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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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Our automated future is brighter than Karl Marx or Mark Carney would ever suggest

Our automated future is brighter than Karl Marx or Mark Carney would ever suggest

Mark Carney, the governor of the Bank of England, hit the headlines at the weekend, claiming that Marxism could once again become a prominent political force in the west.

Automation, it seems, may not just destroy millions of jobs. For all except a privileged minority of high-tech workers, the collapse in the demand for labour could hold down living standards for decades. In such a climate, Communism may seem an attractive political option.

Karl Marx as an economist is a bit of a curate’s egg, good in parts. In the late eighteenth and early nineteenth centuries, it was obvious that the system of factory production was dramatically different to anything which had ever existed, but it was thought that might disappear just as suddenly as it had emerged.

Marx was the first major economist to see that the accumulation of capital in factories represented a new, permanent structure of the economy: capitalism. He developed a theory of the business cycle, the short-term fluctuations in economic growth, which is much more persuasive than the equilibrium-based theories which dominate academic macroeconomics today.

But he was completely wrong on a fundamental issue. Marx thought, correctly, that the build-up of capital and the advance of technology would create long-term growth in the economy. However, he believed that the capitalist class would expropriate all the gains. Wages would remain close to subsistence levels – the “immiseration of the working class” as he called it.

In fact, living standards have boomed for everyone in the west since the mid-nineteenth century. Leisure hours have increased dramatically and, far from being sent up chimneys at the age of three, young people today do not enter the labour force until at least 18.

Marx made the very frequent forecasting mistake of simply extrapolating the trend of the recent past.

In the early decades of the Industrial Revolution, just before he wrote, real wages were indeed held down, as the charts in Carney’s speech show. The benefits of growth accrued to those who owned the new machines. Marxists call this the phase of “primitive accumulation”.

But such a phase has characterised every single instance of an economy which enters into the sustained economic growth of the market-oriented capitalist economies, from early nineteenth century England to late twentieth century China.

Once this is over, the fruits of growth become widely shared.

In fact, Carney’s own charts give grounds for optimism and contradict the lurid headlines around his speech. One is headed “Technology driving labour share down globally”. In other words, the share of wages and salaries in national income has been falling. In the advanced economies, this was some 56 percent in the mid-1970s and is 51 percent now. But all the drop took place before the mid-2000s. If anything, the labour share has risen slightly since.

Similarly, inequality has increased over the past 40 years, but almost all the increase took place in the 1980s. Depending which measure we take, it has either stabilised or fallen since 1990.

The future looks more optimistic than either Marx or Carney suggest.

As published in City AM Wednesday 19th April 2018

Image: Car Factory by Jens Mahnke is licensed under CC0.0
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The chancellor should heed Keynes – and keep public spending down

The chancellor should heed Keynes – and keep public spending down

Last week’s Spring Statement by chancellor Philip Hammond has led to predictable calls to “abandon austerity”.

With massive hyperbole, Labour accused him of “astounding complacency” in the face of what they claimed to be the worst ever public funding crisis.

The facts are rather different. Far from being squeezed, after allowing for inflation, current spending by the public sector has risen almost eight per cent since the depths of the recession in the middle of 2009.

True, the economy as a whole has grown faster, with GDP now almost 18 per cent up from its low point almost eight years ago. But public spending is up, not down.

The recovery has been driven by the private sector. Companies are investing 33 per cent more on new capital equipment now than in 2009.

Personal consumer spending, the single biggest component of GDP, is up by 15 per cent. So living standards have risen more or less in line with the economy as a whole. The growth rate is slightly less, but this is good news. Resources are moving, albeit slowly, into investment, the foundation of growth in the future.

The myth that austerity prevails in the UK is potentially a dangerous one. The simple fact is that Britain is at full employment. Over three million net new jobs have been created, and the total number of people in work stands at a record 32.1m.

The numbers claiming unemployment benefit amount to just two per cent of the total population aged between 16 and 64.

Of the 650 parliamentary constituencies, there are only 33 where the rate is four per cent or more, and in almost all of these it is between four and five per cent. Of the 84 constituencies in the south east, there are only nine where it is even above the national average of two per cent.

A basic premise of economics is that, at full employment, an increase in government spending financed by extra borrowing will create inflation. The economy will not expand, because existing resources are fully utilised. The stimulus will create excess demand for them, which will bid up prices.

We need not rely on conventional economics for this argument. Those who invoke John Maynard Keynes’ name to support “abandoning austerity” ought to familiarise themselves with the words of the great man himself.

Keynes’ magnum opus, the General Theory of Employment, Interest and Money, was published in 1936, shortly after the deepest recession the western economies have ever seen.

Keynes did indeed recommend extra government spending to boost the economy when unemployment is high. Economists have argued ever since as to what extent, if at all, he was correct. But in a key section of his book – chapter 10, for all you fellow trainspotters out there – Keynes writes: “When full employment is reached, any attempt to increase expenditure further will set up a tendency for prices to rise without limit.”

The chancellor should follow the sound advice of Keynes, and stick with his current plans.

As published in City AM Wednesday 21th March 2018

Image: Philip Hammond by Raul Mee is licensed under CC by 2.0
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Let’s join the IFS in acknowledging our misplaced fetishisation of economic data

Let’s join the IFS in acknowledging our misplaced fetishisation of economic data

Tomorrow, the Office for National Statistics (ONS) will publish its latest estimates on how much the UK economy grew between October and December 2017, compared to July to September.

Last month, the ONS thought that there was an increase of 0.5 per cent.

The economy cannot be put in a set of scales and measured. Total output, GDP, has to be estimated by the ONS. As more information comes in, the estimates change.

The numbers will be pored over, particularly in the context of Brexit. A revision down to 0.4, for example, would bring joy to Remainers.

A depressing feature of much of this kind of commentary is the lack of understanding it shows about the uncertainties which surround even the revised numbers. A revision of just 0.1 per cent tells us virtually nothing.

The United States is probably the world leader in economic data estimates. But the Bureau of Economic Affairs’ (BEA) view of growth rate of the economy in any given period can alter quite dramatically over time.

The financial crisis burst on the world in the autumn of 2008. Earlier that year in April, the initial estimate of the BEA was that the American economy had grown just 0.15 per cent in the January-March period over the previous three months. Pretty slow, equating to only 0.6 per cent if sustained over a whole year. But at least it was a positive number.

Now, the BEA believes that US GDP fell by nearly 0.7 per cent in that quarter, an annual rate of 2.7 per cent in fact.

In other words, America was already in a full-blown recession. If only policymakers had known.

This misplaced fetishisation of numbers is the subject of an intriguing article by Paul Johnson in the latest edition of the monthly magazine Prospect.

Johnson is the director of the highly respected Institute of Fiscal Studies (IFS), an outfit which lives and breathes economic and social statistics. But he has become concerned not only about how numbers have come to dominate policy debate, but about the illusion of knowledge which addiction to numbers has created.

His Prospect piece opens with the statement: “I trade in numbers and am passionate about them. But I have also learned to be very cautious in their company.” He offers guidelines to navigate the thicket of data which bombards us on a daily basis.

The first is to be aware of the limitations of statistics. An increase in crimes, for example, might be genuine, or it might just reflect an increase in the propensity to report a crime.

His second point is to take into account the broad picture, and not be seduced by the apparent precision and certainty conveyed by decimal places. GDP growth of around 0.5 per cent a quarter, for example, means that growth is sufficient to keep employment numbers up. It does not really matter whether it is 0.4, 0.5 or 0.6.

The limits to knowledge about economic and social systems is a constant theme of this column. The IFS is a very welcome convert to the cause.

As published in City AM Wednesday 21st February 2018

Image: Regulatory Documents via Max Pixel is licensed under CC by 0.0
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Carillion shouldn’t be brought under state control, but maybe central banks should be

Carillion shouldn’t be brought under state control, but maybe central banks should be

A strong thread in the acres of print about the Carillion debacle is that the private sector should not really be involved in infrastructure projects. The public sector would, apparently, do it better.

Readers who experienced life under the nationalised rail and telephone systems might be forgiven their scepticism.

One idea which is taking hold is that the government can borrow more cheaply than any private company, so it must be more effective for the state to carry out major infrastructure projects.

The interest rates at which different outfits can borrow are plain for all to see. But they are just the tip of the iceberg. We need to look below the surface to see the real economic argument.

Philip Booth of the Institute of Economic Affairs set it out clearly at the weekend. People will lend money to the UK government more cheaply than to a company mainly because the risk of default is much lower. Indeed, the British state has not defaulted on its debts for well over 300 years.

But the risk of an individual project failing may be considerably higher. The huge overrun of costs on the Aberdeen bypass, for example, was one of the reasons for the demise of Carillion.

If this happens to a company, it can go under. The government simply passes the unforeseen costs onto the taxpayer.

The general rate at which the government can borrow does not reflect the true level of risk on a specific project. Ideally, the voters who ultimately pick up the tab would understand this, but in practice it is not spelt out to them. There is an information failure.

All this said, there is a strong argument for bringing some key aspects of economic life back under public sector control.

Central banks are by far the most important example. In the 1990s, mainstream macroeconomists pushed the idea of independence for these banks, and it took hold. One of Gordon Brown’s first acts as chancellor in 1997 was to make the Bank of England independent.

All sorts of benefits were meant to flow from this. But it is hard to discern any of them in practice. The Bank conspicuously failed to head off the financial crisis of the late 2000s. And once the crisis had hit, its initial response was to worry about the esoteric theoretical concept of “moral hazard” rather than saving capitalism.

If the chancellor gets things wrong, the government can be booted out. The Monetary Policy Committee can’t be.

If MPs wanted to change this and take back control, a precedent has been set. The Highways Agency was set up as an executive agency in 1994. But in 2015, the coalition re-constituted it as a company owned by the government.

In practice, transport ministers do not seem to have exercised much control over it. There is an ongoing shambles, for example, with road works both on the M6 north of Birmingham and on the M60, Manchester’s equivalent of the M25.

But in principle they could. It is time to restore control to elected politicians. To, in a word, renationalise the policymaking bodies.

As published in City AM Wednesday 24th January 2018

Image: Carillion by Terry Robinson is licensed under CC by 2.0
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