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Cautious corporates sitting on hoards of cash are to blame for our slow recovery

Cautious corporates sitting on hoards of cash are to blame for our slow recovery

The slow recovery since the financial crisis remains a dominant issue in both political and economic debate.

The economy has definitely revived since 2009, the depth of the recession, in both Britain and America. The average annual growth in real GDP has been very similar, at 2.0 and 2.1 per cent respectively. This is much better than in the Mediterranean economies, where growth over the 2009-2016 period is still negative. Even so, the Anglo-Saxon countries have not expanded as rapidly as they have done in previous recoveries.

A key reason for this is the lack of vision being shown by the corporate sector. True, highly innovative companies like Facebook have emerged over the past decade, and start ups continue to proliferate.

But the longer standing major firms in both the UK and the US have become real stick in the muds. Caution, safety first and an increasingly stultifying bureaucracy envelop them.

The contrast in the behaviour of the corporate sector in the two major financial crises of the 1930s and late 2000s makes this clear. The US national accounts only have data going back to 1929, the year before the Great Recession. But in that year, the net savings of non-financial companies was 3.5 per cent of GDP.

When the recession struck, firms ran down their accumulated cash. Between 1930 and 1934, their net savings were negative, averaging -2.4 per cent of GDP. That amounts to a shift during the recession from a surplus of $650 billion in 1929 to an annual overspend of $450 billion in today’s prices.

In the United States, during the decade prior to the crash, 1998-2007, companies on average had net savings of 2.6 per cent of GDP each year. Since 2009, this has averaged 4.0 per cent. So instead of spending their assets, as they did in the 1930s, companies this time round have simply saved more.

To be fair, American firms are gradually moving back towards their savings patterns prior to the crisis. From 5.4 per cent of GDP in 2010, net savings in 2016 were back down to 3.1 per cent. They are gradually getting their confidence back, their “animal spirits” as Keynes called it.

There are signs of this happening in Britain as well. Between 1998 and 2007, net savings by non-financial companies averaged 1.3 per cent of GDP.  From the trough of the recession to now, the annual average has been 2.7 per cent. As in the US, the figure has come down from 2009-2011, when it averaged 3.8 per cent. But firms remain cautious.

But in both the UK and the US, companies are sitting on piles of cash and lack the entrepreneurial spirit to spend it. Boards obsess about fashionable concepts such as lean and agile processes and management. At the same time they set up procurement systems more suited to the old Soviet Union in terms of the tick box mentality which prevails.

Capitalism must be seen to be delivering the goods, and many of our major companies are simply not doing this.

As published in City AM Wednesday 12th July 2017

Image: London Construction by Bonny Jodwin is licensed under CC by 2.0
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Don’t believe the myths: Capitalism has performed well since the financial crisis

Don’t believe the myths: Capitalism has performed well since the financial crisis

Ten years ago, the financial crisis began to grip the Western economies. During the course of 2007, GDP growth slowed markedly everywhere. By the end of 2008, output was in free fall.

A key theme in economic commentary is the sluggishness of the subsequent recovery of the developed economies.

The picture is not quite as bad as it is usually painted. True, last week the Office for National Statistics announced a dip in UK growth in the first quarter of this year. But from 2009, the trough of the recession, to 2016, GDP growth averaged 2.0 per cent a year.  Not exactly a stellar performance. But from 1973, the year prior to the major oil price shock, to 2007, the British economy expanded by just 2.3 per cent a year on average. The contrast between the two periods in the US is slightly greater. From 1973 to 2007, growth averaged 3.0 per cent a year, and since 2009 it has been 2.1 per cent.

There is a very stark contrast with the experience of the 1930s, the last time there was a global financial crisis. This time is different, things have only got better. The recovery may be slower than desirable, but it has been much more widespread than in the years following the Great Depression of the 1930s.

A decisive indicator is the length of time it took not just for growth to resume, but for the previous peak level of GDP to be regained.  So in the UK, for example, the economy started to grow again in 2010. But it was not until 2013 that there had been enough growth for the economy to get back to its 2007 size.

Looking at a group of 18 developed economies, which includes all the main and medium sized ones, GDP had regained its previous peak within 3 years in no fewer than 8 of them. By 2016, everyone in the group except Finland, Italy and Spain had a GDP which exceeded its previous peak.

Three years after output began to fall in 1930, not a single economy had managed to regain its 1929 level of output. Even by 1938, output was below its 1929 level in Austria, Canada, France, the Netherlands, Switzerland and Spain.

Perhaps Keynes’ most powerful insight was why the slump was so prolonged. He developed the concept of “animal spirits”, which are not a mathematically based prediction of the future, but the sentiment of the narratives which companies form about the future. He wrote: “the essence of the situation is to be found in the collapse of animal spirits…. this may be so complete that no practicable reduction in the rate of interest will be enough.”

Zero interest rates and low growth! Keynes got there before us.

Still, capitalism has performed much better in the aftermath of the financial crisis of the late 2000s than it did in the crisis of the early 1930s. Animal spirits may not be buoyant, but they are in much better shape than in the 1930s.

As published in City AM Wednesday 2nd May 2017

Image: Day 20 Occupy Wall Street by David Shankbone is licensed under CC by 2.0
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The OBR shouldn’t be expected to forecast so far into the future

The OBR shouldn’t be expected to forecast so far into the future

Economic forecasts have become a political hot potato. The Office for Budget Responsibility’s (OBR) predictions, presented as part of the chancellor’s Autumn Statement, have put the government under pressure. The OBR has revised down its forecast for GDP growth over the next four years by 1.4 percentage points.

The real controversy is that their gloomy projections for GDP and government finances have been put down to Brexit. In the simple phrase of the OBR: “Any likely Brexit outcome would lead to lower potential output”. Lower output leads to lower tax receipts, and worse government finances.

To be fair, the OBR does say that “in current circumstances the uncertainty around the forecasts is even greater than it would be in normal times”. But just how great is this uncertainty?

Studies are published from time to time about the accuracy of economic forecasts. The best set of records is kept in America, though less systematic evidence for the UK shows that the track records are very similar in the two countries.

The Survey of Professional Forecasters (SPF) collects the forecasts on variables such as GDP growth and inflation from a wide range of forecasters. Its database goes back almost 50 years to 1968. Just one quarter ahead, the predictions are on average completely accurate. “One quarter ahead” means the next three months, so it would currently refer to the period January to March 2017.

This average accuracy conceals errors in most forecasts for any particular quarter, the errors cancel out over time. For example, the quarter from July to September 2008 marked the onset of the major recession of the financial crisis. At an annual rate, GDP fell by 1.9 per cent compared to the previous quarter. But the SPF predictions made in the April to June period for July to September were for growth of 0.7 per cent.

The SPF predictions account for only 25 per cent of the variability around the average. When we go four quarters ahead – just one year – the predictions are even worse. Negative growth, for example, has never been predicted, even though there have been 26 quarters of negative growth since 1968.

The track record, which has not got any better over time, shows that in relatively calm times, forecasts just one year ahead have a reasonable degree of accuracy. But when major changes are taking place, just when they are really needed, they have none.

The OBR cannot be blamed for producing predictions four years ahead when the track record of the forecasting community shows them to be of no value. That is what George Osborne mandated it to do when he set the independent body up in 2010. But four years ahead, almost any set of predictions is just as good – or bad – as another.

It would be much better to abolish the OBR and restore responsibility to the Treasury and, ultimately, to the politicians. If they get it wrong and are too optimistic, we can at least kick them out.

Paul Ormerod 

As published in City AM on Wednesday 30th November 

Image: Psychic by clairewinterphotography is licensed under CC by 2.0 

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The only way could be down for shares – and Brexit is just the catalyst

The only way could be down for shares – and Brexit is just the catalyst

The Brexit vote creates many uncertainties, exciting or frightening depending on your predilection. One thing which is certain is that the Leave victory was delivered by the less-skilled sections of the electorate.

It seems part of a more general stirring up of what we might think of as the dispossessed, those who feel left behind by globalisation. In France the Front National, in the Netherlands Geert Wilders’s Party for Freedom, in Germany Alternative fur Deutschland – throughout Europe, in fact, these discontents receive an increasingly sympathetic hearing.

Equity markets have been very volatile and nervous in the face of the uncertainties which Brexit creates. But there may be a good reason for this from a longer-term perspective.

Compared to 30 years ago, stock prices both in Europe and the US are at much higher levels. A key reason underpinning this is the shift from wages to profits as a proportion of national income which has taken place. The share of wages in national income has fallen, and that of profits has risen. Profits have grown faster than the economy as a whole, and so the potential future dividend stream from shares has gone up. As a result, shares have become more valuable.

Measuring the share of wages in national income is not as straightforward as it might seem. Should it, for example, include self-employed income or the remuneration of chief executives? In February 2015, the OECD, along with the International Labour Organisation, published a detailed study of trends in the G20 economies since the early 1990s. No matter which measure was used, the data show that the wage share declined significantly in almost every member state of the G20, and nowhere was there a significant trend increase.

The changes themselves may appear small. On one measure, for example, the wage share fell from an average of 69 per cent of national income in 1990 to 65 per cent now. But in terms of, say, the UK economy, four percentage points represents nearly £80bn.

More recently, there has been a levelling off in the downward trend. The distribution of income between wages and profits has been stabilising. Does Brexit signify a tipping point, when the trends of the last few decades might start to be reversed?

The economic orthodoxy, not just in theory but in practice, has been one of open borders for both labour and capital. Both must be allowed to flow freely. But there is an increasing groundswell of public opinion against this. Donald Trump, for example, supports a 20 per cent tax on all imported goods to protect American jobs. Bernie Sanders has opposed every free trade deal which the United States has negotiated, and vowed to “take on corporations which take their jobs to China”.

It is much easier to protect wages in a world of tariff barriers and restrictions on capital movements. Boris Johnson sees Britain as a global entrepreneur, but most Brexit supporters do not. Brexit would not be the cause of a long-term downward revision to share prices, but more a symbol of why it’s happening.

As Published in CITY on Wednesday 29th June 2016

Image: The British Question by Andrew Gustar is licensed under CC BY 2.0

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Is Britain on the edge of recession? History is an unreliable guide

Is Britain on the edge of recession? History is an unreliable guide

Concerns are growing about a marked slowdown in the UK economy. The Lloyds Bank purchasing managers’ index, for example, fell to 52.1 in April, its lowest point since 2013. The initial estimate for GDP, total output, in the first quarter of this year shows an increase of just 0.4 per cent on the final quarter of 2015.

Growth since the start of 2015 has been only 2.1 per cent, a rate which is a rough benchmark as to whether employment rises or falls. Indeed, in February, the latest month for which we have data, the Labour Force Survey showed that the total number of jobs in the UK was unchanged since December.

On the positive side, the economy has definitely grown since the recession, with output being up by 7.3 per cent on its previous peak value just before the recession in the first quarter of 2008. And these are the official estimates, which may not be able to cope with measuring accurately activity in the new cyber economy.

But economic slowdowns and recessions do happen. Indeed, they are a fact of life. The upsurge in inflation in the 1970s, when it reached 25 per cent, captured the mind-sets of policy-makers and prevented them from realising that low inflation, which we have now had for over 20 years, is normal. In the same way, the long period of continuous expansion during the 1990s and 2000s distorted expectations about what is normal. This period, which economists dub the Great Moderation, during which Gordon Brown claimed he had abolished boom and bust, makes people think, incorrectly, that recessions are very unusual.

We have quarterly GDP data in the UK going back to 1955. Economists have a fairly arbitrary definition of a recession as being at least two successive quarters of negative growth. Since 1955, we have had eight such periods. So, on average, we have a recession once every seven or eight years. We had one in 2008-09, and we might think that, on the law of averages, one is due now.

Things are not so simple. Economists write about the “business cycle”, as though the fluctuations in economic growth were regular. But this is a piece of jargon. The Nobel Laureate Robert Lucas pointed out 40 years ago that the key feature about economic ups and downs is that most sectors of the economy tend to move together, so we can presume there are general factors driving the economy. Specific factors will influence specific industries, but these do not cause the economy as a whole to boom or shrink.

The gaps between recessions are in fact pretty irregular. For example, there was one in 1956 and another in 1957. The recession of 1973 was followed quickly by the one in 1975. In contrast, there was a gap of 17 years between the 1990-91 contraction and the financial crisis.

Decision-makers do not like uncertainty, and Brexit is certainly creating this. Capital spending by companies stopped growing in the late summer of 2015. So it might all bounce back after 23 June.

Paul Ormerod

As Published in City AM on Wednesday 12th May 2016

Image: Pound Coin by Andrew Writer licensed under CC by 2.0

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Integration won’t save the struggling Eurozone

Integration won’t save the struggling Eurozone

Olivier Blanchard, the recently retired Head of Economics at the International Monetary Fund, has something of a track record with his predictions.  In 2013, he warned George Osborne that he was “playing with fire” with the UK’s recovery from the financial crisis.  Austerity had to be relaxed. We now know that we were actually nowhere near a drop in GDP.  Growth has been unequivocally positive in every year since 2009.  Compared to the year immediately before the crisis, 2007, GDP is now 6 per cent higher, a recovery of similar strength to that of America, with US GDP being 8 per cent up on its 2007 level.

In August 2008, only a few weeks before the collapse of Lehman Brothers, Blanchard published an MIT Discussion paper on the state of macro-economics.  This is the part of economic theory which tries to explain how the economy as a whole moves, why variables such as GDP or unemployment go up or down.  The state of macro-economics, Blanchard opined, as the most serious crisis since the 1930s was about to burst upon the world, was “good”.

But his pronouncements this week on the Eurozone deserve to be taken seriously, not merely because a stopped clock occasionally tells the correct time.  There is real substance to them.  Blanchard warned that the planned moves to closer integration within the Eurozone would not solve its fundamental problems.  Very powerful figures such as Mario Draghi, President of the European Central Bank, and Jean-Claude Juncker, head of the European Commission, are heading the drive to full fiscal integration of the Eurozone.

Under the plan, member countries of the Euro would pool funds to a Euro Treasury in Brussels.  This outfit would have the ability to transfer funds from strong to weak economies.  The UK Treasury has similar powers to move money around within the UK, which is a monetary union based on sterling.  Huge amounts have been taken from London and the South East and given to the rest of the UK over a period of decades.  But the gap in performance remains.

The relative performance of the Eurozone economies in recent years highlights the problems faced by the zone.  German GDP is now 6 per cent higher than it was in the year just before the crash, 2007.  Positive gains have been registered in countries like Austria, Belgium. France, too, is up, though here growth has more or less stalled since 2011.  Even Ireland, which was very badly hit, is now registering strong growth and the economy is larger than it was in 2007.

But there is another group where growth has been disastrously bad.  The Italian economy has shrunk by 9 per cent since 2007, Portugal by 7 per cent and Spain by 5 per cent.  These economies just do not seem to have the enterprise and the resilience to bounce back in the way in which Germany and its immediate economic satellites have done.   Closer integration may make sense for the successful countries in the Eurozone, but not for the rest.

As published in City AM on Wednesday 14th October 2015

Image: Euro Sign by Alex Guibord licensed under CC BY 2.0

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