Sunday, March 07, 2021
Sunak's budget judgment was right - but the economy still needs fixing
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.

Budgets are a bit like Christmas, a huge amount of anticipation followed by the event itself, which can be a bit of a let-down, particularly if you know beforehand most of what you are going to get. Christmas, of course, is not all about presents. Four days on, however, the kids have got bored with or broken their toys, and I have to try to conjure something up from the leftovers.

Fortunately, there is plenty to say. This was a big budget, a big moment, and the first thing to say is that I have to applaud a budget that precisely met the central recommendation set out here in recent weeks. Last Sunday’s column had the headline “Sunak must support us now and make us pay later” and that is exactly what the chancellor did.

There was plenty of pre-briefing about corporation tax rises and freezing personal income tax allowances and some of it implied that it would happen immediately. Delaying the tax allowance freeze for a year and the corporation tax hike for two years made perfect sense, though in the case of corporation tax, the expectation was of a gradual rise over time, not that the rise from 19 to 25 per cent would be done in one fell swoop.

Meanwhile, we should note the tax dog that did not bark. Tory donors, entrepreneurs and landlords, some of whom fell into all three categories, got very excited in the run-up to the budget about an increase in capital gains tax. It did not happen and, indeed, it was not mentioned. Sunak may have had it in mind to do something but he was persuaded against it, though he will say something more on tax reform on “tax day”, March 23.

The general shape of the budget was, therefore, one that I have no hesitation in applauding. The chancellor did not repeat the prescription of Geoffrey Howe in 1981 and raise taxes immediately with the economy in recession. His support for the economy went further than expected, with the furlough scheme extended to the end of September, not June, and more self-employed people brought into the support net. The budget judgment was right. I’ll come on to the other big support measure in a moment.

Second, and I don’t think this is generally appreciated, if all goes according to plan, the chancellor will have at a stroke set in train a process that will fix the public finances. By 2025-26, according to the Office for Budget Responsibility (OBR), the current budget deficit will have been eliminated. It is a huge 13.3 per cent of gross domestic product (GDP) this year.

The current budget deficit, to explain, is the difference between day-to-day government spending and tax revenues. It means that the government, which intends to devote nearly 3 per cent a year to capital spending, would only then be borrowing to invest, a long-held ambition of chancellors.

Fixing the public finances is a relative term. In five years public sector debt will still be more than 100 per cent of GDP, £2.8 trillion, and public borrowing, in cash terms, will be around £74 billion, according to the OBR. But it would still represent considerable progress.

“If all goes according to plan” is doing quite a lot of work in the paragraphs above. There are serious questions about whether the future tax increase announced in the budget can deliver the expected revenues and whether the economy can sustain a tax burden which has only been achieved once, and very briefly, over the past 70 years. The Institute for Fiscal Studies points out the “sad truth” that it will require the highest sustained tax burden in UK history.

There is also a question of whether the chancellor, whose future plans depend on tight control of public spending after pandemic support is withdrawn, can constrain a fiscally incontinent, big spending prime minister. Already the government is embroiled in a row over a 1% recommendation for the increase in NHS pay. That is one of the many challenges ahead.

Third, I have to try to answer the question about whether the budget addresses any of the issues about Britain’s future economic performance and, in particular, productivity. Will it raise our game?

Sunday, February 28, 2021
Sunak must support the economy now and make us pay for it later
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.

It is worth remembering, as we await Wednesday’s budget, that it was not supposed to be like this. A few months ago, Rishi Sunak, basking in the warm glow of his Eat Out to Help Out scheme in August, was looking forward to presenting his second budget in November. By then, the Treasury hoped, Covid-19 would be in retreat, and the spring 2020 national lockdown would be a fading memory, and it would be time to embark on the task of paying for the pandemic.

Things have turned out differently. Two more lockdowns have happened and the current one is not over and will not be by the time of this week’s delayed budget. Eat Out to Help Out is viewed a little differently these days, though there is talk of a re-run.

This will not, either, be the budget that the Treasury had in mind for last November, for which we may have to wait until November this year.

The delay, however, has been no bad thing. The last update from the Office for Budget Responsibility (OBR), in November, predicted a budget deficit this year, 2020-21, of £394 billion. With two months of the fiscal year to go, the running total is £271 billion. By now, the OBR thought it would be a shade under £340 billion.

There is a complication, in that the OBR is expecting a £29.5 billion write-off of the government’s Covid-19 business loans which do not feature in the monthly figures. Even so, it will be a disappointment if this year’s deficit does not come in below £350 billion, still clearly a massive number, but probably £50 billion – a sizeable budget deficit in a normal year – below what was feared even a few weeks ago.

The other positive, of course, is that the vaccine rollout and the government’s roadmap for the easing of restrictions offers the prospect of a really strong recovery. The Bank of England is not at the top end of economists’ expectations but its latest forecast, published early this month, provides an insight of what we might expect.

In the second quarter, April-June, it expects a rise in real gross domestic product (GDP) of more than 5 per cent, followed by an increase of nearly 5 per cent in the third quarter. To put these in perspective, they would represent the second and third biggest quarterly increases in GDP on record, the biggest (16 per cent) having been in the third quarter of last year. They will also translate into some spectacular year-on-year gains. Second quarter annual growth will be around 18 per cent.

All this is likely, but not guaranteed. We do not yet know if the coronavirus has anything more t throw at us. And, while the GDP statistics point to a very robust growth, for businesses in many sectors it will feel like blearily stepping out into the sunlight and it will take time to adjust.

That is why, looking at all the things that have been said and written in the run-up to this budget, it looks to me very much like a case of continued short-term support for the economy, combined with the beginning of a plan for medium-term fiscal consolidation, in other words tackling the budget deficit.

Some of that short-term support seems very well-judged. It makes sense to persist with the furlough scheme beyond the end of April, and indeed until restrictions are lifted, as with business rate relief. It makes sense too to continue with the VAT reduction for hospitality for now, even if people may not need much encouragement to hit pubs, cafes and restaurants when they are allowed to.

There is less of an argument for extending the stamp duty reduction beyond March 31, given the strong revival in the housing market in recent months. Sunak appears to have decided that a cliff-edge tax increase while the economy is still operating under restrictions is not a good idea, so the new deadline will be the end of June.
He may find that he faces a backlash against increasing it even then. Temporary tax cuts have a habit of becoming permanent.

That leaves the question of tax increases, and the timing of them, on which I wrote last week. The most obvious here is the widely mooted increase in corporation tax. When the Treasury let it be down it was considering that last summer, the talk was of an increase, over time, from 19 to 24 per cent. More recently, two versions have emerged, with end goals of either 23 or 25 per cent, with the additional suggestion of an announcement now but implementation in the autumn. That leaves open the question of whether the first percentage point increase will come in 2021-22 or 2022-23.

Interestingly, Lord Wolfson, chief executive of Next, said the other day that higher corporation tax was a reasonable price to pay for the government huge support during the pandemic.

Sunday, February 21, 2021
Sunak shouldn't even think of doing a Geoffrey Howe
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.

This is a time for momentous anniversaries. It is ancient history now, particularly for younger readers, but a few days ago we market the 50th anniversary of decimalisation. It is surprising, unless I have missed it, that we have not had a campaign to bring back pounds, shillings and pence, not that I am suggesting it would be a good idea.

And, while we have embraced metrication – not the same as decimalisation but part of the family – we still measure distances in miles, fuel consumption in miles per gallon, height in feet and inches (well I do) and beer, when we used to be able to drink it in pubs, in pints.

It is, however, another anniversary I wanted to remind you of today. Forty years ago next month a Tory chancellor presented a budget in difficult circumstances. Government borrowing was high, though at 4.3 per cent of gross domestic product (GDP) in 1980-81, it looks like small change these days, but the economy was in its deepest recession since the Second World War
The consensus was clear on what that chancellor, Sir Geoffrey Howe, should do, and it was not to raise taxes, which you did not do in the teeth of a recession. But he did, aggressively, with a new tax on North Sea oil, a one-off windfall tax on the banks, which were benefiting from the government’s high interest rate policy, and big increases is excise duties, including those on petrol. Toughest of all, for a supposedly tax-cutting government was a freeze on allowances at a time of very high inflation, increasing income tax on everybody.

The budget produced the now famous or infamous reaction in the form of a letter from 364 economists, including a much younger Lord (Mervyn) King, warning that it would deepen the recession. Margaret Thatcher, challenged by the Labour leader Michael Foot to name two economists who supported her policies, snapped back Alan Walters and Patrick Minford, before saying in private in the car taking her back to Downing Street: “It’s a good job he didn’t ask me to name three.”

The letter from the 364 has been much mocked because the spring of 1981 marked the start of the long 1980s’ recovery, though unemployment continued to rise for years and was more than three million six years’ later. The 364 had failed to spot that Howe’s fiscal tightening masked a big monetary relaxation, including a two percentage point cut in interest rates; chancellors could do that in those days.

Anyway, forty years on, Rishi Sunak is facing a dilemma similar to his predecessor, except that all the magnitudes are so much bigger. The budget deficit this fiscal year, 2020-21, will be not far below 20 per cent of GDP, a figure that would have been unimaginable to his predecessors, though figures on Friday suggested that the deficit will come in well below the feared £400 billion.

The economy has had the deepest recession, not since the Second World War but since before the War of Jenkins’ Ear. Not for more than 300 years have we seen anything like last year’s 9.9 per cent slump in GDP. And, while the worst of it is behind us, and happened in March and April last year, the economy is back in a period of declining GDP in the current quarter.

Even as the economy pulled back from the worst at the end of last year, the economy was 7.8 per cent below pre-Covid levels, with consumer spending down 8.4 per cent and business investment 10.3 per cent
Some of the old tunes from 1981 have been playing. There has been talk that Sunak, like Howe, could announce a stealth increase in income tax by freezing allowances, though at a time of low inflation the impact would be a lot less now than then.

Sunday, February 14, 2021
Not Project Fear - but Brexit reality for firms and the economy
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.

It takes something to break through the blanket coverage of the pandemic, on which the news is not as encouraging as it might be. I don’t think, a year ago, that many people would have been anticipating the introduction this month of the harshest travel restrictions so far, or for there to be a debate about whether even staycations will be possible this summer. I think they will, but I am an optimist on these things.

What is clear, I think, is that even with a successful vaccination programme there is not going to be a “with one bound we are free” moment. Restrictions should be less than now in the April-June period, but they will not have been removed completely. That says something about the nature of the coming recovery. While we are still on course for some big year-on-year gains in economic activity, after last year's worst-for-300-years plunged of 9.9 per cent, for many businesses it will seem like slow progress and a long haul.

One thing has broken through the blanket coverage, however, and that is the UK’s new trading arrangements with the EU. The penny appears to be dropping. Peter Cowgill, the chairman of JD Sports, spoke for many when he said that Brexit was turning out “considerably worse than feared”. He is considering establishing a new distribution centre within the EU as a result of trade frictions and red tape costs running into “double digit” millions. The UK’s deal with the EU was “not properly thought out”, he added.

A survey by the British Chambers of Commerce (BCC) found that nearly half, 49 per cent, of exporters were finding trading difficult. They outnumbered the proportion finding it easy by more than three to one.

“Trading businesses – and the UK’s chances at a strong economic recovery – are being hit hard by changes at the border,” said Adam Marshall, director general of the BCC. ““For some firms these concerns are existential and go well beyond mere ‘teething problems’. It should not be the case that companies simply have to give up on selling their goods and services into the EU.”

Sunday, February 07, 2021
Negative rates? No, the Bank should be starting to think of when to raise
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.

Many is the Thursday lunchtime I have waited with bated breath for the Bank of England’s interest rate announcement, and many is the time when it has been much ado about nothing. So it seemed last week, when the eight men and one woman on the Bank’s monetary policy committee (MPC) left official interest rates at a record low of 0.1 per cent and opted not to increase its quantitative easing (QE) total from an already massive £895 billion, including corporate bonds.

The announcement was not without its moments, however. The Bank wants to add negative interest rates to its toolkit, but the banks will need six months to prepare, so that probably kicks it firmly into touch, which for me is good thing. It is also examining how it might reverse some of that massive QE and has asked Bank staff to investigate. Its position used to be that this could not happen until Bank rate had risen to 2 per cent (later reduced to 1.5 per cent). It may be that its future position will be that it can happen at any time, which would also be a good thing.

If all goes to plan, or at least according to the Bank’s new forecasts, the next few months will see both a powerful growth bounce and an upturn in inflation. The only debate, on both counts, is by how much.

Recent history suggests that there could be a rise in inflation as the impact of this crisis fades. Inflation rose to 5.2 per cent in September 2011 after the financial crisis. Some of this was due to the rise in VAT to 20 per cent at the start of 2011, but most of it reflected other factors, including a recovery in oil and commodity prices.

The Bank of England’s survey of public opinion on inflation, conducted by the market research company Kantar, shows an expectation that prices will be rising by more than the official 2 per cent target in 12 months’ time.

The latest survey, carried out at the end of last year, showed a median expectation of inflation of 2.7 per cent a year on. Nearly a fifth, 18 per cent, think inflation will be more than 5 per cent. Two-fifths, 39 per cent, think inflation will be 3 per cent or more.

A significant proportion of economists also think that a period of above-target inflation is on the way, either because the Bank will allow it to happen, or because it is unable to prevent it. The Centre for Macroeconomics of the Centre for Economic Policy Research recently carried out a survey.

Of those surveyed, 22 per cent thought the Bank would allow inflation to exceed the target, while 19 per cent said it would be unable to prevent an overshoot. The combined total, 41 per cent, exceeded the 37 per cent who expected the target to be met.

Some prominent economists have been warning of higher inflation for some time. Tim Congdon of the Institute of International Monetary Research has long argued that the big increase in the money supply as a result of aggressive quantitative easing (QE) by central banks will push inflation to 5 per cent or more. He has also pointed to the recovery in commodity prices and other “early warning signs” of rising inflation.

Commodity prices are recovering – the Bloomberg commodity index is up by more than 35 per cent from its low point last March – and the Bank is more optimistic than the consensus about growth. It predicts that the economy will grow by 5 per cent this year and just over 7 per cent next. This year’s recovery, which is subject to the speed of the vaccine rollout and the extent to which people feel confident enough to spend again, sees the economy “projected to recover rapidly towards pre-Covid levels”.

Sunday, January 31, 2021
Can this stuttering recovery still pick up the pace?
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.

The International Monetary Fund’s January world economic outlook is always interesting. It normally coincides with the annual Davos jamboree in the Swiss mountains. This year, like many things, Davos took place virtually. But, having not been invited to attend the real thing for a while – it is a long story – I did not take part in the online version either, but I did devour the IMF’s new assessment.

It provides an interesting update on how the world’s economies fared during the pandemic last year, and how they are expected to do this year and next. The big picture is that the world economy shrank by 3.5 per cent last year, which means it was a big recession. It compares with a fall of just 0.1 per cent in 2009, the big negative year during the global financial crisis.

This year, according to the IMF, the global economy will grow by 5.5 per cent. You do not need a calculator to tell you that this means that the world economy will get back above its pre-pandemic level this year, implying a deep but short-lived world recession.

I have mentioned before the performance of China, the world’s second largest economy, which grew by 2.3 per cent last year, is expected to expand by 8.1 per cent this year, before settling down to a more normal (these days) 5.6 percent in 2022.

America, the world’s biggest economy, did not have a bad year in 2020, its economy contracting by “only” 3.5 per cent, despite Donald Trump’s mishandling of the coronavirus crisis, or maybe because of it. Joe Biden’s first year should see 5.1 per cent growth the IMF says, followed by 2.5 per cent next year.

China and America, in fact, will see much less economic “scarring” than other countries, the IMF believes, with GDP next year in these countries only a little bit below where it would have been in the absence of the coronavirus crisis.

The world economy’s other two big players, Japan and Germany, suffered falls of 5.1 and 5.3 per cent in 2020, the IMF says. They will recover but will not get back to pre-pandemic levels until next year.

Now let me bring it right back to home. The IMF thinks the UK economy contracted by 10 per cent last year. This matters for those interested in historical parallels. If the economy shrank by less than 9.7 per cent, it would merely be the worst since 1921. If it is more than that, it takes us back to 1709, and the Great Frost.

If you think that the IMF is being unduly gloomy, the latest assessment of independent forecasts from the Treasury has a fall last year of 10.6 per cent.

One of the big debates at the moment is whether the statisticians at the Office for National Statistics (ONS) have made the UK GDP figures look worse by applying a “gold standard” of measurement to the output of the public sector, which other countries do not.

I hesitate to remind parents who are tearing their hair out at this very moment, but unpaid home tutoring, like housework, does not count towards gross domestic product (GDP), though online teaching by teachers does. Measured activity in the National Health Service is suffering, despite the extraordinary pressure created by the coronavirus crisis, because of all those cancelled operations and non-Covid treatments.

That the UK had a big recession last year is not, however, in doubt. Even in the third quarter of last year, when the economy enjoyed a strong but short-lived bounce, consumer spending was 10 per cent down on pre-pandemic levels, while business investment showed a 19 per cent fall.

The safest thing to say is that the UK was among a clutch of poorly performing European countries, along with France, Italy and Spain.

Sunday, January 24, 2021
Tax rises aren't easy, so Sunak will have to proceed with stealth and reform
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.

There are some traditions that, even in a pandemic, are being maintained. When March budgets were the norm, it was traditional at this time of year for tax ideas to be run up the flagpole to see whether they would fly. While gardeners can measure the approaching spring by the appearance of crocuses and daffodils, economy-watchers could see it in the form of budget stories.

Last Sunday this newspaper reported that government sources were still indicating that a corporation tax hike was still on course for the March 3 budget. The story was widely followed.

This, you may recall, was part of a trio of tax rises that the Treasury was reportedly considering last summer, in order to bring the public finances back under control after the pandemic. Another was to more closely align the taxation of capital gains and income, as recommended by the Office of Tax Simplification (OTS), which was asked by Rishi Sunak to look at it. The third was an old favourite, reforming higher rate pension tax relief.

There are some serious sums to be raised in these areas. Every percentage point increase in corporation tax, currently 19%, raises an eventual £3.4bn a year, so a phased increase of five percentage points, which has been suggested, could bring in an additional ££17bn a year. The government has already turned against the corporation tax mantra of George Osborne and Philp Hammond, cancelling a planned cut from 19% to 17% last April.

The OTS pointed out that capital gains tax raised a relatively small amount, just over £8bn, in comparison with income tax, and covered a relatively small number of taxpayers. Its proposals, if adopted, would widen the net and bring in significant additional revenue.

Pension tax relief costs £21.2bn a year, with most of that going to higher rate taxpayers, with an additional £18.7bn of relief on employer contributions.

The idea that corporation tax could begin to rise in the March 3 budget has already drawn a frosty response. It looks like no way to treat businesses emerging from the worst recession in centuries and, as is likely at the time of the budget, still subject to significant restrictions. The chances of the current lockdown being lifted by then look slim.

Not only that, but only a few days ago the prime minister assembled the great and good from British business to advise him on the post-Covid recovery. I doubt that any of them would say that the best way to do that would be to whack up business taxation. It is hardly a welcome sign to international businesses to invest in the UK, when set against the disadvantages that Brexit will impose. “Global” Britain would look as if it was pulling up the drawbridge.

Some of the attacks on the suggested corporation tax hike, is from the usual suspects, like the Taxpayers’ Alliance and Institute of Economic Affairs, which tend to oppose any increase in tax. But some of it comes from business advisers aware of the signal it would send, not to mention the reality of paying more tax.

Sunday, January 17, 2021
In a post-Covid world, the UK can't be a tech also-ran
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.

It has always struck me as hugely impressive that even as the Second World War was raging, serious thought was being given to the post-war economy. The Beveridge report, which provided the foundations of the modern welfare state, was published in 1942. The Bretton Woods conference, which provided the template for the post war international financial system, including the International Monetary Fund and World Bank, was in July 1944.

The question is whether we are planning similarly, for the post-Covid world, or just trying wearily to get over the line to some kind of normality. The pre-Covid world, to remind you, was one in which Britain had suffered a decade of productivity stagnation and, since the 2016 EU referendum, very weak business investment.

To know what needs to be done, you have to be aware of where you are starting from. If you asked a lot of people in Britain, they would probably take the view that when it comes to science, technology and so-called knowledge-based industries, we do pretty well.

This has been reinforced by the successful development of the Oxford/AstraZeneca vaccine, though other countries have also developed vaccines. Cambridge, also sometimes known as Silicon Fen, stands out as hugely successful, as does London’s fintech (financial technology) sector.

Boris Johnson, in his foreword to the latest Tech Nation annual report, described the UK as “Europe’s number one tech nation” Tech Nation is the body that provides a “growth platform” for UK tech companies and leaders. The prime minister’s boast appears to be based on the fact that there was more than £10bn of inward investment into UK technology businesses in 2019.

We should be optimistic about things that this country is good at, but how close to reality is this boosterish assessment of the UK?

Richard Jones, professor of materials physics and innovation policy at Manchester University, came to prominence last year when one of his papers was quoted approvingly by Dominic Cummings, Johnson’s former chief of staff, last year.

In a blog on his website, Soft Machines, ‘How does the UK rank as a knowledge economy?’, he draws on data from the science and engineering indicators published by America’s National Science Board. It looks at five high R & D (research and development) intensive industries, aircraft; computer, electronic, and optical products; pharmaceuticals; scientific R&D services; and software publishing.

It also includes, as Jones notes, eight medium-high R&D intensive industries: chemicals; electrical equipment; information technology (IT) services; machinery and equipment; medical and dental instruments; motor vehicles; railroad and other transportation; and weapons, as well as some knowledge-intensive services. The UK’s performance relative to other countries is a bit of a jolt for those who believe the “number one tech nation” boast.

“From this plot we can see that the UK is a small but not completely negligible part of the world advanced economy,” Jones writes. “This is perhaps a useful perspective from which to view some of the current talk of world-beating ‘global Britain’.”