Sunday, September 16, 2018
Pay's up - but don't put out the bunting just yet
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.

According to my well-thumbed Collins French-English dictionary, déjà vu literally translates as ‘already seen’. Mostly, however, we think of it as the sensation of having lived through something before, which can be disconcerting.

I say this because, to quote the great American baseball player Yogi Berra, no relation to the bear of similar name, I am getting déjà vu all over again. The source of it is close to home for all of us; pay.

The latest official figures brought news that regular pay in July was 3.1% up on a year earlier, its strongest rate of growth for three years. Private sector pay growth (3.2%) was at a three-year high, while the public sector (3%) has not seen stronger growth in earnings for six years.

For those of who you like these things, if regular pay growth had picked up to 3.2% across the whole economy, it would have been the strongest since December 2008.

The picture for total pay, including bonuses, was slightly less remarkable. It was also up by 3.1% in July but this was only the strongest since last December. Even so, it was better than expected.

So why the sense of déjà vu? It is because this is not the first time in recent years that pay growth has appeared to be breaking higher, only to subsequently disappoint. Just when the Phillips curve appears to be working – the lower the level of unemployment the higher the pressure for pay rises – it has gone on the blink again.

Is it for real this time, or another false dawn? Are we about to see a sustained acceleration in pay growth, to the relief of beleaguered retailers and the government, if not the firms forced to cough up?

Let me first set out the case for the prosecution. One argument for faster pay growth, plainly, takes up straight to the Phillips curve. The unemployment rate did not fall further in the latest three months but at 4% it remained at its lowest since the winter of 1974-5. Back then, by the way, annual pay growth was about 25%. And, while the rate of unemployment may not have changed this summer, its level fell by 55,000 in the May-July period.


Those who think something is definitely stirring, such as George Buckley, an economist with Nomura, the Japanese investment bank, point to other ways of measuring the acceleration in pay growth as slack in the labour market is used up. Annualised private sector pay growth in the past six months is 3.4%, he points out.

There is another factor, highlighted by the Bank of England in the minutes of its latest meeting, the outcome of which – an unsurprising interest-rate hold – was announced on Thursday. One of the factors holding pay down in recent years is that people have been more reluctant to change jobs than in normal times.

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Sunday, September 09, 2018
Austerity had to be done - but did it lead to Brexit?
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.

When looking for the real-world impact of the events of a decade ago, people who had never heard of Lehman Brothers then, and may still not have heard of them now, will be able to tell you two things. One is that stagnant productivity has gone in hand with stagnant real wages; in both cases the worst performance not just for decades but for centuries. The other is austerity.

I shall leave productivity and wages for another day, though there is always something new to say. There is also something new to say on austerity, particularly in the context of the Commission of Economic Justice report published a few days ago, and championed by Justin Welby, the archbishop of Canterbury.

It is easy to forget just how much the events of the autumn of 2008 transformed, for the worst, the economic and fiscal outlook in Britain. The Treasury’s March 2008 budget, under the title “Stability and opportunity: building a strong, sustainable future”, was six months after the run on Northern Rock and in the same month that Bear Stearns, th4e US investment bank, hjad to be bailed out.

The outlook, however, was expected to be barely clouded by these events, with growth predicted of 2% in 2008, 2.5% in 2009 and 2.75% in 2010. The budget deficit would be 2.9% of gross domestic product in 2008-9, 2.5% in 2009-10 and 2% in 2010-11.

If you don’t want to know the score, look away now. This was when the then Labour government insisted it was meeting its fiscal rules and the policy of the Tory opposition, crafted by David Cameron an d George Osborne, was to “share the proceeds of growth” been tax cuts and higher public spending.

The earthquake that hit the economy and the public finances rendered such talk obsolete. The growth numbers turned out to be very different. The economy shrank by 0.3% in 2008 and 4.2% in 2009, making it the biggest post-war recession, before a modest return to growth, 1.7%, in 2010. The deficit, government borrowing, went off the scale, with figures of 7.3% in 2008-9, 9.9% in 2009-10 and 8.5% in 2010-11. Over those three years, borrowing was a staggering £319bn higher than the Treasury expected in March 2008.

Unlike now, the differences between the parties on the appropriate response to this were small. Tories were un happy with the idea of a short-term fiscal stimulus to ease the impact of the recession at a time of already high government borrowing. But the fiscal stimulus, largely in the form of as temporary Vat cut and ideas like a “scrappage” scheme for old cars, was quite small.

Both main parties were agreed that there was no alternative to deficit reduction – austerity - through a combination of tax hikes and public spending cuts. Tory austerity under Osborne was intended to achieve its goals of eliminating most of the budget deficit more quickly, and Labour would have relied on tax hikes (including the 50% top rate it announced before leaving its office). But there was no serious political disagreement that, faced with a budget deficit of 10% of GDP (higher on initial figures), there was no alternative but to act.

There were, of course, plenty of noises off among economists arguing against austerity, and that the appropriate course for a weakened economy was for the government to spend , more, rather than less. I never argued, as some did, that austerity itself could provide a stimulus, by lower long-term interest rates. But I did think there was no alternative.

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Sunday, September 02, 2018
The Amazon effect has kept a lid on prices - but not for much longer
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.

We live in a time of generally low inflation, and have done for some time. That may not be true of Venezuela, once lauded by Jeremy Corbyn, where the inflation rate has just topped 80,000% and the International Monetary Fund thinks it could hit the one million per cent mark by the end of the year; the kind of rate where people are obliged to carry even redenominated banknotes around in wheelbarrows.

But it is true in most countries. Looking across the advanced world, America’s inflation rate of nearly 3% is at the top of the range while Japan’s, just under 1%, isn near the bottom. Eurozone inflation is 2%, while Britain has a 2.5% rate. No big economy has a serious inflation problem.

Independent central banks can take much of the credit for that and, in fact, since Bank of England independence in 1997 – Gordon Brown’s greatest legacy – Britain’s inflation rate based on the consumer prices index has average exactly 2%, in other words it has been bang on target over the period as a whole, even if it has deviated from that target most months.

The Bank and its counterparts elsewhere would be the first to admit that other factors have been at work in this shift in the global inflationary environment. Some of these factors – the China effect, the rise of the discounters and the impact of Amazon and e-commerce in general – fall into the same category. They brought about a step-change down in prices, squeezed the margins of traditional manufacturers and retailers but brought significant benefits for consumers.

It was once common to talk about the China effect on inflation. Low-cost imports of goods from China dragged down inflation. The result was often that prices of goods fell year upon year – goods price deflation – even as service-sector inflation remained above the overall 2% target.

The China effect has not gone away but it is not what it was, and over time it became more complicated. China as a source of cheap goods also became a country which, because of its sheer size and rate of growth, put much upward pressure on oil and commodity prices..

The China effect and the impact of discount retailers on inflation were closely related. It is an impact that persists, notably in the grocery sector, though not enough to prevent a pronounced, mainly weather-related rise in food prices in coming months, which the Centre for Economics and Business Research has warned about.

Elsewhere, however, that effect too is diminishing. The pound shop model, if not broken, is under strain. Pound shops selling increasing numbers of products for over £1 are never going to have the same impact on inflation, though their approach did change the pricing behaviour of other retailers.

Another effect, the impact of Amazon and e-commerce, is however an apparently enduring one. The rise of online retailing, now such a key element on everyday life, has been swifter than you might think. According to official figures, online retailing accounted for less than 3% of all retail sales as recently as late 2006 and early 2007.

Now it is 17.1% on an unadjusted basis, having hit a high of 19.9% in November last year as a result of “Black Friday”. Assuming another Black Friday this autumn, and this is one US invention I would prefer to have seen staying on the other side of the Atlantic, a new record is likely to be broken. In a seasonally adjusted basis, July’s 18.2% online share was a record.
The benefits in lower prices of internet retailing have not necessarily been evenly spread; the young and computer-savvy being bigger beneficiaries than older consumers and those for whom the online marketplace is a minefield.

But the effect has permeated through to all retailers and is one of the sources of high street distress. Lower internet prices mean even John Lewis cannot claim to be never knowingly undersold in comparison with online-only rivals but it like most successful bricks and mortar retailers has had to embrace online retailing.

How big has the impact on inflation been of e-commerce? Central bankers are mainly clear that there has been an impact. Jerome “Jay” Powell, the chairman of the Federal Reserve, told the Senate Banking Committee earlier this year that the “Amazon effect” had been a factor keeping inflation low since the financial crisis.

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Sunday, August 26, 2018
As the budget defciit falls, Hammond's task is clear
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.

For a chancellor there are few things more comforting than good news on the public finances. And the latest news, released a few days ago, was good. The downward momentum for the budget deficit established by George Osborne from 2010 has been maintained by Philip Hammond.

A budget surplus in July is not unusual but this July’s, of £2bn, was the best for 18 years. Borrowing – the deficit – in 2017-18 was £39.4bn, the lowest for 11 years, and the last pre-crisis year of 2006-7. Borrowing so far this fiscal year is the lowest for 16 years.

The Office for Budget Responsibility (OBR), the fiscal watchdog, is not given to hyperbole but it noted the “substantial year-on-year improvements in the deficit”. In celebration, the chancellor may have been inclined to add to booming alcohol duty revenues - - up 7.4% or nearly £300m this year compared with last – with a tincture or two of his own.

The question is what to with it. While all eyes may be on the European Union, a tax-cutting experiment is under way on the other side of the Atlantic. Donald Trump may have had other things to think about in the past few days but his aggressive cuts in corporate and personal taxes have provided a significant spur for America’s economy.

There is also the argument, first set out in this newspaper immediately after the EU referendum, that some of those aggressive tax cuts, specifically a cut in corporation tax to 10%, from 19% now, would boost investment and help maintain Britain’s attractiveness to inward investors during the current period of Brexit uncertainty. Hammond himself once talked in a German newspaper interview of adopting a different economic model for the UK. That was always said to be one of the EU’s fears.

Tax is one thing, spending another. The National Health Service has had its 70th birthday present, in the form of additional spending building up to more than £20bn a year by the early 2020s. Other departments, creaking under the strain of eight years of austerity, want presents too, and lots of them.

So how will all this go down at the Treasury, as the chancellor starts detailed preparations for his autumn budget? The watchword I think will be that, while the public finances are better, they are not yet out of the woods.

Government debt, at nearly £1.8 trillion (there are 11 noughts in that figure) is still rising and, while it has started to edge down relative to gross domestic product, it is still a high 84.3% of GDP. It has risen by £1.25 trillion in 10 years and, as reported here recently, is on a trajectory that could see it rise alarmingly from the early 2020s, mainly because of demographic factors.

As for the deficit, the OBR has been having a bad time with its borrowing forecasts in the past couple of years, overestimating the impact of slower growth on the public finances. Its November 2016 forecasts were for borrowing of £68.2bn in 2016-17, £59bn in 2017-18 and £46.5bn in 2018-19. This compares with outturns of £45.8bn and £39.4bn respectively for the first two years, and what looks like roughly £30bn this year.

The Treasury will gratefully grab this improvement relative to the forecast, which adds up to roughly £50bn, with both hands. But it is also aware that there has been significant slippage in the public finances compared with what was expected quite recently. So if we take the OBR’s projections a year earlier, in November 2015, a big gap is starting to emerge. 2016-17 was roughly right but the 2017-18 deficit was projected to be under £25bn, this year less than £5bn and next year, 2019-20, a budget surplus of more than £10bn. Some of that slippage reflects policy changes; most is due to slower growth.

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Sunday, August 12, 2018
A no-deal Brexit - the silliest of silly season ideas
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 a time of year when it is customary to talk about the silly season for news, and one prominent example of it has been running for the past few days, Boris Johnson. When it comes to Brexit, meanwhile, it has not so much been the silly season this summer as the stupid one.

I refer, of course, to the idea that a no-deal, cliff-edge Brexit next March is something we should not fear. Indeed, you sense that some are slavering at the prospect.

With one bound we would apparently be free of the European Union; free of those sneery continentals Michel Barnier and Jean-Claude Juncker; free of the requirement to pay the so-called divorce bill of about £39bn, and ready to negotiate buccaneering trade deals with the rest of the world.

And, just in case anybody is worried about the disruption, the shortages of foods and medicines, the massive queues at Dover and other ports that would follow a disorderly Brexit, apparently the rules of the World Trade Organisation would prevent anything like that happening.

Liam Fox, the international trade secretary, told this newspaper in an interview last week that the chances of no deal were 60-40 and, in a separate interview, that no deal would be preferable to the prime minister seeking an extension of the Article 50 negotiating timetable. That suggests to me that the trade secretary needs to do some work on the effects on trade of a no-deal Brexit.

Sir Bernard Jenkin, the Brexit-supporting Tory MP, said fears that no-deal being hugely disruptive were like those of the millennium bug panic almost two decades ago. The analogy is a poor one. An enormous amount of time, money and effort went into testing and adapting systems, to deal with a technical change. A no-deal Brexit is no mere technical change, and few would say that a huge amount of time, money and effort has been expended on it.

The truth is, as business is rightly starting to warn, a no-deal Brexit would be dangerous, disruptive and expensive, with much of the cost being incurred by consumers. It is surprising to me that so many Brexiteers either enthusiastic or blasé about the prospect.

If anything were calculated to give Brexit a bad name it would be a chaotic Brexit hitting people’s day-to-day lives. Nor is the no-deal talk doing anything to strengthen the prime minister’s negotiating position. The EU recognises bluster when it sees it, and that no sane government would risk crashing out of the EU and subjecting its economy and its citizens to an unnecessary shock.

Let us take the different aspects of no-deal in turn. Could Britain escape the £39bn divorce bill or, as the new Brexit secretary Dominic Raab has suggested, make it conditional on the EU negotiating a trade deal? The answer to that, apart from the fact that the EU is willing to negotiate a trade deal, though not necessarily the one the government wants, is no.

The divorce bill represents Britain’s liabilities to the EU, incurred in the expectation of continued membership, less assets such as Britain’s share of the capital in the European Investment Bank. It has to be paid, unless this country wants to embark on its new era by defaulting on international obligations.

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Sunday, August 05, 2018
A curiously downbeat rate rise. Is it going to hurt?
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.

Lord Keynes once memorably hoped that economists should be thought of as “humble and competent” people like dentists, a statement that students of the great man have been debating the meaning of ever since.

But if, as is likely, he meant that economists should be thought of as technocrats, quietly going about their business, Thursday’s interest rate rise was very much like a visit to the dentist. I don’t mean that it was particularly painful but there was no fanfare to mark the moment when Bank rate moved above the emergency 0.5% level it has occupied for almost the past 10 years.

There were no dancing girls, or boys. No banners outside the Bank. Mark Carney, the Bank governor, is not given to rhetorical flourishes, or the carefully-honed sporting analogies favoured by his predecessor, but his determinedly technocratic explanation of why the official interest rate had been raised to 0.75% ensured that nobody got too excited. Given that the markets had fully priced-in the announcement by the time it occurred, perhaps excitement was too tall an order.

It was, nonetheless, an important moment, and it was important – and perhaps the only surprise – that the decision was unanimous. A split vote on the nine-member monetary policy committee (MPC) had been expected. I have argued before that when the Bank broke out of the long period of ultra-low rates it was important that every member of the MPC was signed up to it.

That was not so in November, when the Bank reversed the emergency Brexit rate cut, and hiked from 0.25% to 0.5%. It was this time, and that is a good thing.

Was this unanimity reflected in the strength of the case the Bank made for raising rates? In my time following these things, I have witnessed approaching 70 increases in UK interest rates. The past 10 years have thus been unusually fallow.

Most rate rises have fallen into two categories. Traditionally, the reason for raising rates was to stem a slide in the pound. Either the markets transmitted to the authorities that policy was too loose by selling the pound, or action simply had to be taken to stop a sterling rout and its subsequent inflationary effects.

That was the traditional reason. Since Bank independence in 1997, however, it is hard to recall a single example of a sterling-driven rate hike. The other reason for raising rates, which at times has been screamingly obvious, is to slow an over-exuberant and thus inflationary economy. At the end of the 1990s, when the Bank took charge and the economy grew by more than 3% a year for four years in a row, it was not hard to argue for rate rises.

Times have changed. Though sterling has been soggy, and remained so after the rate rise, it was not the culprit. Similarly, nobody would say that, other than the passage of a very long time with interest rates at emergency low levels, it was screamingly obvious that they had to go up now.

One of the other traditions about rate rises is that they are not generally welcomed by business organisations. Sure enough, the British Chambers of Commerce described Thursday’s hike as “ill-judged” while the Institute of Directors accused the MPC of having “jumped the gun”. Did they have a point?

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Sunday, July 29, 2018
Will they or won't they? A big moment for the Bank
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.

We have arrived at another of those moments for the Bank of England, for two reasons. Markets, not for the first time, expect the Bank to provide a cooling draught in the summer heat by raising interest rates on Thursday. And there is also keen anticipation among Bank-watchers about a new form of guidance on interest rates it will release at the same time.

Let me take the two things in turn. Market expectations of a rise in interest rates this week from 0.5% to 0.75% are, as I say, high, roughly 90%. I do not need to tell you that we should treat these expectations with caution. They have been wrong before on rate rises and were spectacularly wrong in both Britain’s EU referendum and Donald Trump’s presidential election victory.

Markets do not, however, operate in a vacuum. Expectations of a rate rise this week were boosted by a narrowing of the monetary policy committee (MPC) vote to leave them on hold to just 6-3 last month, with one of the three including the Bank’s chief economist.

Unlike in May, there has been no real attempt to pour cold water on the prospect of an August rise. Then, anticipating a weak first quarter, Mark Carney nudged the markets away from a rise. This time the Bank has been mainly happy to go with the flow. The closest to a dampener was a speech by deputy governor Sir Jon Cunliffe, who argued in favour of “stodginess” in raising rates.
If markets are disappointed on Thursday by the absence of a hike they will have some justification.

For me, it comes down to a battle between two arguments; those based on the data and those arising from the strategic. As I wrote here a couple of weeks ago, the argument for a rate hike based on the data is rather a weak one, an argument that has been reinforced by subsequent news.

Thus, inflation stayed at 2.4% last month rather than picking up, earnings growth decelerated, retail sales fell, though not by enough to derail a strong second quarter and the overall growth bounce in April-June, to an expected 0.4%, is modest by past standards.

The debate does not, however, end there. The Bank does not just rely on back data, the rear view mirror, in making its decisions, but what it anticipates about the future. In this, two things are important: the economy is close to full capacity, as evidenced by, among other things, the lowest unemployment rate for more than four decades. At the same time, its speed limit – its ability to grow – has come down in the Bank’s estimation to about 1.5% a year, not much better than half what it was in the 2000s.

It does not, in other words, take much growth to put upward pressure on an economy already close to capacity. The fact that recent data do not suggest it is yet happening, far from excludes it happening in the future. On a forward-looking view, notwithstanding the potential for further Brexit-related economic damage, the case for a rate rise is stronger.

It is also stronger if you believe, as many central bankers do, that it is healthy to “normalise” interest rates, in other words take them away from the emergency settings established during the financial crisis. That is part of the strategy of the Federal Reserve in America, which already has several rate rises under its belt, and will sensibly ignore Donald Trump’s expressed displeasure at rate hikes.

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Sunday, July 22, 2018
Why Britain's debt is on a dangerous trajectory
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 most important, and very worrying, economic report in recent weeks came a few days ago from the Office for Budget Responsibility. For what it said about the outlook for the public finances and in particular the explosion of government debt in coming decades it did not get the attention it deserved.

The OBR’s fiscal sustainability report does what it says on the tin, it looks at the sustainability of the public finances over the long-term. They are not, judging by its latest report, remotely sustainable. Let me provide a little context.
Before the global financial crisis, one of Gordon Brown’s two fiscal rules as chancellor was the sustainable investment rule. This held that public sector debt should be limited to no more than 40% of gross domestic product over the economic cycle.

When the crisis hit, inflicting profound damage on the public finances and exposing Labour’s aggressive increases in spending in the run-up to it, it was a shock to discover that it would take a generation to get over the effects of the crisis. The debt soared, both in absolute terms and as a percentage of GDP. Projections showed that, even on the basis of tight spending controls, it would not be possible to get debt back down to 40% of GDP until the early 2030s. As hangovers go, this was a very long one.

It got worse. The OBR’s June 2015 fiscal sustainability report, published a month after the general election that year, suggested that George Osborne’s policy of achieving a budget surplus by 2020, and maintaining it, would succeed in reducing government debt from more than 80% to 54% of GDP by the early 2030s, but then it would then start to rise again, reaching 87% of GDP by the mid-2060s, largely because of the impact on spending and to a lesser extent tax revenues of the ageing population. That self-imposed limit of 40% of GDP under Brown’s chancellorship, swept away in the crisis, appeared gone for ever.

If that seemed very gloomy, let me tell you that you ain’t seen nothing yet. The OBR’s new projections show that in the short-term, government debt will come down, from 85.6% of GDP in 2017-18 to 80% by 2022-23. Figures on Friday showed that this process has begun. After that, however, the OBR’s baseline projection is for debt to exceed 100% of GDP by the early 1930s and to be a massive 282.8% of GDP by 2067-68. Ignore the decimal point and the precision of the numbers and this is still very scary. It would imply, in today’s prices, public sector debt of nearly £6 trillion, or more than £90,000 for every member of the population.


To put it in context, the all-time high for government debt to GDP was reached in the immediate aftermath of the Second World War, 252% of GDP in 1946-47. Then, there was a clear route to running down the debt by reducint the huge proportion of the economy claimed by the public sector in wartime. This time, the debt would still be on a rising trend half a century hence, although as the OBR puts it pithily: “Needless to say, in practice policy would need to change long before this date to prevent this outcome.”

How have things got so much worse so quickly? Three years is not, after all, a very long time but, it seems, has resulted in additional net debt of nearly 200% of GDP in 50 years’ time.

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