Sunday, November 19, 2017
Hammond needs a few rabbits if he is to hang on to his hat
Posted by David Smith at 09:00 AM
Category:

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My regular column is available to subscribers on www.thesundaytimes.co.uk This is an excerpt.

The traditional task of a chancellor at budget time is to take on the role of conjuror by pulling rabbits out of what appears to be an empty hat. Philip Hammond’s task on Wednesday is slightly different; the hat really is empty yet for his survival and that of the government he has to come up with some significant rabbits.

Budgets, it should be said, rarely change very much and, when they do so, it is often for the worst. The City is expecting a dour budget, given the very limited room for manoeuvre. But unless a few bouncing bunnies appear at Wednesday lunchtime, the chancellor’s first unified autumn budget could also be his last. I hope not.

One of those rabbits, almost certainly, will be on housing, of which more in a moment. Theresa May does not visit new housing developments for nothing, as she did last week, though she avoided the hi-vis jacket she once mocked George Osborne for turning into his uniform of choice.

Some of the budget, almost certainly, will involve creative accounting. The hat is empty , or nearly empty, because, as discussed here two weeks ago, the Office for Budget Responsibility (OBR) will downgrade its productivity assumption, removing most of the wiggle room the chancellor had allowed himself in meeting his fiscal rules.

The announcement on Wednesday that productivity, measured by output per hour, jumped by 0.9% in the third quarter, after falling in the first half of the year, will not stay the OBR’s hand. It will see this rise, brought about mainly by a fall in hours worked, as firmly in the ‘one swallow doesn’t make a summer’ category. The chancellor will want to address productivity weakness in his budget.

It isn't all bad news. The OBR, in forewarning of its productivity downgrade, pointed out that this will be partly offset by higher employment. This year's borrowing undershoot will carry over, in part, to future years.

The decision by the Office for National Statistics to reclassify housing associations back to the private sector is technical,and has no impact on the underlying state of the public finances. But it will reduce headline borrowing by perhaps £5bn a year relative to what it would otherwise be, and lower debt, and chancellors do not look this kind of gift horse in the mouth.

The pressure for higher spending, on the National Health Service, education, fixing universal credit and any number of other things, is intense,

The Treasury has been looking at ideas that will enable the chancellor to meet his fiscal target of a budget deficit of less than 2% of gross domestic product and falling debt (relative to GDP) by the end of the parliament, while giving him the leeway to spend more in the meantime.

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Sunday, November 12, 2017
Time for a pay rise? Let's see some productivity first.
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

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My regular column is available to subscribers on www.thesundaytimes.co.uk This is an excerpt.

Something, it seems, is stirring on pay. After years in the doldrums, and with pay growth apparently stuck at 2% when inflation is 3%, two surveys in the past few days have suggested that, finally, things are beginning to pick up. Bearing in mind that there have been plenty of false dawns before, is this at last the moment?

One of the surveys, from the Bank of England’s regional agents, clearly influenced the monetary policy committee (MPC) when it raised interest rates earlier this month. It suggested that, in comparison with pay increases this year of 2% to 3%, the outlook for next year was somewhat higher, 2.5% to 3.5%.

The other, from the Recruitment and Employment Confederation (REC), a monthly survey of recruitment agencies, suggested that shortages of available candidates are starting to have an impact on pay. Starting salaries for permanent staff rose at their second strongest rate since November 2015.

“Anecdotal evidence suggested that candidate shortages and strong competition for staff had driven up starting salaries in the latest survey period,” the REC said. “Data indicated that rates of pay inflation were sharp across all monitored regions, with the steepest increase seen in the South of England.”

Unite, the union, is urging 9,000 Ford production workers at Ford – always a trendsetter – to accept a pay offer worth 4.5% in the first year and a minimum of 6.5% over two years.

In many respects this is not a huge surprise. Unemployment, at 4.3% of the workforce, is at its lowest rate since 1975. If the traditional Phillips curve, the inverse relationship between wages and unemployment, means anything, it should mean bigger pay rises when unemployment is this low.

Recruitment difficulties, as highlighted by the Bank’s agents and the REC survey, are increasing. Some employers are already suffering the loss of EU migrant workers, or are having to compensate for the drop in their earnings expressed in euros, Polish zlotys or other foreign currencies as a result of sterling’s post-referendum weakness.

Inflation, 3% on the basis of the consumer prices index, 3.9% according to the retail prices index, is running ahead of pay, so real wages are falling. In the past, the current combination of inflation and unemployment would be associated with average earnings growth of 5%, not 2%.

If this is the moment, it would be a cause for some celebration in official circles.
The Bank would be even more convinced that it is doing the right thing in gradually raising interest rates. Faster growth in wages would be good for the public finances and ease some of the political pressure on the government. Beleaguered retailers would have a little less to worry about.

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Sunday, November 05, 2017
A bad news budget will follow this bad news rate hike
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

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My regular column is available to subscribers on www.thesundaytimes.co.uk This is an excerpt.

So it happened. The Bank of England was not crying wolf this time and this time the boyfriend was not unreliable. There has been a wailing and gnashing of teeth from some in response to the first rise in interest rates for more than 10 years but that seems overdone.

A quarter-point rate hike is both small and fully reversible. The Bank’s credibility would have been damaged had it not acted. It cut rates last year when the purchasing managers' surveys for construction, services and manufacturing were plunging. It has raised them at a time when those surveys are stronger than expected, though confidence is weak. It was the right thing to do.

Beyond that, I do not want to dwell on it too much. The arguments were set out here last week. One thing that is worth of comment, however, is that this was a “bad news” rate hike. In the long fallow period since the last time interest rates went up there was an understanding that, when the moment came, it should be greeted as good news.

This is not because savers outnumber borrowers, which they do, but because it would be a signal that the economy was strong enough to come off emergency support. The start of normalisation would be something to celebrate.

This was not that rate hike. It came because inflation is above the official 2% target and set to stay there for some time. It came, more importantly, because the supply-side of Britain’s economy has been so badly damaged – now capable of growing by only 1.5% a year without generating inflation – that it had to happen even though growth is weak.

Through the fallow years, similarly, there was an implicit understanding that it deficit reduction – austerity – meant that fiscal policy was contractionary, it was appropriate for monetary policy, as set by the Bank, to be aggressively expansionary.

Members of the monetary policy committee (MPC) would argue that it still is; they like to use the analogy of easing off on the accelerator rather than slamming on the brakes. But the idea that monetary policy would only be tightened after the task of deficit reduction was complete, and austerity over and down with, has also taken a knock.

We will have to wait a few months for the next increase in interest rates but the next big economic policy announcements, in Philip Hammond’s budget on November 22nd, are only 17 days away.

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Sunday, October 29, 2017
The case for a rate rise may be weak - but the Bank should do it
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

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My regular column is available to subscribers on www.thesundaytimes.co.uk This is an excerpt.

Small numbers can make a big difference. Had the third quarter gross domestic product figures come in at 0.3% a few days ago, this column would have been a lot more challenging to write. Yes, a rate rise this week from the Bank of England would still have been more likely than not, but it would have been a very close call.

As it was, of course, the GDP figure came in at 0.4%, weak by normal standards but stronger than the Bank and the markets expected. Now it will be a considerable surprise if we do not see a quarter-point rate hike on Thursday.

It is not, of course, a nailed-on certainty. When the Bank said in September that a majority of members of the monetary policy committee (MPC) favoured what is described as a removal of some monetary stimulus in coming months, it did not name a date.

Two MPC members, Sir Jon Cunliffe and Sir Dave Ramsden, have indicated that they will not be supporting a hike. The small difference in the GDP number may not have convinced them that growth is anything but weaker than it should be.
They may also be worried about what is coming down the track. Ramsden was the Treasury’s top economist while Cunliffe led the work 14 years ago on Gordon Brown’s famous “five tests” exercise, which kept Britain out of the euro.

Even so, the expectation is that they will be in a minority on Thursday, with the City looking for a 7-2 vote for a hike. That, perhaps, is the Bank’s first difficulty.
In the long wait for an interest rate hike, which now stretches for more than 10 years, I had always thought that when the moment came it would be a big and important enough moment for it to be a unanimous vote.

Others disagreed but my argument was that if you could not convince everybody around the table of the need for a tightening, how could you expect to convince the public and business?

This brings me onto the Bank’s second problem. Again, when thinking ahead to this point, I expected we would reach a time when the case for a rise in interest rates would be both unanswerable and easy to explain in layman’s terms.

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Sunday, October 22, 2017
Mind the skills gap, or we really will struggle
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

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My regular column is available to subscribers on www.thesundaytimes.co.uk This is an excerpt.

The Organisation for Economic Co-operation and Development (OECD) attracted headlines this week by saying that leaving the European Union will damage the economy and stifle growth for years, and that Britain’s best interests will be served by maintaining the closest possible ties with the EU.

It is right, but this is familiar territory. Nor do I want to waste time on the saboteurs, including former Tory cabinet ministers, who would have us leaving the EU without a deal, on WTO (World Trade Organisation) terms. I dealt with the consequences of that in my “Still clueless on Brexit” piece a couple of weeks ago. There are none so blind as those that will not see.

Instead, it was another aspect of the OECD’s Economic Survey of the UK I wanted to focus on this week. It explains why so many British employers have been glad of the supply of migrant workers, and in particular those from the EU. It also has worrying implications for the future, in the sense that if things do not improve we will struggle.

I refer to the problem of low skills and poor education. According to the OECD, more than a quarter of the UK workforce has low basic skills, identified as low levels of numeracy, or literacy, or both. Many, as identified by the Leitch Review of Skills more than a decade ago, are functionally illiterate. Though definitions vary, one commonly used measure of this was an inability to look up something simple in the Yellow Pages like finding a plumber.

The proportion of young people, 16-24 year-olds, with these low basic skills, 30%, is high in Britain compared with other countries. In addition, and in contrast to pretty well everywhere else, the proportion of the young with low skills is similar that for older people, those in the 55-65 age group.

The norm elsewhere in the advanced world is that younger people are better educated than older age groups. In Britain, disturbingly, that is not the case.


And, while some have sought to blame low-skilled immigrants for weak wages and low productivity, the evidence is that most of the problem of low skills is home grown.

As the OECD put it: “The productivity of low-skilled workers is weak in the United Kingdom, and some estimates suggest that their contribution to aggregate productivity growth has been negative. Insufficient skills could explain the high reliance of the UK economy on immigration. Between 2010 and 2016, average annual GDP per capita growth was 1.2%, out of which increases in hours worked per capita of immigrants explain nearly 60%. Over the same period, the contribution of native workers was about nil.”

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Sunday, October 15, 2017
Don't give up the ghost entirely on Britain's productivity
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

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My regular column is available to subscribers on www.thesundaytimes.co.uk This is an excerpt.

The biggest UK economic news this week came from an unusual source. When the Office for Budget Responsibility (OBR), reviews its own forecasts, as it does regularly, this is normally one for the nerds and pointy-heads.

But, without wishing to align myself too much with either group, the latest Forecast Evaluation Report from the government’s fiscal watchdog had bite as well as bark. One Treasury official described it as a “bloodbath” for the public finances.

The issue is a straightforward one, which has appeared on many occasions in this column. Productivity is the key to prosperity and living standards. Higher productivity – more output for every worker or hour worked – determines the growth of real wages and the economy’s ability to grow with a given size of workforce. It is, as the economist Paul Krugman once memorably put it, not everything, “but in the long run it is almost everything”.

It is also intimately linked to the state of the public finances; government debt and deficits. Productivity growth has a direct impact on tax revenues and establishes the economy’s “speed limit”. The lower that speed limit, the more difficult it is to grow your way out of a budget deficit. As the OBR puts it: “Other things being equal a downward revision to prospective productivity growth would weaken the medium-term outlook for the public finances.”

The significance of its latest assessment is that the OBR has been dutifully waiting for something to turn up on productivity for many years. Every year since 2010, when it came into being, it has assumed a recovery in productivity growth to its long-run average of around 2% a year. Every time it has been disappointed.

Even when all the ducks have been in a row for a rise in productivity, it has failed to happen. Instead of a 2% annual rise in productivity, the past five years have delivered just 0.2% a year. Productivity is no higher than it was a decade ago, when a normal performance would have delivered a 20% rise.

So, while the OBR has not said precisely what figures it will use to underpin the November 22nd Budget, it has said it will be “significantly reducing” its assumption for productivity, to bring it more into line with the recent disappointing experience.

The story of how it has got to this position reads a little bit like a Whodunnit. Post-crisis productivity weakness is not confined to Britain but the gap with other countries – German output per hour is 36% higher than British, France’s 29% - is embarrassing.

One of the first explanations for the weakness of productivity in Britain was that firms had hoarded labour during the 2008-9 recession, during which employment fell a lot less than feared. With a surplus of workers relative to output, productivity weakness was not surprising.

However, as the OBR notes, that explanation “became less appropriate once firms began hiring again”, so attention turned to other factors.

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Sunday, October 08, 2017
Clueless on Brexit - and it is taking its toll
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

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My regular column is available to subscribers on www.thesundaytimes.co.uk This is an excerpt.

Give Us a Clue was a popular TV show featuring the entertainer Lionel Blair. It was also what Tony Blair, no relation I think, was reported to have said to Gordon Brown when the latter, as chancellor, was refusing to divulge his budget plans to his prime minister.

Give us a clue is back, though in a more important context. Sixteen months on from the EU referendum, and less than 18 months until Britain’s formal departure, business still does not have much of a clue about Britain’s future relationship with the EU.

It is, frankly, astonishing that so far into the process, the government does not have a Brexit blueprint that it can communicate. This is not, to be clear, to avoid showing our negotiating hand to the EU. There is no blueprint.

Leaving aside the difficulties she encountered during her Manchester speech, the furthest Theresa May could go in her more substantive Florence speech last month was to say that neither a Canada-style free trade agreement with the EU (which took seven years to negotiate), nor Norway-style European Economic Area membership – staying in the single market but not the customs union – would suit Britain. We thus know what the government is against, but not yet what it is for, a familiar Brexit position, and the frustration is growing.

“Businesses are clear that they want a comprehensive transition period, lasting at least three years, and pragmatic discussions on the future trading relationship between the UK and the EU firmed up by the end of 2017,” said the British Chambers of Commerce. “They will judge the government’s progress on Brexit by this yardstick and will take investment and hiring decisions accordingly.”

The Institute of Directors attacked “the big let-down” of the party conference season and the fact that “far too little time has been spent explaining the plan for how we leave the EU.”

This is not just a matter of the convenience of business. Those that have made contingency plans for a Brexit deal that falls well short of what they need to operate in the EU and have either pressed the button on those plans or are close to doing so. Sam Woods, a deputy governor of the Bank of England, warned a few days ago that if we get to Christmas and no agreement has bene reached on transition arrangements what he described as “diminishing marginal returns” will kick in. The City, in other words, will take action on the basis of no deal and no transition.

The economy, meanwhile, is prey to the uncertainty. The construction sector is struggling because of a lack of new projects and may be back in recession, while service sector growth has slowed. The economy is crawling along, with the third quarter of the year set to similarly weak growth as the first two quarters.

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Sunday, October 01, 2017
Lessons in how to wreck an economy
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

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My regular column is available to subscribers on www.thesundaytimes.co.uk This is an excerpt.

This is the way economies descend into chaos and failure. A weak and divided government, out of energy and ideas, capitulates to the most left-wing Labour government in recent times. The difficulties of Brexit are compounded by an anti-business, anti-enterprise agenda.

Two years ago this would have been the stuff of fantasy, a “what if?” scenario that had no chance of becoming reality. Voters, we thought, would never support anything like this. Now, it is becoming a serious possibility.

There is clearly a direct link between Brexit, and the way in which in last year’s vote unfolded, and the fact that Labour could talk confidently at its Brighton conference about forming the next government without being laughed off stage.

Without Boris Johnson and Nigel Farage, we would not be talking about the prospect of Jeremy Corbyn and John McDonnell getting their hands on the levers of power, not so much Little England as Little Venezuela.

Fake news has a lot to answer for, as well as misuse of statistics. But so too do the warnings of an immediate and damaging economic fallout following the referendum and, indeed, a Donald Trump victory in last year’s presidential election. The negative economic impact of the Brexit vote is, of course, already apparent but the danger is that people will take with a pinch of salt warnings of the adverse consequences of a Labour victory.

This is despite the fact that McDonnell, the shadow chancellor, has rather cleverly said that Labour is “war-gaming” the run on the pound that would follow an election victory for his party. By doing so, he was following a Labour tradition. In 1964, George Brown and Harold Wilson, secretary of state for economic affairs and prime minister respectively in the 1964-70 Labour government, criticised the “gnomes of Zurich” who were selling the pound. By pitching himself against the speculators, the shadow chancellor has pitched himself into a battle in the court of public opinion which he can win.

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