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Government debt addiction means you can be sure of one thing: Stealth taxes will rise

Government debt addiction means you can be sure of one thing: Stealth taxes will rise

Elections create uncertainty. But we can be sure of one thing. Regardless of the result, during the course of the next Parliament, stealth taxes will rise. This week, we have a sharp rise in speeding fines. Even doing between 31 and 40mph in a 30mph zone can now land you with a penalty of 50 per cent of your weekly income.

Governments across the West are running out of ways to pay for the spending levels which the electorates appear to demand.

A key way in which public spending has been financed over the past 40 years has been through debt. Almost everywhere, the level of public sector debt relative to GDP has risen sharply.

A few years ago, the International Monetary Fund (IMF) published long runs of historical data on the public debt to GDP ratio for countries across the globe. The Bank of International Settlements (BIS) updates the ratio regularly.

In 1977, gross public debt in the United States was 39 per cent of GDP. In 2016, it was 98 per cent. Over the same period, the UK, using the IMF and BIS definitions, the rise was from 49 to 115 per cent of GDP. In France, the ratio went up from 15 to 115 per cent. Even in debt-wary Germany, there was an increase from 27 per cent in 1977, to 78 per cent in 2016.

There are different ways of defining public debt, and no two measures are the same. But regardless of how we put the figures together, the conclusion is clear.

Public sector debt has risen massively. The simple fact is that most governments in most years now routinely spend more than they dare raise in taxes. The resulting deficit has to be financed by issuing debt. But the limits are now being reached, a lesson the Greeks have learned so harshly in recent years.

Over the course of history, public sector debt, relative to the size of the economy, has been at much higher levels than it is now, with no apparent serious consequences. In 1946, for example, UK public debt was 270 per cent of GDP.

But in the past, governments with high debt levels typically did one of two things. They either defaulted, or they tried to pay it off. The left wing Labour government of Clement Attlee ran huge budget surpluses in the late 1940s, peaking at around £100bn a year in today’s terms.

Most debt used to be incurred as a result of war. In 1861, US public debt was less than 2 per cent of GDP. The Civil War bumped this up to 30 per cent. In the late 1810s, as a result of the Napoleonic Wars, the first truly global conflict, British debt was 260 per cent of GDP. It took decades to get it down to sustainable levels, but governments did succeed and pay it off.

In stark contrast, debt has been built up in the late twentieth and early twenty-first century to finance the services provided to voters. It is simply unsustainable.

As published in City AM Wednesday 26th April 2017

Image: Speed Trap by Peter Holmes is licensed under CC by 2.0
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Brexit was the final straw: it’s time to scrap the IMF

Brexit was the final straw: it’s time to scrap the IMF

Sports fans will all be familiar with the commentator who almost always gets things wrong. “Arsenal are very much on top here” he – it is invariably a “he” – will pronounce, or “Root is looking very settled”, only for the opposition to score a goal immediately and for the Yorkshireman to be clean bowled. In economics, a similar role is played by the International Monetary Fund (IMF).

In the middle of July, Remain fanatics had a field day. “The IMF has slashed its forecasts for the UK economy for next year after Brexit”, crowed the Financial Times. Maurice Obstfeld, the Fund’s chief economist, claimed that Brexit “has thrown a spanner in the works”. Global growth projections for 2017 were cut back, but most of all for the UK.

But on the first day of September, the IMF was forced to admit that growth in Britain had, in a splendidly bureaucratic phrase, “surprised on the upside”. On the same day came the news that manufacturing activity in August had posted its biggest monthly rise in 25 years. On Monday this week, the Markit purchasing managers’ index for the service sector registered the biggest monthly increase in its 20 year history.

The IMF has real form. In 1998, East Asia was experiencing a major economic crisis. Yet in May 1997, the IMF was predicting a continuation of very strong growth in most countries for the year ahead: 7 per cent for Thailand, 8 per cent for Indonesia and 8 per cent for Malaysia. They revised the projections down by December, but even these proved wildly optimistic, as the economies collapsed during 1998, registering a fall in output of over 15 per cent in Indonesia, for example, worse than America in the Great Depression of the 1930s.

Macroeconomics is the study of variables such as GDP which describe the economy at the aggregate level. Since the 1980s, it has been dominated by the concept of equilibrium. Highly mathematical models have been developed, resting on the premise that the economy can correct itself and absorb any shocks. Olivier Blanchard, the IMF’s previous chief economist, was a great enthusiast for this project. In August 2008, he published a paper which concluded with the claim “the state of macroeconomics is good”. Three weeks later, Lehman Brothers collapsed.

Apart from the European Commission itself, the IMF has been probably the biggest cheerleader for the euro. Since the inception of the single currency in 1999, a whole series of statements and technical articles from the IMF has eulogised its mystical benefits. At the end of July this year, the IMF’s own Independent Evaluation Office (IEO) was totally scathing of the Fund’s record on this. The top staff became impervious to other points of view and ignored warning signs of the financial crisis. In their view of the world, it simply could not happen.

The IMF exercises enormous influence and power. Yet its persistent ineptness makes England football managers look like world beaters. To add insult to injury, its staff enjoy tax free salaries. It’s time to close the Fund down and go back to the drawing board.

As published in CITY AM on Wednesday 7th September 2016

Image: Valsts kanceleja/ State Chancellery is licensed under CC BY 2.0

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The coming explosion in natural debt is a serious risk to the economy

The coming explosion in natural debt is a serious risk to the economy

Martin Feldstein of Harvard is an economist who should always be taken seriously. Writing in 1997 about the forthcoming introduction of the euro, for example, he argued that “the adverse economic effects of a single currency on unemployment would outweigh any potential gains from trade flows”. He went on to predict that the euro was likely to lead to increased conflicts within Europe. Looking at the current state of the continent, his forecasts appear spot on.

In the latest issue of the American Economic Review, he reminds us of the crucial importance of reducing government deficits. The Brexit referendum has essentially frozen David Cameron’s government from taking almost any action at all. But despite a convincing General Election victory, the drive to cut the deficit was already slowing down. In particular, the government appears to have lost its nerve in terms of cutting public expenditure. At the slightest sign of protest or opposition, it backs down.

Feldstein’s paper on the American experience should spur Cameron to think again. Feldstein begins with an optimistic view of the US economy. Since the 1970s, the unemployment rate has only briefly dipped below 5 per cent, its current level, so America effectively is back at full employment. Inflation remains low, despite employment rising by 14m since 2010. Economic growth is limited by the absence of excess capacity rather than by demand.

In the longer term, the most serious risk to the American economy, Feldstein believes, is the explosive growth of national debt as a percentage of GDP which will happen unless there are serious measures taken to cut spending. The public sector deficit is the difference between income from taxation and public spending in any given year, and a deficit adds to the stock of debt which is outstanding.

Feldstein points out that the debt to GDP ratio has risen from less than 40 per cent 10 years ago to 75 per cent now. The comparable numbers in the UK are from 35 to 85 per cent. He suggests that a very effective way of controlling future increases is to raise the retirement age even more. He has a neat suggestion to counter legitimate worries that life expectancy has gone up more for the better off than it has for the poor. Just link the retirement age to lifetime earnings. The lower they are, the earlier you can give up work.

The shape of the recovery in the United States suggests that there is little to fear from following Feldstein’s arguments and really getting to grips with public expenditure. The trough of the recession was in 2009. By 2015, GDP in real terms had increased by 13.3 per cent. Despite scare stories that growth has been driven by unsustainable consumer spending, this rose at a virtually identical rate, by 13.9 per cent. Corporate investment, in contrast, has shot up by 51 per cent. And current public spending has fallen by 7.5 per cent.

Despite siren voices such as those of junior doctors, the UK government should keep its nerve too. The American experience shows that cutting public spending can expand the economy.

As published in City AM on Wednesday 1st June 2016

Image: National Debt Clock by Nick Webb licensed under CC BY 2.0

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No more whingeing, please. The recovery is solid.

No more whingeing, please.  The recovery is solid.

Last month saw some very positive economic news. The US Federal Reserve raised interest rates for the first time in over seven years.  The Bank of England reported on the major stress test of UK banks which it launched in March 2015.  It concluded that “the banking system is capitalised to support the real economy in a severe global stress scenario”.

Yet much of the discussion on the economy remains tinged with various hues of gloom.  We expect John McDonnell, the Shadow Chancellor, to be living in the past.  So it is not surprising that he has launched a “fight against austerity” with Yanis Varoufakis, the former Greek finance minister.  But many commentators seem to find it hard to believe that the recession in the UK is well and truly over.

Some argue that the recovery has taken place, but that it is somehow “unbalanced”.   True, manufacturing is struggling, with highly publicised plant closures in what have become effectively commodity industries, like steel.  But the data from the Office for National Statistics suggests a virtually textbook example of a sustainable recovery.

The depth of the crisis was reached in the spring and summer of 2009, and we now have the initial estimates for the economy for the same period in 2015.  GDP as a whole increased by £100 billion, after allowing for inflation, a rise of nearly 13 per cent.  Companies spent an additional £32 billion on new investment in 2015 compare to the same period six years ago.  In percentage terms, this was by far the fastest growing sector of the economy, up by 26 per cent.   In contrast, consumer spending grew by only 10 per cent, less than the economy as a whole.  It has been an investment-led recovery, with the role of public spending being negligible.

From a historical perspective, the recovery profile is better than it was in the 1930s, the previous time there was a major financial crisis on a world scale.  The economic historian Angus Maddison devoted his life to constructing the annual national accounts of the developed economies going back to the late 19th century, and his work has widespread academic credibility.  Peak output prior to the Great Depression was in 1929.  In his sample of countries, only just over a half had regained this level by 1937.   This time round, taking the same group of economies, 80 per cent of them had a higher GDP than in 2007.

The only area which really continues to struggle is the Mediterranean economies in the EU.  In Spain, output is 4 per cent lower than in 2007, in Portugal it is 6 per cent down, in Italy 9 per cent and Greece has seen a drop of no less than 26 per cent.  The crisis exposed deep structural problems with these economies.

In contrast, GDP in the G20 economies has risen by 24 per cent since 2007, the last year before the recession began.  And they account around 85 per cent of world output.  The economic discourse has become disconnected from reality.

As published in CITY AM on Wednesday 6th January

Image:Yanis Varoufakis by Marc Lozano licensed under CC BY 2.0

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It is not just the Euro. Southern Europe faces a major structural crisis

It is not just the Euro.  Southern Europe faces a major structural crisis

Major shocks to social and economic systems ruthlessly expose weaknesses which can be contained in more normal times.  When the price of oil quadrupled in 1973/74, the different levels of resilience in the labour markets of Western Europe were quickly revealed.  Inflation initially rose sharply everywhere.  By 1976, it had fallen to 4 per cent in Germany, but was still 14 per cent in the UK.  German workers realised that the oil price rise was out of the control of their own government.  Demanding bigger money wage increases would be self defeating.  It took the deep recession of the early 1980s, when unemployment rose to 3 million, and the defeat of the miners to bring British inflation back under control.

In the same way, the financial crisis of 2007 to 2009 uncovered deep structural faults in most of the economies of Southern Europe.   The recovery in the UK took a long time to get hold, and it was only really in 2013 that we began to get over the shock.  But GDP here is now 6 per cent higher than it was at the start of 2008, when output began to contract.  In contrast, in Spain GDP is now 5 per cent lower than it was nearly eight years ago, and Portuguese output is 6 per cent lower. In Italy, the fall in GDP is as much as 9 per cent.  So between 2008 and 2015, a dramatic gap of 15 per cent has opened up between the levels of GDP in the UK and Italy.

Membership of the Euro does not help.  But there are much more fundamental issues.  A fascinating paper by Gianluigi Pelloni and Marco Savioli in the latest issue of the Economic Affairs journal focuses on why Italy is doing so badly.  A crucial reason is that Italy has a high level of corruption.  Transparency International ranks the countries of the world on this measure.  The least corrupt is Denmark.  Germany and the UK come into the charts at 12 and 14 respectively.  Italy is at number 69, along with Greece, Romania and Senegal.

Italy has suffered from a lack of restructuring of production.  The products in which Italy specialises are very similar to those of twenty years ago.  And the economy continues to be populated by vast numbers of tiny firms, specialising in commodities with low technological content in both the manufacturing and service sectors.

There are many barriers to both innovation and expansion.  For example, access to credit is difficult and complex, as a 2013 World Bank study highlights.  Start up costs are high.  The average number of years of tertiary education in the population aged over 25 is only half that of France, Germany and the UK, so the workforce is less capable of dealing with technological advances.

Pelloni and Savioli do detect some positive signs in sectors such as chemicals, food and pharmaceuticals.  But mere tinkering will not be enough.  Drastic reforms are needed to deal with the structural weaknesses exposed by the financial crisis.

As published in City Am on Wednesday 25th November

Images: Euro by Images Money licensed under CC BY 2.0

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CEO compensation and Jamaican demands for reparations: two sides of the same coin

CEO compensation and Jamaican demands for reparations: two sides of the same coin

David Cameron’s visit to Jamaica last week led to vociferous demands for the UK to pay the Caribbean island billions of pounds in reparations for slavery.  Most people here reacted with predictable eye-rolls and sighs.  Slavery was abolished throughout the British Empire in 1833, nearly two centuries ago.  Jamaica has been independent since 1962, over fifty years ago.  Surely they have had time to sort themselves out and get a decent economy?

There is much to be said for these arguments.  In the early 1960s, for example, South Korea was essentially a poor, agricultural society, only one step up the ladder from subsistence level incomes.  Now, it has a dynamic, modern economy with living standards similar to those of the West.  Countries such as Singapore have followed similar trajectories.

The demands for payment are a classic example of what economists call “rent seeking” activity.  The word “rent” here does not mean what you pay on your apartment to live in it.  The concept goes all the way back to Adam Smith himself, though the phrase was only coined in the late 20th century.  Rent seeking means trying to increase your share of existing wealth without creating any new wealth.

But we should not feel too much moral superiority over the Jamaicans.  Rent seeking has proliferated in Western society in the last couple of decades.  The US economy has performed well over this period.  Its success is reflected in the amounts paid to CEOs, with the average compensation in the top 350 firms being around $15 million a year.  This enormous sum is some 300 times higher than the amount the companies pay to the typical worker.  In the mid-1970s, the ratio was not 300:1 but only 30:1.  Even in the mid 1990s it was around 100:1.  This later figure would still hand the average CEO some $5 million today, not a bad sum to have.  It is hard to justify these payments in terms of the contribution the individuals are making to creating new wealth.  Some of it, yes, but essentially these pillars of our society have been rent seeking on a grand scale.

Rent seeking by the public sector characterised Gordon Brown’s long period as Chancellor.  Public spending rose dramatically.  But much of the increase did not go to provide better public services.  Instead, it paid for the private consumption of those employed in the public sector.  Some graduates in Hollande’s France flee abroad.  Most of the rest aspire to become a fonctionnaire.  Good pay, virtually unsackable, and with a gold plated pension at the end, it is a much sought after position.  Little wonder that France has essentially registered no economic growth since 2011.  Jeremy Corbyn eulogised the Italians for subsidising a steel plant rather than letting it go under like Redcar.  But rent seeking proliferates in Italy, and their living standards are now back to those of the late 1990s.

Economists disagree about many things, but they are united in their opposition to rent seeking, an unequivocally Bad Thing.

As published in City AM on Wednesday 7th October 2015

Image: “Street in Montigo Bay Jamaica Photo D Ramey Logan” by WPPilot – Own work. Licensed under CC BY-SA 3.0 via Wikimedia Commons.

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