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Unemployment down, GDP up – there’s no logic for a public spending boost now

Unemployment down, GDP up – there’s no logic for a public spending boost now

Despite the warmth of the days, there is a distinct autumn feel to the mornings.

And in the autumn, thoughts begin to turn to the Budget.

Speculation has already begun about what the chancellor Philip Hammond might or might not do.

For Labour, recent weeks have been dominated by Jeremy Corbyn’s alleged antisemitism and undoubted incompetence. So the anti-austerity tour of Britain by shadow chancellor John McDonnell, begun in Hastings in July, has scarcely obtained a mention in the media.

McDonnell obviously believes that there is a need to “end austerity”. He is far from being alone.

It is remarkable how this anti-austerity narrative continues to pervade political and economic discourse – it is as if the UK were in the grip of a massive recession.

In reality, the economy continues to do well. GDP is now over 18 per cent higher than it was at the trough of the recession in the first half of 2009. Unemployment has fallen steadily since the Brexit vote, and now stands at its lowest rate since February 1975.

The name of John Maynard Keynes is frequently invoked by those who want to “abandon austerity” and increase public spending. Yet in his major book The General Theory of Employment, Keynes stated very clearly: “when full employment is reached, any attempt to [stimulate the economy] still further will set up a tendency in money-prices to rise without limit”.

In other words, according to Keynes himself, at full employment any further stimulus will simply lead to higher inflation, with no benefit to output or employment.

Unemployment is at a 40-year low, while employment is at a record high, with 32.3m people in work – an increase of 3.4m from the depths of the financial crisis. This sounds like full employment in anybody’s language.

The overall shape of the recovery since 2009 has been balanced. Consumer spending has actually grown less than GDP, by just over 16 per cent since 2009 compared to an 18 per cent rise in GDP. Capital investment by companies has gone up by 35 per cent.

Public spending has also risen, but only by seven per cent (all figures after allowing for inflation).

This has been a recovery generated by the private sector.

The same point applies even more strongly to the US. Compared to the low point of the recession in 2009, public spending has actually fallen by three per cent, though there has been a modest rise in employment in that sector of 100,000. In contrast, the private sector has roared away: 19.5m net new jobs have been created since the winter of 2009, and GDP is up by over 22 per cent.

As in the UK, an important driver of the recovery in America has been investment by firms. This has grown by no less than 54 per cent compared to 2009.

There is no case at all for stimulating the economy by increasing public spending (funded by increased taxes) and abandoning so-called austerity, not when the private sector has done such a good job on its own.

As published in City AM Wednesday 5th September 2018

Image: Money by Max Pixel is licensed under CC0 1.0 Universal

 

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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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Investors should intervene to stop high executive pay, before the regulator does

Investors should intervene to stop high executive pay, before the regulator does

Shareholder discontent over executive pay continues to rise. Last week, the outgoing boss of BT, Gavin Patterson, was in the firing line.

At the company’s annual general meeting, 34 per cent of investors voted against the remuneration report, which included a £1.3m bonus payment to Patterson.

Concern about top pay has spread even to the regulatory bodies in the United States. Traditionally, they adopt a rather hands-off approach, and yet, when they do decide to act, they act decisively.

About 40 years ago, the typical compensation of a chief executive in America was around 30 times more than that of the average employee. By the mid-1990s, this has risen to a ratio of 100 to one, and now it is some 300 times as much.

True, share prices have boomed over this period, but the rate at which the economy has grown has fallen.

Between 1957 and 1987, real GDP in the US grew by 3.5 per cent a year, but by only 2.5 per cent from 1987 to 2017.

Chief executives have not got better at expanding the rate at which goods and services are produced, but they have got better at free-riding on the rise in equity markets.

Against this background, in September last year, the US Securities and Exchange Commission mandated that companies must disclose the ratio of the chief executive’s compensation to median employee pay.

Some may see this as bureaucratic meddling. But the behaviour of board members both here and in America has given rise to what economists describe as an externality.

The decisions to reward the relative failure on the part of executives have consequences outside of the decisions themselves. So while capitalism is by far the most successful economic system ever devised, the perception that executives are receiving unfair levels of compensation is undermining belief in capitalism itself. This is the externality.

In economic theory, the existence of externalities provides a sound justification for intervening in the workings of the free market.

A fascinating paper published a year ago by Ethan Rouen of Harvard Business School provides strong evidence that unwarranted executive pay levels adversely affect firm performance.

He obtained very detailed data, some of it not publicly available, from the US Bureau of Labor Statistics for 931 firms in the Standard and Poor’s 1,500 between 2006 and 2013, including total employee compensation and the composition of the workforce.

Overall, Rouen found no statistically significant relation between the ratio of executive-to-mean employee compensation and performance. This is telling in itself.

His results went on to show “robust evidence of a negative (positive) relation between unexplained (explained) pay disparity and future firm performance”. In other words, people do not mind high pay – when it can be justified. It is when the snouts are in the trough that resentment rises and performance suffers.

Shareholder opposition to excessive executive packages is certainly rising, but has rarely been decisive. Investors need to act if they are to avoid the regulators really clamping down.

As published in City AM Wednesday 18th July 2018

Image: Fat Cat by Linnaea Mallette is licensed under CC-BY-1.0
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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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Brussels elites who fiddled while Rome burned may soon get their comeuppance

Brussels elites who fiddled while Rome burned may soon get their comeuppance

The new Italian government looks set to cause shock waves across Europe.

The two parties promise mass deportations of immigrants and huge increases in public spending.

Both the social and the economic policies of the Italian coalition clash directly with those of the European Commission, and Germany and France. They represent a decisive break with the consensual approach of the past.

The performance of the UK economy since the financial crisis of the late 2000s has been disappointing. But it has positively boomed in comparison with that of Italy.

Italian GDP, according to the OECD’s database, peaked in the first quarter of 2008. By the spring of 2009, it had collapsed by eight per cent. There was a feeble recovery, before it started to fall again in late 2011. Even now, GDP remains over five per cent below its value of 10 years ago.

It not only looks dramatic – it is dramatic. The failure of the Italian economy to recover for a whole decade breaks all records, not just in Italy itself, but across the western economies as a whole.

Angus Maddison spent many years at the OECD constructing estimates of GDP in the western economies going back to 1870. His database puts the recent performance of the Italian economy squarely in the spotlight.

Some capitalist economies have experienced truly devastating collapses: Austria, for example, when it was overrun by the Red Army in 1945, and Japan when it was subjected to massive nuclear and conventional bombing attacks in the same year.

But leaving the World War years and their immediate aftermath aside, we can identify, prior to the recent financial crisis, 191 instances of peacetime recessions in the western economies since 1870 from the Maddison database.

Across some 20 capitalist countries, GDP has fallen for a year (the data is annual) 191 times.

Out of these 191 examples, on 113 occasions GDP bounced back above its previous peak value the following year. Two years after a fall, the peak had been regained no less than 151 times. So most recessions are very short. Capitalism is a very resilient system.

The previous longest recession on record across the west as a whole was that of the United States. The collapse during the Great Depression of the early 1930s was so severe that, even with a boom later in the decade, it took until 1939 to recover the peak 1929 level.

That is the context in which we should view Italy’s decade-long recession. It is hardly surprising in the circumstances that the Italian electorate has supported parties which are pledged to overthrow the status quo. If they do what they say they will, the impact will be greater than that of Brexit.

Greece and Portugal are in the same position as Italy, with GDP in both economies still being below pre-crisis levels. But they are small.

The bureaucrats in Brussels, aided by Germany, have allowed Italy to be crushed by the longest peacetime recession in the history of capitalism. No wonder they may now get their comeuppance.

As published in City AM Wednesday 24th May 2018

Image: Vatican Sunset by Giorgio Galeotti is licensed under CC Attribution 4.0
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Trump’s tariffs are unlikely to plunge the global economy into a Great Depression

Trump’s tariffs are unlikely to plunge the global economy into a Great Depression

The Trojans had to beware of Greeks bearing gifts.

In the same way, politicians need to be suspicious of petitions signed by economists.

The vast majority of the UK economics profession backed Project Fear, which predicted a rise in unemployment of half a million by the end of 2016. Instead, unemployment has fallen almost continuously since the Leave vote in June of that year.

In 1981, 364 economists signed up to urge Margaret Thatcher’s chancellor, Geoffrey Howe, to end austerity. No sooner was the ink dry than the economy started to boom.

The latest petition, on the face of it at least, should be taken more seriously. Over 1,000 American economists, including 14 Nobel Prize winners, have written to President Donald Trump. His trade policies, they claim, repeat the mistakes of the 1930s and threaten to plunge the world into another Great Depression.

It is a big claim to make. The financial crisis recession of the late 2000s was a mere blip by comparison – GDP in the US fell by four per cent. In the early 1930s, it dropped by over 20 per cent.

These economists cite the Smoot-Hawley Tariff Act of June 1930 as being a major cause of the massive recession. Output was already falling sharply in America. The claim is that the Act exacerbated the problem. It increased tariffs on over 20,000 types of products imported into the US, and was followed by a string of retaliatory measures across the world.

But the 1,140 economists – at the last count – who have signed the petition ignore a very well established result in economic theory. This is the so-called “theory of the second best”, published by Richard Lipsey and Kelvin Lancaster in 1956.

The economies of the west owe much of their success to the fact that they are market based. But they are not entirely the free market ideal of the economics textbooks. It might be thought that making them a bit more free market would make them even better. Conversely, taking them further away from the ideal, by imposing a trade tariff for example, would make things worse.

Lipsey and Lancaster showed that in general this result could not be demonstrated theoretically. It might be true. But only empirical evidence could show whether it was or not.

The petitioners should also look at a paper just published in the American Economic Association’s prestigious Journal of Economic Perspectives (JEP). Arnaud Costinot and Andre Rodriguez-Clare, of MIT and UCLA at Berkeley respectively, pose the question: what if America abolished all trade? Not just impose a tariff, but no trade at all.

Their detailed empirical evidence suggests that the effects are rather small. GDP would be between two and eight per cent less. A fall, it is true, but hardly one to generate such a furore over a policy, not of abolishing trade, but just making it that bit more expensive.

The JEP paper also shows, not surprisingly, that trade tends to widen inequality. The poor might lose out, even if the economy overall benefits.

President Trump seems to grasp the political importance of this.

As published in City AM Wednesday 9th May 2018

Image: Great Depression via Wikimedia Commons is licensed under CC0.0
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