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It’s fanciful to think China’s economy will overtake the US’s anytime soon

It’s fanciful to think China’s economy will overtake the US’s anytime soon

Possibly the single most important of the tensions stoked up by President Trump is the rivalry between the United States and China. Economic strength will be the ultimate determinant of this struggle for the position of Top Nation.

Comparisons of the size of economies, particularly ones at very different levels of income per head, are fraught with difficulties. Taking a deep breath, annual output in China is currently around $10 trillion a year, compared to $17 trillion in America.

Over the past 30 years, the US has grown at an annual average rate, after allowing for inflation, of 2.4 per cent, and China by 9.3 per cent. If we project these rates forward, the Chinese economy will be as big as the American by 2024. By 2037, it will be more than twice the size.

We can allow for some slowdown in China’s growth, to, say, 7 per cent a year, and a bit faster expansion in the US, to take account of the fact that the average over recent decades is influenced by the impact of the financial crisis. Even so, we soon reach a situation where the two are of comparable size.

But a paper in the latest issue of the world-class Journal of Economic Perspectives argues persuasively that the sustainable Chinese growth rate in the medium and longer term is much lower, in the range of 3 to 4 per cent a year.

Hongbin Li and colleagues, based both in Stanford and top universities in China, note that Chinese growth since the start of the economic reforms in 1978 has been the fastest that any large country has sustained for such a long period of time. But much of this is due to the rapid transition from a centrally planned to a market oriented economy. Forty years ago, virtually no-one operated in the private sector. Now, well over 80 per cent of workers do so. This shift obviously cannot be repeated.

 

Closely intermingled with this has been the massive move of population from the countryside to the cities – or more precisely, from low productivity agriculture to higher productivity urban economic activities. But the annual growth rate of rural-to-urban migration has fallen from over 11 per cent in the 15 years before 2000 to only 3 per cent since. And the authors argue that the growth of migration almost certainly will decline further given that “rural-based surveys are finding that less than 10 per cent of young able-bodied rural individuals are now living (and working on farms) in rural areas”.

Until 2011, the authors point out that China enjoyed what they call a “demographic dividend”. The age group of the working population was unusually high as a share of the population as a whole. But because of what the authors tactfully refer to as “the fall in fertility” since the early 1980s, this is now declining fast. The One Child Policy was mainly responsible, but higher incomes also reduce birth rates.

China remains a huge and growing economy. But projections that it will overtake the US within readers’ lifetimes seem fanciful.

Image: Chinese Lanterns by Suloke Mathal is licensed under CC by 2.0
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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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What Dirty Harry tells us about economic forecasters’ Michael Fish moment

What Dirty Harry tells us about economic forecasters’ Michael Fish moment

Economic forecasters are in the dock. Last week, none other than the chief economist of the Bank of England, Andy Haldane, was confessing the crimes of the profession.

The failure to predict the financial crisis was, Haldane said, economic forecasting’s “Michael Fish” moment. Thirty years ago, the BBC weatherman predicted that the UK would avoid the hurricane which devastated the south of England.

Haldane went on to admit that the Bank had “not anticipated” the strength of the economy after the Brexit vote. This is something of an understatement. The Treasury predicted an immediate recession, with the economy shrinking dramatically in the July to September period at an annual rate of up to 4 per cent. The latest Office for National Statistics estimates show that it grew at an annual rate of 2.5 per cent, almost the complete opposite of the prediction made in June.

He attributed these forecasting failures to the fact that economic models assumed that people behaved rationally. However, they had been “irrational” in continuing to spend after the Brexit vote.

This tells us a lot about the mindset of the economics profession. Economists were overwhelmingly in favour of Remain. If you think that the European Union is a great economic success story, bursting with dynamism and innovation, then it would be irrational to continue to spend after a Leave vote. You should be saving for a rainy day. Consumers have taken a different view, but one which may very well be rational.

A serious problem for economic forecasters, and indeed the profession as a whole, is groupthink. Writing about the crisis of the 1930s, Keynes said: “a sound banker, alas, is not one who foresees danger and avoids it, but one who, when he is ruined, is ruined in a conventional way along with his fellows, so that no-one can really blame him.” There is a real reluctance to go out on a limb and risk being proved wrong.

But there is a deeper reason why forecasts repeatedly fail. The problem is that the data on key variables such as GDP and inflation does not contain very much genuine information.

To make successful forecasts in any scientific setting, the data needs to have regularities which can be identified. No-one, for example, can successfully predict over time the outcome of the next shake of a fair dice. The outcome is completely random.

Economic data is not quite as bad as this from a prediction perspective. But the economy is bombarded continuously by so many different events that it is hard to pick out any underlying structure.

Imagine watching a hospital soap in which a screen shows the regular heart beat of a patient. Imagine now the screen plagued by constant interference. It would be difficult to distinguish the “signal” (the heart beat) from the “noise” (the interference). This is what economic data is like. And this is why forecasts are often wrong.

As Clint Eastwood said in Magnum Force: “a man’s gotta know his limitations”. Time for forecasters to wake up to this fact.

As published in CITY AM on Wednesday 12th January 2017

Image: Clint Eastwood Vector Portrait by Vectorportal.com.  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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No wonder free trade is under threat: we’re just rediscovering its losers

No wonder free trade is under threat: we’re just rediscovering its losers

It had been an article of faith among economists and policy-makers that free trade is a Good Thing. Trade liberalisation was a key feature of the world economic order enforced by the United States after the Second World War. For decades, the trend of removing trade barriers led to world trade growing around twice as rapidly as world GDP.

All this now seems under threat. Calls for greater protectionism have been a feature of the US presidential race, emanating from both Donald Trump and the Democrat hopeful, ultimately defeated by Hillary Clinton, Bernie Sanders. In Britain, the Brexit vote puts the spotlight on trade policy for the first time for many years. Even the International Monetary Fund (IMF), the high priest of economic orthodoxy, has joined in the debate, with a warning at the end of September that free trade is increasingly seen as benefiting only the well off.

The economic principles which support free trade go back over 200 years, almost to the beginning of economic theory itself. Adam Smith, in his great book the Wealth of Nations, set out the basic arguments in the late eighteenth century. Trade enabled countries to take advantage of specialisation. If Portugal produced, say, wine more efficiently than Britain, and we made cloth better, by concentrating resources on what each were good at and trading the outputs, both benefited. Production of both commodities would be concentrated in the country which was most efficient at each.

David Ricardo, writing in the early nineteenth century, was not just an economist but a self-made multi-millionaire – at a time when a million pounds was a million pounds – and a Member of Parliament. He took Smith’s arguments further, and showed that trade was beneficial even if one country could literally make everything more efficiently than everyone else. Countries should specialise in what they were comparatively best at.

This, the so-called principle of comparative advantage, remains at the heart of the economic theory of trade to this day. Ricardo’s theory was tremendously influential. It was used by the Lancashire politicians John Bright and Richard Cobden to secure the repeal of the Corn Laws. These put high tariffs on the import of corn into the UK. Their abolition meant cheap food for the industrial working class, and was the most important social reform of the entire nineteenth century.

But all theories make assumptions. Ricardo made it clear that he was assuming that capital did not move across borders. It stayed put in its country of origin. In the early nineteenth century, this was a reasonable assumption to make: international capital flows did exist, but not on a massive scale.

If capital can flow freely, Ricardo’s theory needs to be heavily qualified. So, when the Berlin Wall fell, German companies built factories in Poland and the Czech Republic, destroying German jobs. In the long run, trade may still be beneficial, but there will be many losers along the way. Next year sees the two hundredth anniversary of Ricardo’s great book. The IMF has just rediscovered something which good economists knew all along.

As Published in CITY AM on Wednesday 12th October 2016

Image: Donald Trump by Gage Skidmore is licensed under CC BY 2.0

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Look to Twitter for why Britain’s economy proved Project Fear wrong

Look to Twitter for why Britain’s economy proved Project Fear wrong

The economic data on post-Brexit Britain is beginning to emerge.  We discovered last month that employment in May to July grew by 174,000 compared to the previous three months.  Last week, the Office for National Statistics published its estimate for the output of the service sector of the economy in July.  This shows a 0.4 per cent rise on June, and a growth of 2.9 per cent since July last year.  Both are very good figures.

Official data, even for employment, is notoriously prone to subsequent revisions.  Is there any harder evidence that the economy is prospering and that Project Fear, so prominent in the referendum campaign, was wrong?

The key to a growing economy is of course confidence.  This was the great insight of Keynes.  The economy is driven much more by psychological factors – by his memorable phrase “animal spirits” – than by objective economic ones.  If confidence becomes depressed, no amount of stimulus will persuade businesses to spend on their investment plans or hire more people.

My colleague Rickard Nyman has been analysing tweets in the London area every day from the beginning of June.  Now, there is an awful lot of rubbish on Twitter, but the latest machine learning algorithms enable you to dive into the mud and come up with pretty polished estimates of overall sentiment.    The day after the vote, 24 June, stands out as one huge hangover.  The balance of London sentiment went very sharply negative.  Yet by the end of June, it was back to where it stood at the start of the month.  Sentiment wobbles along for the rest of the summer, but since the start of September a strong positive upward trend has set in.

Most tweets of course are about the fortunes of Arsenal, going on holiday, what was on TV, and not directly about the economy.  But the overall mood of Londoners has become much more positive over the last few weeks.

More evidence of positive feelings was provided at a seminar organised last week by the law firm Linklaters and the property outfit Strutt and Parker.  The focus was on commercial property, which is notoriously sensitive to the state of the economy.  There is no doubt that the sector took a hit immediately after the Brexit vote.  But every speaker, from quite different backgrounds, struck a decidedly optimistic note about both commercial property in particular and the UK in general.

Andy Martin of Strutts noted that the value of deals in 2016 is on track to be close to the levels of 2007, the pre-recession peak year for the economy, despite the sharp pause in the summer.  Both Zach Vaughan from Brookfield, one of the largest investors in global real estate, and Chris Morrish, recently retired as head of European real estate for Singapore’s sovereign wealth fund GIC, confirmed the continued strong attraction of the UK for overseas investors.

A coherent picture emerges from this diverse mix of official statistics, social media conversations and global commercial property perspectives.  The UK economy is thriving.

As Published in City AM on Wednesday 5th October 2016

Image: Twitter by Christopher is licensed under CC by 2.0

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