Sunday, August 07, 2022
Looking for a light at the end of a very dark tunnel
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

My regular column is available to subscribers on This is an excerpt. Not to be reproduced without permission

There was a time when “not for those of a nervous disposition” was the standard warning on particularly scary films, often starring the late Vincent Price, or even books. It could easily have been applied to the Bank of England’s latest projections, or maybe Edvard Munch’s The Scream. The Bank’s latest monetary policy report, published alongside its decision to raise Bank Rate from 1.25 to 1.75 per cent on Thursday, was a horror story.

The rate rise, the biggest in 25 years of independence, was expected, and anticipated here last week. The new news was the Bank’s deep gloom about the economy, with inflation peaking at more than 13 per cent later this year and still being at 9.5 per cent in roughly a year’s time, the economy entering a five-quarter recession at the end of this year and the unemployment rate rising from 3.8 to 6.3 per cent over the next three years.

This would be as the Bank made clear, a Putin recession, brought about by a near-doubling of wholesale gas prices since May, because of Russia’s restriction of gas supplies to Europe, with the threat of more to come.

A recession is not inevitable, a I discussed here last week, and the Bank has different scenarios depending on what happens to energy prices. But another big price shock is inevitable this autumn.

The Bank does not do gloom on this scale lightly. Out of interest I looked back to what it was saying in its quarterly reports in 2008. In May and August, it expected a slowdown, but not a recession. Only in November, after the collapse of Lehman Brothers and the bailout of much of the UK banking system, did it recognise the inevitable.

As the Bank said on Thursday, things could turn out either worse or better than it now expects. Though it does not use the phrase, “slumpflation” has become a better description of the outlook it expects than stagflation. Though he would not be drawn on the Tory leadership contest, the noises off from the Truss campaign about Bank independence do not make the job of Andrew Bailey, the governor, any easier. More on that soon.

It would be very easy at this stage to get overwhelmed by the gloom. But, as plausible as the Bank’s forecasts of very high inflation later this year and well into next, so are its predictions that in a couple of years inflation will be at or below its 2 per cent target and in three years below 1 pe cent and skirting close to deflationary territory; falling prices. This was why one member of the Bank’s monetary policy committee (MPC), Silvana Tenreyro, favoured only a quarter-point rise last week.

I do not diminish the problems that we now face, particularly low-income households and energy-intensive firms. Each day brings new horrors when it comes to the likely path of energy bills in the autumn, and the cost-of-living crisis is bearing down on the economy. The decision to allow the holidaying Boris Johnson to continue as prime minister until his successor is chosen has created a vacuum in government at a time of intense domestic pressure on the economy and worrying international tensions.

Sunday, July 31, 2022
The Bank walks a tightrope - can it avoid falling off?
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

My regular column is available to subscribers on This is an excerpt. Not to be reproduced without permission

It will not be a huge shock if the Bank of England raises interest rates on Thursday. It will, in fact, be a big surprise if they do not do so. After a long period in which you could safely write off any action from the Bank’s monetary policy committee (MPC), which was happy not to raise (or lower) rates for most of the period between the global financial crisis and the Covid-19 pandemic, rate rises have been coming thick and fast.

Thursday’s will be special for three reasons. It will be the sixth rate rise in a row, something which has never happened before. There have been plenty of occasions in the past when official rates have risen more in one fell swoop than the “little and often” changes of recent months.

In January 1985, for example, the then equivalent of Bank rate rose by 4.5 percentage points in an effort, which was successful, to stop the pound from falling to less than a dollar. But the nearest thing to what we are seeing now was in the early period of Bank independence, when the rate rose from 6 per cent in May 1997 to 7.5 per cent in June 1998. This period of tightening, which began last December, is quicker.

The second reason is that, following a broad hint earlier this month from Andrew Bailey, the governor, markets expect an increase this week of half a point, or as they would describe it, 50 basis points. Bank-watchers among economists, I should say, are split on whether it will be 25, a quarter, or 50, a half, with the majority favouring the latter. If it is 50, it will be the first time this has happened in the post-1997 independence era, though you only have to go back a couple of years before that, to early 1995, for the last time it happened.

Thirdly, this should be the week in which the MPC signals its intention to actively reverse its quantitative easing (QE). Bear with me a second on this. I am used to people’s eyes glazing over when I talk to them about QE. A short talk on the subject could usefully double up as a sleep aid.

Sunday, July 24, 2022
Not much headroom for fantasy Tory tax cuts
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

My regular column is available to subscribers on This is an excerpt. Not to be reproduced without permission

Yes, I know you are fed up of the Tory leadership contest already but, if I can be allowed one more go, I have a public service to perform. You will be hearing a lot about tax cuts in coming weeks from Rishi Sunak (not now but later) and Liz Truss (both now and later). And you will be hearing, in that context, about the “headroom” for such cuts.

So what is this headroom? Does it exist, and can it be used now? Or is it a version of the sunlit uplands, something that might or might not exist in the future?

The starting point, and stay with me on this, is that the government has fiscal rules, for which it has legislated. The first is that in the third year from now, which happens to be 2024-25, the last year of the current parliament, government debt needs to be falling as a percentage of gross domestic product.

To meet its rules, the government should also only be borrowing to invest by then, which in the jargon means eliminating the current budget deficit; so not borrowing to fund day-to-day spending. There are a couple of other rules, but I won’t detain you with them.

According to the Office for Budget Responsibility (OBR), those rules will be met with room to spare in 2024-25, by £27.8 billion on the debt rule and £31.6 billion on the current deficit rule. There will, in other words, be a current budget surplus of that amount then, on official projections.

Those projections include the 1p cut, to 19p in the pound, in income tax that Sunak announced in his spring statement. They suggest on the face of it that the next prime minister could order his or her chancellor to cut income tax by a further 4p or 5p in the pound, or VAT by 3 or 4 percentage points, just before the next election.

Those are the numbers, but they raise questions. The first is, why wait? Struggling households and businesses would love tax cuts now, not wait for them.
The answer to that is that the headroom does not exist now. The government will still be borrowing for day-to-day spending this year, 2022-23, to the tune of £42.7 billion, within an overall budget deficit of £99.1 billion.

Figures on Thursday, showing public borrowing of £22.9 billion last month, £4.1 billion more than a year earlier and £15.6 billion bigger than the “normal” month of June 2019, suggest that both measures are heading for a significant overshoot compared with the OBR’s forecasts. The public finances are very far from being fixed. Some of this reflects the impact of higher inflation on index-linked gilts, the bill for which will have to be paid in the future.

The second problem is that the headroom only exists because of Sunak’s tax increases. That is why, on the OBR’s projections, a current budget deficit becomes a small surplus next year, 2023-24, and a bigger one in 2024-25. Take away the national insurance increase, the four-year freeze on income tax allowances and thresholds and next April’s increase in corporation tax from 19 to 25 per cent and the rules would be broken I shall come in a second to whether that should matter for a new prime minister.

These are not the only issues. The headroom identified by the official forecaster in 2024-25, roughly £30 billion taking an average between the two calculations, would have been half as much again, if not for the additional cost-of-living help announced by Sunak in recent weeks. It is unlikely that he will ever return as chancellor but his successor, whoever that be, is likely to have to return to this in the autumn, when the cost-of-living squeeze is set to intensify, with a frighteningly large increase in the energy price cap in prospect in October. It would not take many more of these interventions, or as the OBR has warned, further shocks, to use up the headroom, which it says could be wiped out by relatively small changes in the economic outlook.

Sunday, July 17, 2022
Economic supremacy? Not if our population is falling
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

My regular column is available to subscribers on This is an excerpt. Not to be reproduced without permission

Population does not get as much attention as it deserves in economic discussions. So, to tear your attention away from the Tory leadership contest, let me try to fill the gap. A few days ago, the United Nations came out with new global population projections for China and India. They showed, not only that the world’s population will reach 8 billion on November 15 this year, which is scarily precise (and on its way to 10.4 billion by the end of the century) but that India will soon overtake China as the world’s most populous country.

This will happen, according to the UN, next year. The writing has been on the wall for China’s population for some time, mainly but not entirely because of the now-relaxed one-child policy. The country’s population will start to fall very soon, while India’s will continue to grow. By the middle of the century, on current trends, the UN estimates that India will have a population of 1.67 billion, China 1.32 billion. India will not close the economic gap with China immediately but, thanks to stronger population growth, will soon start to do so.

There is also some population news at home. The Office for Budget Responsibility (OBR), the government’s economic and fiscal watchdog, published its new ‘Fiscal risks and sustainability’ report earlier this month. There was a lot of interest in there.

For me, one striking finding was that the UK, like China, is heading for population decline. Before explaining why, we should remember how much this matters. The size of the future population is vital for civic planning, including how many new houses, school places, hospitals, and so on, we will need. It is a key metric for many businesses. It matters for the public finances and it matters for he economy’s ability to grow.

Three factors are weighing down on future population growth. The first is a declining birth rate. You may remember a couple of years ago, some people predicted a lockdown baby boom. The opposite, however, occurred. The UK’s total fertility rate fell in 2020 to a record low and appears to have settled there. The OBR now assumes a birth rate of 1.59, compared with 1.84 in its previous long-term assessment four years ago. A smaller number of births means that that the so-called young-age dependency ratio – those aged 15 and under as a proportion of 16-64 year-olds – will drop from 30 to 25 per cent, with implications for education, children’s services and businesses selling children’s products.

The second factor is a slowdown in the improvement in life expectancy. We have had features in this newspaper about babies born now routinely expecting to live beyond 100, but for a while now this has been going in the opposite direction. The OBR, for example, used to assume that women born in the 2040s could expect to live to an average age of 96. Now, based on changes already occurring, it is less than 93. The effect of low life expectancy, apart from reducing population growth, is to reduce the old-age dependency ratio in the short-term but raise it over time.

The third factor is, of course, migration, an important driver of population growth. The OBR now assumes net migration of 129,000 a year, compared with a previous forecast of 165,000 and the current assumption of 205,000a year used by the Office for National Statistics.

These are important changes and, as the OBR notes: “Taken together these three changes reduce population growth from an average of 0.3 per cent a year over the next 50 years in our 2018 projections to minus 0.1 per cent a year in these latest projections. 5 Indeed, the population peaks in 2044 at 68.4 million and falls to 65.9 million by 2072, the first time our projections have been based on a declining population.”

Sunday, July 10, 2022
PMs and chancellors change - but economic reality remains
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

My regular column is available to subscribers on This is an excerpt. Not to be reproduced without permission

I do not expect much sympathy but spare a thought for those of us who must write an economics column, with a deadline, in current circumstances. Every few minutes I have had to pop away from my desk, not to see what is happening in the tennis, but to see whether the person just appointed chancellor is still chancellor and, if so, how long that is likely to be the case.

Rishi Sunak is definitely no longer chancellor, having resigned a few days ago after two years and just under five months in the job. In his resignation later, he said he was leaving what could be his last ministerial job, though it would not be a huge surprise if he were back at some point, possibly even as chancellor under a new prime minister, if he does not get the top job himself.

That would be no bad thing. Two years or so is not long enough to create a legacy as chancellor. His great hero Nigel Lawson, who also resigned having found it impossible to work with 10 Downing Street, was chancellor for more than six years. Sajid Javid, Sunak’s predecessor, had an even shorter time, never even presenting a budget. Neither should be lost to the country.

I found Sunak to be engaging, outgoing, intelligent, hard-working and with a curiosity and hunger for new ideas. He was very keen on something I wrote, explaining how cuts in the corporation tax rate had not prompted an increase in business investment, which helped him with the argument for increasing the tax.

His response to the pandemic, including the furlough scheme, something we had never seen before, was swift and sure-footed. It was no accident that this response was put in place at a time when Downing Street was preoccupied by the health challenges of the pandemic.

It was only later that the “fundamentally different” approaches Sunak referred to in his resignation letter came through. His aim was to fix the public finances first and cut taxes later, taking his leaf out of the Thatcher government in the 1980s. The tax burden rose for its first few years but fell later.

It was not illogical. The Office for Budget Responsibility (OBR), in its latest ‘Fiscal Risks and Sustainability’ report, thinks government debt will edge lower relative to gross domestic product in coming years. The former chancellor, in the OBR’s view, had some room to cut taxes later in this parliament, roughly £30 billion. He had reason to think that he could go well beyond the promised 1p cut in the basic rate of income tax.

The trouble with his strategy was that it involved raising taxes substantially now, lifting the tax burden to new highs. And the trouble with that, as the OBR pointed out, is that cancelling tax increases that were already in the bag for the future public finances more than removes that room for manoeuvre. Sunak’s big three tax hikes: raising corporation tax from 19 to 25 per cent next year, freezing income tax allowances until 2026 and raising employee and employee national insurance, will between them be raising more than £50 billion a year in additional revenue by 2024-25.

As it is, for now at least, Sunak leaves the Treasury as the instinctive tax-cutter who, largely because of the pandemic, become a big tax-hiker. Every chancellor leaves office with regrets, with a huge amount of unfinished business, but his bulging file of unfinished was bigger than most. His resignation was pivotal to the unseating of a terrible, chaotic prime minister, who was never suited to high office, but that may not be comfort enough.

His successor for now, Nadhim Zahawi, is somebody I know, but not as a politician. Before he ventured into more controversial oil businesses, he was one of the two founders of YouGov, the polling organisation. The other was Stephan Shakespeare. There is a certain neat symmetry in the fact that Zahawi’s parliamentary constituency is Stratford-upon-Avon.

Both worked for Lord (Jeffrey) Archer, when he was running to be London mayor in the late 1990s, before scandal intervened. The business that became YouGov, internet polling, was originally intended to provide instant democracy, with Archer testing his ideas on the public. The Sunday Times began to use YouGov in the early 2000s, at a time when many people were sceptical of internet polling, and I was responsible for it on the paper. Times have changed. Out initial polling was to gauge whether there was public enthusiasm for the UK joining the euro, at the time the hot political topic of the day.

Zahawi did well with YouGov, and he has done well politically over the past couple of years, first as vaccines minister, then education secretary, now chancellor.

Interviewers have been desperate to get him to commit to early tax cuts, but he has been commendably guarded on that. He has got out of, I think, having to deliver a big economic speech alongside Johnson shortly, though you never know. In theory there should be no big political announcements during the period when the Tory party is selecting a new leader, particularly if Zahawi enters the contest himself, but you never know about that either.

The problem for the new chancellor is the same as the problem for the old chancellor. Inflation is at a 40-year high and is going higher. For the next 12-18 months there will be no growth in the economy, at best, and there is not much that can be done about that.

Sunday, July 03, 2022
One crisis killed off productivity - will this one resurrect it??
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

My regular column is available to subscribers on This is an excerpt. Not to be reproduced without permission

Anybody who has travelled by plane recently, as I have, or waited on the phone for a customer services department, or seen the many notices around cafes, bars and restaurants screaming out for staff, will know that the country is beset with labour shortages, of the kind we have not seen for a very long time. The question for today is whether this will bring about something that is essential for our long-term prosperity, a productivity revival.

Before trying to answer that question, some background, courtesy of the Productivity Commission, established by the National Institute for Economic and Social Research (Niesr), as part of the Productivity Institute. It published its evidence review recently, and the results are striking.

For three decades after the Second World War, during the so-called golden age for the world economy, productivity measured by output per hour worked grew by an average of 3.6 per cent a year. In the next three decades, it was 2.1 per cent a year, on average, a figure we have come to associate with long-term productivity growth for the UK.

But then, around the time of the financial crisis, the lights went out. Productivity growth over the 2008-2020 period average just 0.5 per cent a year, or 0.2 per cent from 2007 to the pre-pandemic year of 2019.

For those who are interested in economic history, this is quite something. Productivity growth in the period since the financial crisis has been weaker than at any time since the dawn of the industrial revolution well over 200 years ago.

The Productivity Commission deliberated on whether to date the start of the slowdown to the crisis. One theory was that US productivity began to slow about two years before 2007-8, so on the catch-up theory the UK may have experienced a slowdown anyway. But it settled on the financial crisis as the point where reasonable growth in productivity was replaced by near-stagnation.

All countries experienced a productivity slowdown after the crisis, but the UK’s slowed more than others. Some of that may be because of the fact that the post-crisis recovery in business investment, necessary for lifting productivity, was snuffed out by the referendum, and stagnated for more than three years, long before it took a further hit as a result of the pandemic. Business investment in the first quarter of this year was at its lowest for eight years.

This matters. Niesr calculates that, has productivity growth since the crisis grown in line with that 2 per cent average since the crisis, workers in the UK would be an average of £5,000 a year better off. As it is there has been a prolonged squeeze on real wages. Official figures show that regular and total pay in real terms is barely above, at best, the early 2008 level.

Sunday, June 26, 2022
Six years on, there's no plan to deal with the Brexit damage
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

My regular column is available to subscribers on This is an excerpt. Not to be reproduced without permission

I can remember vividly June 23 2016, the sixth anniversary of which we have just passed. During the afternoon I gave a talk to some schools in Guildford in Surrey, after which the heavens opened in a storm of Biblical proportions. Perhaps somebody was trying to tell us something. The short train journey back to Waterloo took hours, because of the rain not strikers, though I did get back in time to vote in the referendum.

Damage was done that day, with widespread flooding. Today I want to start by reviewing the damage done to the economy by the decision voters took that day. Polls show that they now think by a significant margin it was a mistake, though it is a little late for that.

Then, in the spirit of constructive engagement, I want to examine what we should do about it. It is not, spoiler alert, about rejoining the European Union, though it was a massive economic policy error to leave. The Labour Party is as scared about saying anything positive about the EU as it is about being caught offering support for striking railway workers. That ship has sailed and will not come back into port for many years.

The experience of the past six years is gratifying for economists, including me, because they have panned out as expected. Apart from an explicitly political Treasury forecast commissioned by George Osborne, most economists did not expect a post-referendum recession. That Treasury short-term forecast, of the mildest recession ever, was wide of the mark.

Other forecasts had two central features. One was that sterling would suffer a sharp fall, which it did, the biggest short-term drop of any major currency in the floating era. The other was that the economy would suffer from many years of attrition as a result of the Brexit vote, slow-burn damage, in other words.

I wrote once that there was a danger that people would lose sight of that damage as other things intervened. Other things have indeed intervened, notably the pandemic and the Russian invasion of Ukraine, so it is important that we do not lose sight. And before anybody says it, while the editor of this newspaper at the time backed Brexit, I and many of my colleagues strongly took the opposite view.

How do we measure the damage? An intriguing and widely accepted method, which has been used by the Bank of England among others, is the doppelganger approach. If that sounds a bit sci-fi, it is quite straightforward. The average performance of advanced economies similar to the UK, but which did not Brexit, is the control. Doppelganger UK reflects what would have happened had we not decided to leave, against which the performance of the actual UK can be compared.

The doppelganger approach has been used extensively by John Springford, deputy director of the Centre for European Reform. His latest update, covering the period to the end of last year, was published earlier this month, and the results are striking.

Sunday, June 19, 2022
The UK's 'no mates' economy is down, but not quite out
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

My regular column is available to subscribers on This is an excerpt. Not to be reproduced without permission

The sun may have been shining but some of the lights have been going out all over the UK economy. There have been many falls from grace over the years, but the one that has occurred over the past few months has been particularly sharp.
Not so long ago, around the turn of the year, the UK looked well set. The government, preening itself on getting through the Covid-19 crisis, boasted of the strength of the recovery, which was to be the strongest in the G7. That was the case last year, partly reflecting the UK’s bigger fall in 2020.

Then, reality struck. The big inflation shock that was already building before the Russian invasion on Ukraine, and which has been made worse by it, has exposed the UK’s vulnerabilities. The British economy is weak and skirting perilously close to recession. You can see it in the forecasts.

Last November the Bank of England was predicting a modest 1.5 per cent growth rate for 2023. Now it thinks the economy will instead shrink by 0.25 per cent, though that did not prevent it from raising interest rates again on Thursday, for the fifth time in a row.

Its quarter-point rate rise to 1.25 per cent, on a split vote, with three monetary policy committee members preferring half a point, was its way of balancing a weak economy – it expects the economy to shrink by 0.3 per cent this quarter - and high inflation, with a new predicted peak of 11 per cent. Scary.

The Organisation for Economic Co-operation and Development (OECD) thought last December that the economy would grow by 2.1 per cent next year. Now it predicts zero growth. Consensus forecasts for growth are being cut. The CBI has just cut its growth forecast for 2023 from 3 per cent to 1 per cent and warns that even that will require government action to boost business investment.

Even last year’s strong growth story was not quite what it seemed. The economy has not been particularly strong since the middle of last year. The “oomph” it got from the lifting of Covid restrictions after the third lockdown in early 2021 did not follow through.

Sterling, meanwhile, has become a “no mates” currency, trading at times below $1.20 in recent days, which is even weaker than it fell during its initial post-referendum slump in 2016, the biggest of any major currency in the floating rate era. Some of this is due to a strong dollar, but the pound, trading below €1.15 at times in recent days, before recovering some ground, has also been plumbing the depths against the euro. Foreign holidays beckon for many people but they will cost.

A weak currency tells us something. International investors do not like what they see about the UK economy or British politics. Breaking international law in a way that threatens a trade war with your biggest set of trading partners to shore up a deeply flawed leader is a “sell” signal. Whatever the results of confidence votes among Tory MPs, there is not much confidence out there in this government.

Tony Danker, the CBI’s director general, said that government “grandstanding” over the Northern Ireland protocol was making international businesses think it was maybe not the time to invest in the UK right now. The money flowing into the UK may take the form of foreign buyers snapping up British firms at bargain prices as a result of low valuations and the weak pound.

What happens to the pound matters a lot, particularly at present. The weaker it is, the bigger will be the cost-of-living crisis and the pressure on business costs. Global oil prices have been higher than now than in the past but, priced in dollars as they are, the weaker the pound, the higher the sterling price, which has hit £100 a barrel in recent days. That is why petrol has been touching and in some cases exceeding £2 a litre. The UK is uncomfortably close to the top in one league table, that for the highest petrol and diesel prices in Europe.