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The UK could teach the Eurozone a thing or two about successful monetary unions

The UK could teach the Eurozone a thing or two about successful monetary unions

The Office for National Statistics (ONS) published last week some figures which show how a successful monetary union works in practice.

It is not obvious at first sight, from the dry heading: “regional public sector finances”.

The ONS collects information on the amounts of public spending and money raised in taxes across the regions of the UK. The difference is the so-called fiscal balance of the region.

Only three regions generate a surplus. In London, the South East and the East of England, total tax receipts exceed public spending. The capital has a healthy positive balance of £3,070 per head, followed by the South East at £1,667 per head.

Essentially, these two regions subsidise the rest of the UK. Public spending in the North East, for example, is £3,827 per person above the level of taxes raised in that region. In Wales, it is even higher at £4,545. No wonder that one of the first things Carwyn Jones, leader of the Welsh Assembly, said after the Brexit vote was: “Wales must not lose a penny of subsidy”.

The region which benefits most is Northern Ireland, which gets £5,437 per head more than it generates in tax. Scotland, to complete the picture, receives around half of that, at £2,824 per person.

There is a lot of debate around Brexit and the border between the North and the Republic of Ireland. There is even talk of reunification, but on these numbers the Republic would be mad to want it.

Essentially, the regions receive these subsidies because they are running deficits on their trade balance of payments. The exports of goods and services from the North East, for example, to the rest of the UK are much less than it imports. In balance of payments jargon, the subsidy it receives is a monetary transfer from the rest of the country, principally from London and the South East.

The ONS does not actually produce regional balance of payments statistics. But the fact that most regions receive these large transfers implies that they are just not productive enough to sustain their living standards by their own efforts.

All the regions are in the sterling monetary union. Those running trade deficits cannot devalue to try to improve their position. They must instead rely on subsidy.

Exactly the same principles apply in the Eurozone. The massive difference of course is that there is no central Eurozone government to make sure the weaker performing regions receive the necessary funding.

This is why President Macron and Chancellor Merkel announced they will examine changes to treaties to allow for further Eurozone integration. Even the hardline German finance minister, Wolfgang Schauble, said: “a community cannot exist without the strong vouching for the weaker ones”.

To be sustainable, a monetary union needs large transfers between its regions. London and the South East already put their hands deep into their pockets for the rest of the UK. Gordon Brown did get one thing spectacularly right. He kept us out of the Euro.

As published in City AM Wednesday 31th May 2017

Image: Euro sign by Alex Guibord is licensed under CC by 2.0
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There’s substance to the Trump team’s trade critique of Germany and the Eurozone

There’s substance to the Trump team’s trade critique of Germany and the Eurozone

President Trump’s administration has made many criticisms of Germany. One of the more important was by his top trade advisor, Peter Nabarro. He accused the Germans of using a “grossly undervalued” Euro to “exploit” its trading relationship with America.

The complaint that when the Euro was formed the Deutschmark was too low relative to the other European currencies is a longstanding one within Europe itself.

The Trump administration has raised the stakes. The Euro was described as an “implicit Deutschmark”, whose value is manipulated to be artificially low. This gives Germany, and the rest of the Euro zone, an unfair advantage both in direct trade with the US and in other export markets such as China.

Certainly, the Germans have run a large trade surplus for years.  But this was not always the case. Between 1991, when Germany was re-unified and 1998, their average annual balance of payments deficit was around $20 billion, according to OECD data.

The Euro came into existence on 1 January 1999. Germany took a bit of time to adjust, with their deficit in 1999 and 2000 being just over $30 billion. This fell sharply to $7 billion in 2001. Germany has subsequently run a surplus in every single year. Indeed, since 2010, their average annual balance of payments surplus has been a massive $250 billion.

So the timing of the switch from deficit to surplus lends plausibility to the accusations of the US government.

The balance of payments is calculated in current price terms, reflecting the values of both imports and exports. These in turn are influenced by a wide range of factors, including both domestic costs and exchange rate changes. Another perspective is to strip these out, and look at changes in the volumes of exports and imports rather than their values. The difference between the volumes makes up part of the calculation of GDP, the total output of an economy.

The recession caused by the financial crisis had bottomed out in many economies by the middle of 2009. Output stopped falling, and began a tentative rise.

Since then, the pattern of recovery in terms of the component parts of GDP has been quite different in the Euro zone to both the US and the UK. The increase in the net trade balance in volume terms has been by far the biggest single contributor to the rise in output in the Euro zone as a whole. Just over 40 per cent of the total increase in GDP is accounted for by exports rising faster than imports.

GDP has grown by a lot more in the US and the UK, up 17 and 16 per cent respectively since mid-2009 than the 8 per cent increase in the Euro zone. But in both the Anglo Saxon countries, imports have risen more than exports. Their recoveries have been driven by the domestic private sector, by personal consumption and by strong increases in investment by companies.

From both these perspectives, there is substance in the attacks which Trump has made on Germany and the Euro zone.

As published in City AM Wednesday 22th March 2017
Image: Shipping VW Cars by Jordi Bernabeu Farrús is licensed under CC by 2.0
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A tale of two Eurozones: Greater Germany and Club Med are drifting ever further apart

A tale of two Eurozones: Greater Germany and Club Med are drifting ever further apart

At the end of last week Federica Mogherini met leading members of the Trump administration.

Mogherini, yet another Italian politician turned Euro-bureaucrat, is in fact the foreign policy chief of the European Union. She stood on her dignity, or rather the dignity of the European Commission, issuing a warning to America not to interfere with politics in Europe.

We might reasonably wonder what American armed forces have been doing for the past 70 years, effectively providing the defence of Continental Europe and so sparing local politicians the need to raise taxes to pay for it themselves. But this free riding by Europe is apparently an acceptable form of interference. On anything else, America has to be “warned”.

Mogherini went on to surpass herself, claiming that “the strength of the EU and the unity of the EU I believe is more evident today than it was”. Certainly, this “strength” and “unity” are on full display in the latest instalment of the Greek debt crisis. Output in Greece is over 20 per cent lower than it was in 2007, 10 years ago. And the Germans are showing the greatest reluctance to put their hands in their pockets yet again to bail out the Greeks.

More generally, the data on output – GDP – reveal an absolutely fundamental split between the economies of the EU. What we can think of as Greater Germany has performed far better since the financial crisis than the Club Med.

In the former group, to Germany itself we can plausibly add economies such as Austria, Poland, the Czech Republic, the Netherlands and Belgium. The Club Med is represented by France, Spain, Portugal, Italy and Greece.

To put it starkly, Greater Germany has recovered since the financial crisis and Club Med has not. In every individual year since 2009, Greater Germany has grown faster than Club Med.

Output in the former is just over 14 per cent higher than it was in 2009, the year of deep recession with output shrinking almost everywhere in the Western economies. In the latter, it has also risen, but only by 2 per cent. And growth of 2 per cent was typical for just a single year in the decades prior to the crisis.

In 2009, the two blocs were of very similar overall size. Total output in each was around €5 trillion, with the Club Med group being slightly the larger of the two. Stripping out inflation, output in Greater Germany is now around €700bn higher than it was in 2009, and Club Med has registered an increase of only €100bn. Even removing Greece from the latter makes little difference, given that the Greek economy makes up less than 5 per cent of the Club Med group as a whole.

A massive gap has opened up between two groups of economies within the EU in the space of less than a decade. One has grown almost as much as the dynamic UK. The other languishes with growth close to zero. Strength? Unity? It’s just the way Mrs Mogherini tells them!

Image: European and Greek flags by Reithose is licensed under CC by 2.0
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Why the economics profession remains blind to the benefits of Brexit

Why the economics profession remains blind to the benefits of Brexit

The office for National Statistics last week estimated that the UK economy grew at an annual rate of 2.4 per cent in the final quarter of last year. This is slightly above the long-term average growth of the past three decades.

But a Financial Times survey this month showed that the majority of economists remain just as pessimistic about Brexit’s likely effect on Britain’s economic prospects as they were a year ago.

Most have not changed their minds. But of those who have, the more pessimistic outweigh the more optimistic by three to one. Almost incredibly, economists do not generally feel they were proven wrong by events following the vote.

How can this be? Why is the economics profession so overwhelmingly opposed to Brexit?

The reasons rest on two important underpinnings of the discipline. First is a belief in the benefits to society of free trade. There is substantial empirical evidence which backs up economists’ views on this matter.

The majority opinion among economists, however, is that the UK leaving the EU will necessarily lead to our trade becoming less free. This is a judgement about political economy, on which standard economic theory is silent. Simply put, they agree with Remainers that we cannot negotiate better trade deals on our own than we can from within the European Union.

As the referendum showed, this is a contested issue. The Cambridge economist Bob Rowthorn has pointed out that “there has already been a sharp fall in the size of the Euro-area economy as a proportion of the world economy, and it is hard to see how this trend will not continue”. The deals we need are with fast-growing countries like India and China, and with enormous and innovative markets like the United States. Whether we can get a better deal in or out of the EU is a matter of judgement, not theory.

But the more important reason is that economic theory is in essence about equilibrium. It is about how best to allocate a fixed amount of resources in a static world. Economics has relatively little to say about dynamic processes, about change, about disruption, evolution, innovation, about behaviour out of equilibrium.

This emphasis on a static world leaves many economists unable to see the serious failings of the EU, both actual and potential. In the 1970s and into the 1980s, before the impact of the Thatcher reforms had been felt, it was indeed sensible to look to Europe for inspiration. The UK was plagued by high inflation and low growth.

But now we have had nearly two decades of the euro, one of the most efficient job destruction machines ever created. The combined impact of the euro and their own internal corruption has led output in Italy, Portugal, Spain and Greece to be much lower now than it was 10 years ago. This is a recession without parallel in economic history in its length and severity.

The ability to innovate is the key to long-term growth, as America has shown with Microsoft, Google, Facebook and others. Economic theory has very little to say about innovation. And this blinds the economics profession to the failings of the EU.

As published in CITY AM on Wednesday 1st February 2016

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The NHS will never have enough cash: the English religion needs reformation

The NHS will never have enough cash: the English religion needs reformation

We British like traditions. A well-established one which comes round every year is the “winter crisis” in the NHS. Health provision is a political hot potato not just for this government, or indeed for any particular UK government, but for governments across the developed world.

One of the key assumptions made by economists about human behaviour is that there is no limit to the amount of things that people want. In the splendid jargon of economic theory, this is referred to as “non-satiation”.

But regardless of what name we give to the concept, health is an excellent practical example of it. When the NHS was founded in the late 1940s, many thought that the demands on its services would dwindle over time. As the new system gradually improved the health of the population, fewer would require the NHS.

 On the contrary, the demand for health provision has expanded across the West much faster than the overall economy has grown. As people get wealthier, they want more and more healthcare.

Nigel – now Lord – Lawson once pronounced that “the NHS is the closest thing the English people have now to a religion”. Certainly, any politician tampering with it too much risks his or her career. A striking illustration was provided in the General Election of 2001. The Labour government proposed closing the hospital in Kidderminster on the grounds that it was just very bad. This provoked fury, and a local doctor stood and won as an Independent, destroying the incumbent Labour rising star and holding on until 2010. A subsequent independent inquiry carried out for the NHS showed unequivocally that the hospital was even worse than had been initially thought.

An Institute of Economic Affairs monograph by Dr Kristian Niemietz shows how things could be run much better. The intriguing title summarises the contents: “Universal Healthcare without the NHS”. Niemietz begins with a simple point to debunk the popular view that the NHS is the envy of the world: its structure has never been copied anywhere outside the UK.

In fact, in international comparisons of health system outcomes, the NHS almost always ranks in the bottom third of developed world countries, sitting with places such as the Czech Republic and Slovenia. If the UK’s breast, prostate, lung and bowel cancer patients were treated as in Germany, 12,000 lives a year would be saved.

Most European countries use a social health insurance (SHI) system, in which even homeless people have health coverage. Essentially, these systems are based upon means-tested insurance. Niemietz regards each individual one as having its own particular flaws and irritations, but they routinely achieve much better outcomes for patients, while preserving the concept of universal access.

Their experience shows that, for example, charging for GP appointments does not damage health, and that ordinary people can be trusted to make sensible choices from a range of health insurance plans. The alternative to the NHS is not American, but European health care.

We are, quite rightly, steaming ahead with Brexit, but Europe still has valuable things to teach us in the case of health provision.

As published by CITY AM on Wednesday 25th January

Image: Accident & Emergency Sign by Lydia is licensed under CC by 2.0

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Why Britain and the US are streets ahead of Europe in innovation

Why Britain and the US are streets ahead of Europe in innovation

The proposed takeover of the hugely successful ARM Holdings by the Japanese giant SoftBank is in the news. Cambridge-based ARM is well placed to exploit the white hot concept of the internet of things, highlighting the UK’s recent advances in this field.

The UK has also performed well in biotechnology. But the industry came under scrutiny last week at a Centre for the Study of Financial Innovation seminar. Geoffrey Owen, former editor of the Financial Times, and Sussex academic Michael Hopkins introduced their new book Science, the State and the City.

On a world scale, the UK is second only to the United States in biotech, outstripping everyone else in key performance indicators for the industry. Owen and Hopkins’s book, however, is prompted by the fact that we are a very long way behind the leader. For example, US scientists have 45 per cent of all the citations in life sciences in academic journals, while we have just 15 per cent. The UK government spends roughly double the amount on health research and development of our European neighbours, but America spends at least 10 times as much as we do.

Our distant second places, in these and other areas which determine the success of a high technology industry, feedback on each other and cumulate. As a result, the market capitalisation of US biotech firms is more than 20 times as big as those of the UK.

Why has this happened? After all, what is possibly the greatest scientific discovery of the twentieth century which made all this possible, that of the double helix structure of DNA, was by the British scientists Crick and Watson.

Owen and Hopkins carefully dismantle the myth that it is the short-term outlook of the City which is responsible. This is often compared unfavourably to the long-termist approach of Germany and Japan. But it is the allegedly short-term Anglo-Saxon economies which are by far the best performers in biotech, an industry in which the time period from scientific discovery to marketable product is at least 10 and often as much as 15 years.

They do note, however, that British academics appear more interested in publishing academic papers and securing yet more research grants than in the process of commercialisation. There is a steady flow of entrepreneurial scientists who found biotech companies, but it is very much a minority taste in the UK compared to America.

The US industry clusters, with firms concentrated in San Francisco and Boston. So does the British, mainly near Cambridge. But attempts by European governments to develop clusters in a top down, dirigiste way have not worked. Owen and Hopkins argue that American success is based on a bottom up, evolutionary process, in which a successful ecosystem emerges rather than being designed.

Entrepreneurial academics, teaching hospitals, and venture capital spontaneously collaborated for mutual benefit. The US government also helped, with its massive funding for research and regulatory changes which boosted the industry.

The lesson is a general one for development. The public sector can facilitate but not command success. That arises from the drive of individuals with proper incentives.

Paul Ormerod

As published in CITY AM on wednesday 27th July 2016

Image: DNA representation by Andy Leppard is licensed under CC BY 2.0

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