colleague Rickard Nyman, I have been using artificial intelligence techniques to measure daily levels of sentiment on social media in the Greater London area since June 2016, and the general level of sentiment among individuals shows no sign of collapse either.

Official forecasts insisted that a sharp recession would take place in the UK in the second half of 2016 if the electorate voted to leave the EU. But the social media based sentiment measure showed no signs at all of collapse at the time.

We could see in real time that it became more positive after the referendum, even in the Remain stronghold of London. And, of course, there was no recession.

Over the past three months, sentiment shows no change on its level in the same period in 2018.  Admittedly, the latter was definitely lower than in 2017, a slowdown which ONS data, appearing several months later, confirmed.

None of this means that the economy is roaring away. Growth has been modest, and while debt levels are being controlled, their height from a historical perspective means that they act as a constraint on spending plans.

Ironically, perhaps the biggest threat of a recession comes the EU, and specifically from Germany, the Remainers’ paradise. It is much more dependent on manufacturing than the UK, and these exports have been hit by US-China trade tensions. The warnings from economists in Germany are not about a mere recession, but of a potentially severe one.

As published in City AM Wednesday 17th July 2019
Image: Shopping Max Pixel licensed under CC0 1.0
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From taxes to cats, May’s government has been an affront to Tory ideology

From taxes to cats, May’s government has been an affront to Tory ideology

Theresa May has finally announced her resignation. How can we capture the flavour of her tenure in office?

This can be found in the dry and measured content of the Economic and Fiscal Outlook from the Office for Budget Responsibility (OBR).

The OBR stated in its latest publication in March 2019 that: “the tax receipts-to-GDP ratio ends the forecast in 2023-24 slightly higher than its 2018-19 level”.

Of course, this is a forecast, and all the usual caveats need to be attached. But, remarkably, it was the intention of a Conservative government for taxation to be higher in five years’ time than it is now.

Already, taxes are high. Taxes as a percentage of GDP in 2018/19 were higher than at any time since 1979, the first year with Margaret Thatcher as Prime Minister.

Gordon Brown effectively ran economic policy from 1997 until 2010. Even at the time, he was satirically referred to as the Great Helmsman, a name bestowed upon leaders of centrally-planned economies such as Joseph Stalin.

Brown could not resist detailed meddling of the most microscopic variety, exactly as if he were in charge of a Five Year Plan in the old Soviet Union. But during his long reign, taxes as a percentage of GDP remained lower than they are now.

And it’s not just taxes but regulation too where the government under May is behaving in a decidedly un-Conservative manner.

Despite what the Tories like to say, the culture of interference seems to have got even worse under May.

A rather minor issue symbolises the mentality of the May regime. This is the Cats’ Bill, a private member’s bill sponsored by Rehman Chishti, Tory MP for Gillingham and Rainham. Michael Gove has described the bill as an “inspiration”.

There is undoubtedly a problem with cats being hit by motor vehicles. Campaigners estimate that 250,000 are either killed or injured every year in this way. These incidents create a great deal of stress and unhappiness for the owners. It would obviously be good if the number could be reduced.

The bill would force owners to microchip their cats so that they could be identified. This seems reasonable. But Chishti proposes that a motorist hitting a cat should be required not just to stop, but to report the incident to a vet, on pain of a fine of up to £20,000.

The bill is brought in with the very best of intentions. But it will simply create another regulated industry.

Vets will demand that the motorist pay a fee for their effort in making a record of the accident – even better, that they get a special subsidy from the taxpayer.

Civil servants will be recruited to check that the vets’ forms are correctly filled in. There will be demands for new regulations on vets to ensure that they are trained to comply with the new law, and a way to enforce these rules for drivers.

None of this seems to have occurred to Chishti. For him, a problem exists, and the way you solve it is by state intervention.

Another way, of course, is for owners to take more personal responsibility for their cats, but that doesn’t seem to occur to politicians.

From cats to taxes, May essentially created a social democratic government, not a Conservative one.

As published in City AM Wednesday 29th May 2019

Image: British Cat by Colicaranica via Wikimedia is licensed under CC BY-SA 3.0
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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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