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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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It is the private sector, not the state, that has enabled America’s economic recovery

It is the private sector, not the state, that has enabled America’s economic recovery

The American economy continues to power ahead. The widely respected and independent Congressional Budget Office (CBO) reckons that the actual level of GDP in the US in 2017 is finally back at the level of potential output.

The potential level of GDP is the amount of output which would be produced if there were no spare capacity in the economy. In a service and internet-oriented economy, any estimates of it are fraught with difficulties.

The maximum output of a car plant or steel mill is reasonably straightforward to work out, at least in the short term. But it is less obvious what the constraints are on any web-related business.

Still, the concept of potential output is taken seriously by policy-makers. And the CBO does a better job than most at guessing what it is.

On their figures, the last time actual and potential GDP were in balance was in the year immediately prior to the crisis, 2007, which at least makes sense.

In 2009, the depth of the recession, the CBO calculates the gap between the two to be six per cent. That may not sound a lot, but in money terms that represents more than one trillion dollars.

American GDP is now almost 15 per cent more than it was in 2007, and 20 per cent more than in 2009.

Along with this, employment has surged, with 17.2m net new jobs being created from the low point of December 2009. As in the UK, employment is at record highs.

The increase in employment is entirely due to the private sector, where it has grown by 17.3m.

In contrast, the numbers employed by the government, whether federal or state, have been cut by 100,000.

The same applies on the output side. Again, it is the private sector which is driving the recovery.

Compared to the bottom of the recession in 2009, and after stripping out inflation, public sector spending is down by $200bn.

In contrast, private sector investment has risen more than 10 times this amount – an increase of $2.1 trillion.

So, despite strict restraints on the public sector, the American economy has recovered well from the crisis – indeed, better than the best performing main European economies, Germany and the UK.

The evidence has been there all along, as soon as the US began to pull out of the recession in the early part of this decade. It is evidence which seems to be studiously ignored by the strident voices in British academic circles calling for an end to “austerity”.

Of course, there have been tax cuts, and these stimulate the private sector. But the risk over the longer term is that growth will not be rapid enough to bring in enough revenue to curb the growth in public sector debt.

Indeed, the CBO sees the potential rise in this debt as an important threat to the long-term growth of America. Higher public borrowing, in its view, reduces the private sector investment which is needed for growth.

As published in City AM Wednesday 6th December 2017

Image: New York via Pixabay is licensed under CC by 0.0
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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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There’s a difference between priceless and worthless, but economics can’t measure it

There’s a difference between priceless and worthless, but economics can’t measure it

The so-called “productivity puzzle” just does not go away.

The October, employment figures released by the Office for National Statistics (ONS) brings it into focus.

The number of people in work rose to a new record high of 32.1m, with an increase of around one per cent compared to a year ago.

Total output, measured by GDP, continues to rise, but modestly. We do not yet have official estimates for the year to October, but GDP seems to be up by some 1.5 per cent.

Productivity is defined as output per worker, so it is only around 0.5 per cent higher than a year ago. No scientific consensus has yet emerged to explain why productivity growth continues to be so low.

But there is increasing evidence that the rate of growth of output is being systematically underestimated.

The economy cannot be put in a set of scales and measured. Its size has to be estimated, and the ONS uses a wide variety of methods to do this.

The fundamental problem is that the foundations for estimating GDP were built in the 1930s and 1940s, when the economy was dominated far more by manufacturing. Measuring how many things have been produced is inherently easier than measuring services.

The ONS does not stand still, and tries to take account of the massive changes in the economy which have taken place. But the rise of the internet economy brings entirely new problems to solve.

A key one is what the futurologist Alvin Toffler many years ago called the “prosumer” sector.

Traditionally, products are developed and sold by companies, and consumed by, well, consumers.

In the prosumer sector, consumers themselves participate in the production and development of products and services.

A good example is the statistical package R. This is open source, and freely and readily downloadable by anyone.

In recent years, R has become the package of choice for young scientists in a wide range of disciplines around the world. They both use it, and contribute to its development by uploading their own algorithms.

A huge range of routines can be downloaded. Its graphics features are amazing. Software is appearing on it that has the potential to take on commercial giants such as Word and Powerpoint.

It has become a very valuable tool for scientific research, using the word “valuable” in its every day sense of the word. But it is run by a small not-for-profit foundation, so in ONS terms its value is close to zero.

The problem is that R is what economic theory describes as a “public good”.

This jargon phrase applies to anything where anyone can consume it, and where the supply never runs out. No matter how many people use R, it is always available for the next person.

For most goods and services, this is just not true. When I put my swimming towel on the pool lounger, it is no longer available to you.

The prosumer sector creates a lot of output. But economics has not yet solved the question of how to value public goods.

As published in City AM Wednesday 8th November 2017

Image: Vintage Scales by Public Domain Pictures is licensed under CC by 0.0
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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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