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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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Act now, think later: Card surcharge ban is typical of myopic soundbite politics

Act now, think later: Card surcharge ban is typical of myopic soundbite politics

Companies and service providers are no longer allowed to charge customers for using a credit or debit card. The new law came into effect last Saturday.

The economic secretary to the Treasury, Stephen Barclay, trumpeted: “rip-off charges have no place in a modern Britain and that’s why card charging in Britain is about to come to an end.”

It all sounds good. But far from reflecting well on the government, it calls into question just how much a so-called Conservative administration understands the workings of market economies.

One immediate effect of the new law is that it is no longer possible to pay your tax bill online direct to HMRC. The relevant part of their website proclaims “you won’t be able to pay with a personal credit card from 13 January 2018”.

Exactly at the time when people are coughing up, a new regulation designed to benefit the consumer has made it harder for them to pay. In economist-speak, this reduces consumer welfare.

Many retailers, especially the large ones, will of course simply find other ways of passing the costs on. Just Eat, for example, has introduced a 50p service charge on all orders. Previously, the company added a 50p charge to card transactions. But now all customers will have to pay it. Other retailers will just add the odd bit here and there so that no-one will really notice.

The fundamental point is that, ultimately, only individuals can pay taxes and charges.

Even if a retailer chooses to absorb the fee and not pass it on, this leaves less money for its other commitments. Such as money for wages, dividends to shareholders, and payments to suppliers.

Credit and debit charges seem to attract bad legislation. A change introduced in 2015 has probably made consumers worse off overall. In this case, the blame can safely be laid at the door of the EU. It was their regulatory requirement.

The card schemes such as Visa and Mastercard charge card companies such as Barclaycard and Capital One a fee. This “interchange” fee is a sort of royalty. It is just a fee for being part of the big scheme, not for any sort of processing.

There is a genuine market in operation here, because the card companies can switch schemes. There was a wide variety of fees, such as a fixed percentage of the transaction being financed, with and without a maximum cap, and fixed amounts.

But through competition, high value transactions such as car purchase or tax payments had tiny percentage fees.

The EU in its wisdom capped the interchange fee at 0.2 per cent of the transaction value. But just as universities have all charged the maximum student fee set by the government, the interchange fee is now very frequently set at the maximum 0.2 per cent.

So car buyers, for example, lost out by having a much bigger fee passed on to them.

The urge to meddle unthinkingly in micro detail, without grasping that this will change behaviour, is a besetting sin of modern politicians.

As published in City AM Wednesday 17th January 2018

Image: Credit Cards by Nick Youngson is licensed under CC by 3.0
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The OBR’s forecasts should be taken not just with a pinch of salt, but with the contents of an entire mine

The OBR’s forecasts should be taken not just with a pinch of salt, but with the contents of an entire mine

There has been a great deal of crowing in metropolitan liberal circles over the report of the Office for Budget Responsibility (OBR), published with the Budget last week.

The OBR revised downwards its projections for GDP growth for each of the next five years. Annual average growth to 2022 is predicted to be just 1.4 per cent a year.

The OBR believes that the UK is experiencing a “negative supply shock”.

But forecasts are merely forecasts. They do not constitute scientific evidence at all. This is especially true of economic predictions.

One section of the OBR’s report which relates to facts rather than views about the future has been seized on. This is that growth in the euro area during 2017 has been both stronger than it was in 2016, and stronger than in the UK. This is represented as showing that the EU is dynamic, and the UK is fading away.

But the experience of just a few months data – we only have official data to, at the very latest, the end of September – needs to be put into context.

Since 2007, the year immediately before the financial crisis, GDP in the UK has grown by just over 10 per cent.

This does indeed represent a decade of growth which, by historical standards, is low.

But the figure is very similar in Germany. In France, output is only around six per cent higher than it was 10 years ago. In Spain, GDP has risen by five per cent.

In Italy, however, the economy has shrunk by some five per cent since 2007. The Italians have had a decade not just of low growth, but of negative growth. They have gone backwards.

Despite over 40 years of EU membership, the UK economy remains far more synchronised with the US in terms of the year-on-year fluctuations of the business cycle.

So over this period, we see some years when economies in the EU have grown faster than in the UK, and some years when they have grown more slowly. This is precisely what to expect when the cycles are not coordinated.

The OBR itself is fully aware of the huge potential for error in economic forecasts.

Indeed, the report illustrates the uncertainty around its five-year projection of 1.4 per cent annual GDP growth in a so-called “fan chart”. This shows the potential range around the prediction, based on past errors made in official forecasts.

At worst, growth could be negative, with an annual average fall of one per cent. But at best, we could have a sustained boom with growth of over four per cent a year.

Based on how wrong past forecasts have been, the next five years could see a cumulative fall in GDP of over five per cent, or a cumulative rise of over 20 per cent.

The OBR’s forecasts should be taken not just with a pinch of salt, but with the contents of an entire mine.

As published in City AM Wednesday 29th November 2017

Image: Philip Hammond via Wikimedia is licensed under CC by 2.0
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Doublethinking or dim? Why the Labour party can’t be trusted with the economy

Doublethinking or dim? Why the Labour party can’t be trusted with the economy

Are members of the Labour Party frontbench experts in doublethink? The concept was invented by George Orwell for his novel 1984, written in the 1940s as a critique of the Soviet Union.

Masters of doublethink can hold, for purposes of political expediency, two opposing opinions at the same time, one of which might be complete nonsense.

The Leader himself set a good example during the general election campaign when he promised to abolish all outstanding student debt. Jeremy Corbyn rather backtracked on this after the votes had been cast, when it was pointed out to him that this would cost around £100 billion – over £1,500 for every man, woman and child in the UK.

His close ally, the Shadow Chancellor, followed this up on Sunday. Asked about the cost of Labour’s re-nationalisation plans, John McDonnell said that “you don’t need a number because you swap shares for government bonds”.

Independent experts put a provisional costing of around £500 billion on McDonnell’s plans. This amounts to over 20 per cent of GDP.

Imagine you want to buy a house for £10 million but have no savings. And imagine that you somehow persuade someone to lend you the money. True, you have acquired an asset worth £10 million and have a debt of the same size. Your net wealth position is unchanged.

But you face the problem of paying the interest on the loan, the terms of which may be very onerous, reflecting your credit risk.

McDonnell argues that nationalised industries will make a profit, which will take care of the interest payments.  Stretching credibility even further, Labour argues that because the interest on government bonds is currently only just over 1 per cent, the payments would not amount to much.

Yet it is obvious that the markets might want a much higher rate of interest to finance the plans of a Chancellor who wanted to add £500 billion to public debt.

Emily Thornberry, the Shadow Foreign Secretary, has also got in on the doublethink act. Challenged on TV to name any country where Labour’s policies of financing spending by issuing debt had worked, she finally came up with Germany and Sweden.

The Bank of International Settlements complies data on the ratio of government debt to GDP. There are several ways to do this, but on their preferred approach in Germany it is currently 73 per cent and in Sweden 44 per cent. In the UK it is already 116 per cent.

Much more plausible comparators are Italy and Greece, where the ratios are 150 and 173 per cent, figures which McDonnell would reach easily. In Italy, GDP is still 5 per cent below its peak level in 2007, a whole decade ago. And in Greece it is 26 per cent lower.

Are the top Corbynites cynical exponents of doublethink? Less charitable people might say they are just plain dim. As so often in economics, the evidence so far does not enable us to decide between the two hypotheses. But, either way, they are bad news.

As published in City AM Wednesday 22nd November 2017

Image: Corbyn and McDonnell by By Rwendland is licensed under CC by 4.0
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Catalonia tries to avoid repeating history, but Spain has economic reality on its side

Catalonia tries to avoid repeating history, but Spain has economic reality on its side

Karl Marx famously wrote: “History repeats itself, first as tragedy, second as farce”.

The phrase might well have been coined with Catalonia in mind.

Generalissimo Franco began a military coup against the elected Spanish government in the Canary Islands in 1936. The battle spread across Spain, and Catalonia was the last redoubt of the Republic to fall, in 1939. Franco took brutal revenge. Tens of thousands were imprisoned or executed, many of these within living memory. The Catalan language was banned.

Now the Catalans have proclaimed independence and Spain has imposed direct rule.

We do not of course know how events will pan out this time around. Things may turn serious. Yet there is certainly a slapstick element to having two different sets of police on the streets, and two different groups of civil servants, each taking different sets of orders.

In both the late 1930s and now, economics has a potentially decisive role in the eventual outcome.

There are many reasons for Franco’s victory. An important one is that the Republican side could just not obtain enough modern armaments. Catalonia even then was the richest part of Spain, but the arms the Catalans needed were made abroad, and, as the civil war progressed, increasingly they could not afford them.

A leading element in the Catalan government was the Workers’ Party of Marxist Unification (POUM in Spanish). POUM was inspired by Leon Trotsky, in much the same way as Jeremy Corbyn and his close acolytes appear to be today.

Sympathy for the historical role of POUM goes a long way to explaining why Corbynistas are enthusiastic supporters of the contemporary Catalans.

But POUM made a catastrophic mistake: initiating a policy of expropriating private property. One effect was a major loss of confidence, and the collapse of the Republican peseta on the foreign exchanges, meaning that all imports, not just weapons, became punitively expensive.

Another generalissimo who was a political contemporary of Franco, one Joseph Stalin, described Trotskyists as a “gang of wreckers and diversionists”. In this, at least, he was surely correct.

This time, the Catalans are desperately trying to create separate a currency, using technology based on digital tokens. Their government is considering an e-residency programme such as the one in Estonia. This provides a way to operate a location-independent business online.

More traditional businesses have already voted with their feet. Almost 1,700 companies, including two big banks (Sabadell and CaixaBank), have switched their headquarters to other parts of Spain since the crisis escalated at the start of October.

The EU has made it clear that an independent Catalonia would not be a member of either the EU or the Eurozone. The latter would probably be a decided advantage, but effective expulsion from the EU could cause serious short term dislocations.

It is not just loyalty to Spain which is leading a lot of Catalans to demonstrate against independence. Whatever the long term outlook, the immediate economic costs would be substantial.

As published in City AM Wednesday 1st November 2017

Image: Demonstration by By Màrius Montón  via Wikimedia Commons is licensed under CC by 4.0
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It’s time to question the macroeconomic orthodoxy on interest rates and inflation

It’s time to question the macroeconomic orthodoxy on interest rates and inflation

Mark Carney, governor of the Bank of England, is getting his retaliation in early.

Faced yet again with the Bank failing to deliver its designated target of a two per cent inflation rate, in a speech last week he suggested that his remit was broader.

“We face a tradeoff between having inflation above target and the need to support, or the desirability of supporting, jobs and activity”, the governor stated.

In other words, he claimed that the Monetary Policy Committee (MPC) of the Bank should be concerned not just with inflation, but with what economists describe as the “real” economy, output and jobs.

The Federal Reserve in the US is explicitly mandated to take account both inflation and the real economy when it sets interest rates. This is definitely not the case with the Bank of England. When Gordon Brown made it independent in 1997, its remit was unequivocal. It was to ensure that inflation was two per cent a year.

This time round, inflation is above the Bank’s target. The current level of some three per cent may even rise in the short term because the weakness of sterling is pushing up the cost of imports.

But in recent years, inflation has been below the two per cent desired rate, even falling to zero in 2015.

All this time, Bank rate has been essentially flat. The MPC cut it to just 0.5 per cent in March 2009, where it remained until the reduction to 0.25 per cent in August 2016.

To put this into perspective, when the rate fell to 1.5 per cent in January 2009, this was the first time it had been below two per cent since the Bank was created in 1694, well over 300 years ago.

So here is a puzzle for mainstream macroeconomists, whether in central banks or universities. Central banks are meant in theory to be able to control inflation by setting short term interest rates. Inflation has been low since 2009. But at the same time, the Bank rate has been at all-time record lows.

Perhaps more pertinently, inflation has fluctuated from year to year, even though interest rates have to all intents and purposes not changed. It was 4.5 per cent in 2011, and 0.7 per cent in 2016.

In short, inflation seems to lead a life of its own, independently of what the experts on the MPC either say or do.

Inflation really is a naughty boy all round. A central concept in orthodox economic thinking, encapsulated in the quote from Carney above, is that there is a tradeoff between inflation and jobs and output. The faster the economy grows and unemployment falls, the higher inflation will be.

But starting in the early 1990s, for around 15 years across the entire Western world, both inflation and unemployment experienced prolonged falls.

The idea that a central bank can control inflation by adjusting interest rates is shown by the evidence to be absurd.

It is yet another example of the limits to knowledge in orthodox macroeconomics.

As published in City AM Wednesday 25th October 2017

Image: Mark Carney by Bank of England is licensed under CC by 2.0
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