One of the most striking developments in the global economy, with direct effects on businesses and consumers everywhere, has been the performance of oil prices. As I write this the price of crude in New York is nudging $60 a barrel and this, I am happy to acknowledge, is not something I had expected. There may yet be worse to come.

A plausible story about oil prices, indeed one I have told here, was that they would spike higher during the invasion of Iraq two years ago, but subside pretty quickly afterwards. This, after all, was precisely what happened during and after the first Gulf war. Then, oil prices rose when Saddam Hussein invaded Kuwait in the summer of 1990, but fell back sharply after the allied victory in early 1991.

Even when this did not happen in 2003, it was possible to argue that this was just a delay. The security situation in Iraq, the insurgency, had made it hard to lift oil output and cast a shadow over prospects for oil supplies elsewhere in the region. But the return to normality, surely, was only a matter of time.

Now, however, we have to recognise a rather different reality. Iraq, it seems, was a red herring in the oil story. While it raised some short-term questions over global oil supplies, the real action was on the other side of the equation – the rise in demand for the precious black stuff.

It is this new reality that recently prompted Goldman Sachs, the investment bank, to come up with the eye-catching suggestion that crude could hit $105 a barrel. That, to put it in perspective, is four times the official $22 to $28 a barrel target range the Organisation of Petroleum Exporting Countries had ahead of the Iraq war.

Goldman Sachs, it should be said, is not predicting that oil prices will stay at $100 a barrel plus. Their forecast was for a “spike”, in other words a temporary move, in prices to this level. In certain circumstances, they warn, that spike could see prices as high as $135. But even the Goldman forecast of longer-term sustainable prices offers little comfort. It predicts an average of $50 a barrel for US crude (so-called West Texas intermediate) this year, rising to $55 a barrel next. What happened to the prospect of a new cheap oil era?

Nor, it should be said, is this an ivory tower forecast. Goldman Sachs is one of the biggest traders in energy derivatives and knows the market well. That does not mean their forecasts will be right; it does mean it comes from a position of some knowledge.

Why are prices so high? We all know the China story, and rising demand from the world’s fastest growing big economy. This remains important, and is the single biggest reason for the tightness of the supply-demand equation in recent years. At current (and rising) levels of demand from China, there is very little spare supply capacity in the world, despite efforts by the OPEC to dampen down prices.

But China is not alone. An important part of the Goldman Sachs forecast is that prices have not yet risen by enough to bring about a cut in demand in America. American motorists changed their driving habits (and the size of their cars) after the two oil shocks of the 1970s. Then, spending on gasoline reached 4.5 per cent of gross domestic product, or 6.2 per cent of personal disposable income. This time, even if we get to $105 temporarily, and stay in $50 a barrel plus territory, the equivalent figures are 3.6 per cent of GDP and 5 per cent of personal disposable income. It could take a spike to $135 a barrel to persuade US motorists to part with their gas-guzzling giant SUVs (sports utility vehicles).

What will be the consequences for the economy and industry of, say, long-term $50-60 a barrel oil prices? Despite some signs that inflation is re-emerging, notably in America, the biggest impact of dearer oil is likely to be on growth, not prices. The proper way of looking at high oil prices is as a tax levied by the producing nations on consuming countries. Like tax, high prices are not something that consumers can avoid.

Britain is relatively well placed compared with other industrial countries, not just because of North Sea oil (though output is in decline) but also because the UK economy is less oil-dependent than America and most EU economies. Some of that, sadly, has to do with our relatively small manufacturing sector.

That is little comfort to energy-intensive sectors, which will bear the brunt of the price rise. I do not think it is going to tip the world into recession but it is not going to be comfortable. Dear oil, it now seems, is here to stay.

From The Manufacturer, April 2005

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The Centre for Economics and Business Research has delved into the Treasury's Public Expenditure Statistical Analysis, and come up with some interesting findings:

Parts of the UK are as dependent on the state as some Soviet bloc countries were at the time communism collapsed, a new analysis based on official figures shows.

It paints a picture of large areas of the country whose prosperity in recent years owes everything to Gordon Brown’s largesse with taxpayers’ money, and which will struggle when spending slows down to more normal levels.

The analysis, carried out by the Centre for Economics and Business Research (CEBR), is based on detailed statistics on public spending released by the Treasury earlier this month.

It shows that in the northeast of England, Wales, Scotland and Northern Ireland, government spending exceeds 50% of their gross domestic product (GDP). In the northeast and Wales it accounts for almost 60% of the economy. In Northern Ireland it accounts for more than two-thirds of its GDP at 67%. In London and the southeast, in contrast, government spending accounts for just one-third of the economy.

“Some of these places are very heavily dependent,” said Professor Doug McWilliams, chief executive of the CEBR. “It’s like a drug — once you’re on it, it is very hard to get off.

“The eastern European countries as they emerged from communism typically spent about 60%, for example Hungary in the early 1990s and the Slovak Republic in the mid-1990s, but they have cut back ferociously since. Today, only Sweden and Denmark are anywhere near these numbers.”

Much of the difference between the UK regions is accounted for by so-called “social protection” spending; mainly state pensions and welfare benefits.

These range from 9.6% of GDP in London to 20.3% in the northeast and 21.3% in Northern Ireland. This reflects not only a higher proportion of people who are unemployed or on incapacity benefit outside the south, but also much greater reliance on state pensions.

But the figures, from the Treasury’s Public Expenditure Statistical Analyses, also show that big increases in employment, education, health and other public services — with job numbers up by about 750,000 since Labour came to power — have had a huge impact.

“Manufacturing job losses have impacted particularly severely on the Midlands and the north,” said David Frost, director-general of the British Chambers of Commerce. “Public-sector jobs have filled the gap, but that can’t carry on for ever.”

The Treasury figures show that since 1998-9, when the current series of figures began, government spending has risen from 53.8% to 58.7% of the economy in the northeast and from 46% to 51.7% in Scotland. Nationally, it has increased from 38.3% to 41.3%.

Economists believe that the “socialisation” of large parts of the UK’s economy will harm Britain’s ability to compete. Some areas will prove impossible to wean off the state, they warn.

“It is a chicken and egg situation,” said McWilliams. “One of the reasons these places have a large public sector is because they don’t have enough private enterprise.

“But one of the reasons they don’t have enough private enterprise is because it is squeezed by a large public sector.

“This analysis shows how great the scale of divergence is between regions, not just in total quantity but also by function. It also indicates that public spending trends in the UK are different from most other countries worldwide, with it growing faster than GDP in the UK whereas it is falling as a share of GDP in the majority of other countries.”

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Today's opinion polls suggest Labour's lead is solid enough to suggest a victory by a margin of at least 100 seats. YouGov in The Sunday Times has Labour on 37% (up 1 on last week), the Tories on 33% (down 2) and the Liberal Democrats on 23%. ICM in The Sunday Telegraph has the lead at six points, down from a stretched-looking 10 a week ago.

Are the polls overstating Labour's lead by underrecording Tory votes? Perhaps, although Labour's lead on economic competence is as big as in 2001. And, in the end, that's what matters.

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A week ago I launched my alternative election coverage — the things they are not telling you about — and got an encouragingly large postbag on the north-south divide. This week’s second instalment was intended to be about pensions.

I cannot, however, quite carry that off, for two reasons. One is that the Tories have indeed tried to make pensions an election issue, and to a certain extent succeeded. The other is that, important though the subject is, the great risk of an article about pensions is that nobody gets beyond the second paragraph, particularly in bed on a Sunday. Other temptations, such as the omnibus edition of the Archers, are simply too great.

So let me try a different tack. One theme here in recent weeks has been that the economy does not feel as good as it should, given an unbroken run of growth stretching back to 1992, when many of the voters who will be casting their ballots in 11 days’ time were still in short trousers. In fact, as far as consumers are concerned, this has been an unusually fertile period.

Roughly speaking, consumer spending should rise in line with gross domestic product. If we take the period from 1948, GDP recorded a real-terms rise of 308%, consumer spending slightly more, 326%.

In the past few years, however, consumer spending has grown nearly one-and-a-half times as fast as GDP. Since 1997, GDP has risen by 20.7%, consumer spending by 27.2%. In every year under Gordon Brown’s chancellorship consumer spending has outstripped GDP. That has never happened over such a sustained period before.

In this, Britain has been something of a “mini me” to America. Stephen Roach, chief economist at Morgan Stanley, points out that US consumer spending has been growing faster than incomes since 1995.

In Britain there have been some special reasons. The pound’s rise, which occurred just before Labour took office eight years ago, gave consumers the benefit of lower prices while making life more difficult for exporters. Business has been prey to the vagaries of the global economy; consumers have been the main beneficiaries of the low interest rates put in place to see the economy through the world’s vicissitudes. Consumers have also been able to tap into the property boom through equity withdrawal (taking out some of their gains from higher house prices).

Most of all, consumers have been able to spend more because they have saved less. The saving ratio, net saving as a percentage of disposable income, dropped from 9.7% when Labour was elected, in the spring of 1997, to just 5.6% last year. It has been even lower under Labour; the lowest quarterly figure was a mere 3.5%.

When we used to be told sternly that we were living beyond our means, the usual symptom of that was a trade deficit. Sure enough, Britain’s trade deficit in goods ballooned from £12 billion in 1997 to £58 billion last year.

But there is another important sense in which we have been living beyond our means, and this is where we come back neatly to pensions.

Goldman Sachs, in a paper entitled How Big is the UK Savings Gap?, attempts to put a figure on this. The paper, by Ben Broadbent, first estimates how much more we need to save as a nation to bring the current-account deficit (£25.7 billion last year) into balance and maintain the UK’s capital stock — in others words, to invest enough to preserve the economy’s productive capacity.

The answer to that question is that savings need to be about £17 billion a year, or 1.5% of GDP, higher. The story, however, does not end there. Broadbent then looks at what the country needs to be saving to offset the effects of an ageing population.

Because we are getting older, the working-age population is set to decline quite sharply as a percentage of the total, from 63.2% in 2008 (slightly higher than now) to 56.7% in the 2030s.

If there is no response to that now in the form of higher saving, the future will be a lot poorer. The fewer workers there are, and the more dependants, the less well-off everybody will be. Roughly speaking, the population would be 10% a head worse off than in the absence of an ageing population. This can be partly offset by longer working, which will surely be part of the government’s solution when presented with the final recommendations of Adair Turner’s Pensions Commission later this year.

Mainly, however, it will require more saving, perhaps £30 billion a year on top of the £17 billion. Rounded, the savings gap is £50 billion.

That gap is not going to be closed overnight but even a modest increase in savings has a big effect on the economy. The Ernst & Young Item Club, in its new forecast to be published tomorrow, simulates the consequences of an increase in the saving ratio from 5%-6% to 7%-8% of income.

The effect is to reduce consumer spending growth this year and next, to only 1.2% in 2006. Significantly, it would usher in a period in which consumer spending would grow at a slower rate than GDP for several years, breaking the recent pattern.

If savings suddenly shot up by £50 billion a year, of course, the economy would dive into recession. This was Keynes’s famous paradox of thrift: more saving is good but too much more, too quickly, is bad.

Are consumers already starting to adjust? Last week’s soft official retail sales figures for March confirmed the change of mood among British shoppers. For the past two years, in fact, consumer spending has barely outstripped GDP. In the final three months of last year it was weaker.

Why is this? Higher interest rates have played a part, as has the squeeze on real incomes described here recently. But maybe, just maybe, people are starting to get wind of the need to save more. And perhaps, too, the penny is starting to drop that the next few years will not be nearly as good as the last.

PS: Is the game up for us interest-rate doves? Does last week’s shock news that inflation jumped to a seven-year high of 1.9% last month mean we should accept the inevitability of an early rise in rates from the Bank of England? Let me deal first with the seven-year-high bit. While this is true for the new consumer-prices measure now targeted by the Bank, it is emphatically not so for the old target measure, the retail-prices index excluding mortgage-interest payments. Inflation on this measure was 2.4% last month, the same as in January last year. It was higher for 14 months, from November 2002 to December 2003. So we should keep the latest numbers in perspective.

The risks of a rate hike are bigger than they were. But this particular dove has not yet flown the cote.

From The Sunday Times, April 24 2005

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You pay you money and you take your choice in this morning's opinion polls. YouGov in The Sunday Times has Labour just one-point ahead on 36% of the vote, against 35% for the Conservatives and 23% for the Liberal Democrats. That would point to a Labour majority of around 50.

In contrast, ICM in The Sunday Telegraph has Labour 10 points ahead on 40%, compared with 30% for the Tories, enough for a landslide majority of about 150. ICM in the News of the World, in a poll conducted only in marginal seats, takes a similar view.

What will it be? Peter Kellner of YouGov, in The Sunday Times, predicts a two-point Labour lead on polling day, and a margin of victory of 70 seats. My long-term view has been for a rather larger majority than that, of 100-120. The reason? Labour is well ahead on economic management. In the YouGov poll Tony Blair and Gordon Brown are two to one up on Michael Howard and Oliver Letwin on this issue. Brown outscores Letwin by three to one.

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The most confusing election debate over tax and spending for years boils down to three simple questions:

Can the efficiency savings all three main parties are relying on through cutting government waste be achieved?

Can Labour meet its promises for public services, and stick to Gordon Brown’s fiscal rules, without raising taxes substantially?

And can the Conservatives simultaneously cut taxes by £4 billion while reducing government borrowing by £8 billion and spending at least as much as Labour on “priority” public services?

Cutting waste

Efficiency savings are this election’s hot fashion item. Two years ago Brown commissioned Sir Peter Gershon, former managing director of Marconi, to investigate the scope for cutting waste in government.

Gershon’s report last summer said up to £21.5 billion could be saved by 2007-8 through a long and detailed series of civil service cuts, reorganisations and efficiencies. As importantly, he said such savings were at the limit of what could be achieved without damaging services.

For the Tories, however, £21.5 billion was not enough. Their efficiency watchdog, David James, identified

£35 billion of savings. Much of this overlapped the Gershon savings, but the Tories announced much deeper cuts in civil service jobs — 235,000 compared with the government’s 84,000 — and specific reductions in government activity.

Most of Labour’s New Deal and the Small Business Service would be scrapped; the Office of the Deputy Prime Minister, John Prescott’s empire, would be reduced to a stripped-down local government department; and the government’s budgets for advertising and management consultants would be slashed.

In all, said the Tories, 72% of their additional £13.5 billion of savings would come from reducing activity.

The Lib Dems have added £5.7 billion to the £21.5 billion of savings identified by Gershon, by abolishing the Department of Trade and Industry, for example, and pulling out of the Eurofighter project.

According to Professor Colin Talbot, director of the Policy Centre at Nottingham University, all three parties are playing “fantasy efficiency savings”. He says only a small part of the supposed Gershon savings will come from job cuts, the record of government in achieving any savings through integrating so-called back office functions is poor, and the idea that there are huge savings to be made from more efficient purchasing is unrealistic.

Talbot is also critical of the Gershon review’s claim that more than £8 billion can be achieved through “non-cash” savings — boosting public sector productivity.
This presents a problem, too, for the Tories and Lib Dems, although Talbot says £12 billion of the £35 billion of Tory savings probably can be achieved because they involve axeing specific government functions, not merely carrying them out more efficiently.

Labour has said it will plough its £21.5 billion back into frontline public services, so a failure to achieve that figure means services will suffer. The same is true for the other parties.

Will taxes rise if Labour is re-elected?

Unlike in 2001, Brown’s aides insist there is no strategy to raise National Insurance (NI) contributions. Plan or no plan, outside economists say taxes will need to rise.

A substantial rise in taxes is already built into the Treasury’s plans. By 2007-8, it says, the tax burden will be nearly 3% of gross domestic product higher than in 2003-4. That is equivalent to £35 billion at today’s prices. The assumption is that this can be achieved by “fiscal drag” — pushing people into higher tax and NI brackets — and a clampdown on tax avoidance.

Outside economists think that will not be enough. The International Monetary Fund has said there will need to be new taxes of £12 billion a year to meet the chancellor’s rules. The Institute for Fiscal Studies (IFS) and other bodies take a similar view.

The Lib Dems are the only party to promise an explicit tax rise, a new 50% rate for those earning over £100,000, raising £5.5 billion a year by 2007-8. The party’s planned switch from council tax to a local income tax is a new tax cut, of £2.4 billion. But a quarter of households, those with incomes above £38,000 a year, would face higher bills.

Having allocated most of their 50% tax hike to free personal care for the elderly, local taxes and abolishing university tuition fees, they would face pressure similar to Labour for other tax hikes.

Can the Tories cut taxes and borrowing while boosting spending on key services?

The independent IFS says yes. An £8 billion cut in public borrowing, combined with Tory plans to increase spending at a slower rate than Labour, would head off Labour’s third-term tax increases. A £4 billion cut in taxes (just over a penny off the basic rate of income tax) would also be affordable, but no more.

There is, however, an important caveat. The Conservatives, like Labour, are relying mainly on cuts in waste and only partly on reducing government programmes. If those efficiency savings are unachievable, as the experts say, the Tories would face the choice between tax cuts and squeezing frontline public services — the same problem that every government has had to confront, sooner or later, in the past.

From The Sunday Times, April 17 2005

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There’s not long left, so now is the time to launch my short series: Things they are not telling you during the election campaign.

Let me start with one important issue, the prospect of deep regional disparities reasserting themselves in the coming years. The north-south divide is on the way back, and this time with a vengeance.

Figures last week gave a hint of the shape of things to come. Unemployment rates on the claimant-count measure rose last month in just three regions of Britain — northeast England, Yorkshire & Humberside and the East Midlands.

The government’s panic over MG Rover, and the questionable use of £6.5m of public funds during a pre-election period to stave off redundancies, unsuccessfully, shows that ministers are not at all confident about the job-generating ability of regions that depend on manufacturing.

Why haven’t regional disparities been at the fore in recent years? One reason is that London and the southeast suffered from the three-year bear market in shares and the downturn in the global economy. According to Experian Business Strategies, London suffered a recession in 2002, its gross domestic product falling by 1%, and managed only 0.4% growth in 2003, before returning to normal (over 3%) last year.

A second reason is that Gordon Brown’s public-sector recruitment drive has been of particular benefit to regions outside London and southeast England. In the north, state jobs account for a much higher proportion of employment, and that proportion is rising. Brown’s deliberate policy of shifting public-sector jobs away from the southeast is reinforcing this effect.

Other policies pursued by Brown have had a significant regional impact. His strategy of redistribution from better-off to poorer households is well known. What is less often noted is that these policies, such as tax credits and the national minimum wage, do not take account of the higher cost of living in the southeast. They therefore have a much bigger impact in the regions.

A third reason is that regional differences look less troubling when the economy is doing well. The northeast’s unemployment rate, 3.9%, is nearly 2½ times the southeast’s 1.6%. But that doesn’t look as bad as it would if the figures were, say, 10% and 4% respectively.

So the government has succeeded in keeping a lid on the north-south divide. All that, however, is going to change. Public-sector employment growth will ease back and normal service will be resumed. Ove Arup and Partners and Oxford Economic Forecasting set out some of this in an excellent recent report for the government, Regional Futures: England’s Regions in 2030.

The north (defined here as northeast and northwest England and Yorkshire) has an abject job- creation record. In the period 1971-2004, just 10,100 net jobs were created, and that includes the recent burst of public-sector jobs. In the Midlands over the same period there were 619,000 net new jobs, while in the south there were 2.73m.

“These trends are unlikely to be reversed in the next 25 years,” the report says. “Graduate employment, R&D, new business formation and other competitiveness indicators are all much higher in London, the southeast and the east of England.”

Closely related to the dynamics of employment growth are those of population. London accounts for 63% of the natural increase in the (English) population and 60% of net inward migration from other countries. Official projections have the regions and counties furthest away from London experiencing population decline or only modest growth over the next quarter of a century, while the population of the south rises by 15%-16%.

The Arup report characterises London as a mega-city, its hinterland taking in a population of 18m, nearly a third of the UK total. There are prospering cities in the north, notably Leeds and Manchester, and in Scotland, notably Edinburgh, but they are dwarfed by London’s scale, influence and reach.

Nick Banks, one of the authors of the report, sees much of the north as still being rooted too much in the industrial society of the past, while the south has adapted to the new reality of a 21st-century, post-industrial society.

The outlook, according to regional forecasters, is for growth in the south to exceed significantly that in the north. The top four regions for growth and employment over the period 2004-12 will be the southeast, the east of England, London and the southwest, according to Experian Business Strategies.

If that looks like a smug, comfortable outlook for the south, it is far from that. The “mega city” that is London suffers from its own success. The southeast’s infrastructure is creaking under the strain and increased congestion means that quality of life is suffering.

The government, sensibly, has rejected the old-style regional policy approach of trying to limit growth in the southeast in the mistaken belief that this will help the north. Unfortunately, it has failed to follow through with the alternative, that of removing enough barriers to growth in the southeast so that the region effortlessly pulls the rest of the country along with it.

Thus, projected new housebuilding is running well behind the growth of households (next time you look at advertisements for new houses check how many of them are outside the southeast).

One big post-election political battle will be over the government’s ability to force through a much bigger increase in housebuilding within striking distance of London.

Meanwhile, investment in transport is running well behind demand. London’s Crossrail project, first proposed in 1989 and endorsed in Labour’s manifesto last week, will not be operating until at least 2013-14.

Can anything be done to achieve a better regional balance in Britain? For as long as I have been writing about this subject people have suggested that technology — distance working — would come to the regions’ rescue. That is not happening, and looks unlikely to do so. Neither manufacturing nor the public sector offers solutions. Economically, the north has to adapt so that it becomes more like the south. And that is a lot easier said than done.

PS: The markets have decided that the election result is a foregone conclusion, hence the lack of any pre- polling day volatility. Investors and traders see Labour returned but with a reduced majority and in some cases, via spread betting, are putting their money where their mouths are.

A narrow Labour victory and a French “oui”, on the other hand, would not be great news for sterling. It would put pressure on the government to get a yes vote in Britain’s own referendum, planned for next year, and reopen old Labour wounds over Europe. All eyes, it seems, will soon be on Paris.

From The Sunday Times, April 17 2005

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At first it was a curiosity. When oil prices rose above $30 a barrel before the invasion of Iraq two years ago, we knew they were following a familiar pattern. Sure enough, once the statues of Saddam Hussein began tumbling, so did the oil price, dropping below $25 a barrel.

But that did not last either. Rather than settling at a non-crisis level, and indeed within the Organisation of Petroleum Exporting Countries’ target range of $22 to $28, the oil price began a fresh climb and hit $40 a barrel a year ago.

That, you might have thought, was that. But it wasn’t. North Sea Brent hit the giddy heights of $50 a barrel last autumn, subsided a bit over the winter, but has been above $55, before dipping late last week. But prices could rise again.

In an eye-catching report, Goldman Sachs suggests that oil prices could “super-spike” to more than $100 a barrel, with US crudes reaching $105 or more. This, it should be said, contains many ifs and buts, and is not intended to be the firm’s main forecast. But even its base case has Brent crude averaging $50-$55 a barrel this year and next, before coming down in 2007.

These are big numbers and raise key questions. Why haven’t prices at this level caused more obvious economic distress? Oil has been associated with some of the great economic disasters of the past, so why not now?

Will there be a big impact on growth, or inflation, or both? Oil plays a central role in the economy: petrol is perhaps the most visible price. People who could not tell you the cost of a loaf of bread would have a fair stab at the price per litre of unleaded. Unless you drive with your eyes closed, never sensible, petrol prices are hard to avoid.

The same is true in America. Petrol is already above $3 a gallon.The threatened rise to $4 is a “nightmare scenario” the White House has been studying, not least because it looks as though it might come true.

Alan Greenspan joined the fray a few days ago, referring to the lack of global refining capacity as “worrisome” but predicting that the “price frenzy” would subside. The Federal Reserve Board chairman also offered the fascinating statistic that 11% of the world’s energy consumption was by vehicles on US roads.

Although Britain is also more car- dependent than ever, and the government admits it will miss its target for cutting carbon-dioxide emissions to 20% below 1990 levels by 2010, oil has less of an economic impact here than it had in the past.

The “oil intensity” of gross domestic product in Britain has declined by more than 60% since 1970. This does not mean that oil demand has dropped by that much. The economy is much bigger, and so is our demand for oil.

It does mean that the ratio of oil consumption to GDP has dropped. So, whereas in the past a 1% rise in GDP was associated with roughly a 1% rise in oil demand, now it means a 0.4% rise. Oil intensity has also dropped, though by slightly less, in other industrial countries.

The reasons are familiar. Industry in general, and heavy industry in particular, has been in retreat, replaced by a less energy-intensive service sector. Energy efficiency has improved; in the past quarter of a century average new-car fuel consumption has fallen by 25%.

It does not mean, emphatically, that high oil prices are an economic non-event. But it does mean we should think about them differently. Higher oil prices push up inflation, and the extent to which this becomes a problem depends on so-called second-round effects; the extent to which they are reflected in higher wages, for example.

Rises in oil prices also reduce growth, particularly in a world where most firms (except the oil companies) find it hard to pass on cost increases. This reduces profits, investment and employment.

Last year the International Energy Agency, together with economists from the Organisation for Economic Co-operation and Development and the International Monetary Fund, carried out simulations on the effect of a sustained $10 rise in the price of oil, from $25 to $35 a barrel.

It suggested that industrial countries’ GDP would be reduced by 0.4% in the first year and by a further 0.4% in the second. Consumer prices would be 0.5% higher in the first year and 0.6% in the second.

Applying this to the $30-a-barrel rise we have seen, assuming that it sticks, would hit economic growth by 1.2% a year for two years, and push prices up by 1.5% to 2%. In a low-inflation world that would be a big hit.

If oil rose to $100 a barrel and stayed there for any length of time, a global recession and much higher inflation — stagflation — would be what the models predict.

Why, with oil well established in the $50-plus range, are we not seeing many of these effects so far? The models could be wrong, although the IEA stressed that its approach was conservative. It may be too soon. We do not yet know whether $50 will stick, let alone that the super-spike to $100 feared by Goldman Sachs will come to pass.

Perhaps, too, policymakers have become more sensible. In the past, higher oil prices would have had central bankers quickly responding with interest-rate rises, thereby exacerbating the impact on growth.

Both the Bank of England and European Central Bank left interest rates unchanged last week. They recognise that dearer oil is a brake on growth. The last thing the economy needs is a heavy foot on that brake.

PS: With an election looming, I’m glad to say this column is maintaining a reputation for balance. The number of readers accusing me of being too soft on Labour is balanced by those suggesting I am a Tory stooge. Most, I should say, are too polite to infer either.

A better question, says Crafts, is whether the recent rise in prosperity has been better than before and here, he suggests, the golden age comes out well on top of the Gordon age.

From The Sunday Times, April 10 2005

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The great economist Adam Smith, who had a cynical attitude towards the motivations of businessmen, once wrote that whenever they got together “the conversation ends in a conspiracy against the public, or in some contrivance to raise prices”.

These days, of course, the prospect of the Office of Fair Trading breathing down your neck means that when businessmen get together they emphatically do not discuss this kind of thing. It is a fair bet, however, that seldom do they meet and the conversation not turn to regulation and red tape.

Red tape is not confined to business. All aspects of our lives have become more regulated, and thus more complicated. The evidence is indeed that we live in a more litigious society, despite the fact that in most respects we lead safer and healthier lives than ever before.

But for business, red tape and regulation is more than an irritant. It costs money and, in some cases, it means that some things are no longer viable. And it is getting worse. According to the British Chambers of Commerce’s ‘Burdens Barometer’, published recently, the cumulative cost to firms of regulations introduced since 1998 is now £39 billion.

This figure is not snatched out of the air. It is compiled by academic experts Francis Chittenden and Chanyeon Hwang of Manchester Business School, together with Tim Ambler of the London Business School and, crucially, all the numbers are extracted from the government’s own estimates in so-called regulatory impact assessments (RIAs).

The £39 billion cumulative cost, in fact, is likely to be an underestimate. It is the cost of the 46 major regulations introduced by the present government (or European Union directives implemented during their period in office). Smaller regulations and some significant policies – most notably the national minimum wage (which is due to rise to £5.05 an hour in October, and £5.35 next year) are excluded.

The really costly regulations included in the calculation are the working time directive, with a cumulative cost of £13.6 billion; the vehicle excise duty (reduced pollution- regulations, £5.5 billion; the data protection bill, £5.3 billion; the control of asbestos at work rules, £1.4 billion; the disability discrimination regulations, £1.2 billion; the so-called National Insurance service provision through intermediaries rules, otherwise known as IR35, also £1.2 billion; and the flexible working (procedural requirements) regulations, £0.7 billion.

“British businesses are fed up with the spiralling costs of regulation,” says David Frost, the BCC’s director-general. “Businesses must be free to compete in the global economy. They simply cannot afford to be held back by the mounting costs of complying with regulation. As well as the cost, firms tell us all the time that they are spending too long dealing with paperwork and trying to get their heads around each and every regulation. Small firms say it takes large chunks out of their day, when they should be concentrating on running their businesses.

“While we recognize the need for proportionate regulation, the government must ensure that new regulations are well targeted and business friendly. Unnecessary burdens are not a sustainable option for our firms.”

Many would agree with his diagnosis, and with his concern that, on top of this, the proposed increases in the national minimum wage will hit firms in certain sectors – usually those already struggling to compete – hard. Red tape and regulation, together with the widespread perception that this is a government that does not really understand how business works, has been the bugbear of companies for the past few years.

What is harder, however, is to demonstrate the damage that this onslaught of red tape is causing. If we look at the big numbers for the UK economy – fifty consecutive quarters of economic growth (a record), record employment and the lowest unemployment for 30 years and, just recently, a revival for business investment, it is hard to claim that this is an economy hamstrung by over-regulation. Britain’s performance, in fact, is demonstrably superior to the euroland average, in spite of our having acquired a lot of new EU regulations over the past few years.

It would be wrong, though, to conclude from this that no damage is being done. The first point is that we do not know what would have happened in the absence of this additional red tape. Britain has done pretty well in comparison with the rest of Europe but less so in relation to other “Anglo-Saxon” economies such as America and Australia. It may be that the re-regulation of the UK economy is to blame for this.

The second key point is that these things take time. It took until well into the 1990s before the labour market reforms introduced when Margaret Thatcher was in office began to show through in improved flexibility. For some thing, there may be a 10-15 year lag between changes being introduced and their impact. By the same token, the red tape now being introduced may not have an adverse effect on the economy until after 2010. And by that time, there will still be plenty of people around ready to say: “I told you so.”

From British Industry, March 2005

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Having promised last week to return to the subject “If Britain is doing so well, how come it doesn’t feel like it?”, first aired here on February 27, I had not expected a gift from the Institute for Fiscal Studies.

The IFS, as many will have seen, produced figures — based on government statistics — showing that average real household incomes, after taxes and benefits, fell 0.2% in 2003-4 compared with a year earlier. This was the first annual drop since 1992 and, as the Treasury’s reaction has made clear, about as welcome to Gordon Brown as another invitation from Tony Blair to dine at Granita.

The figures, which showed in graphic terms the impact of Labour’s post-election tax hike during this parliament, were also a reminder of the probable consequences of further increases (denied by the chancellor) during the next.

To be fair to the government, not everything in the figures was bad. Median, as opposed to mean, incomes rose 0.5% during the year in question. The difference between the two, as every schoolboy knows, is that the mean is simply the arithmetic average of all incomes, while the median is in the middle of the income distribution, with an equal number of households above and below.

The IFS exercise also shows the Blair government in a relatively good light compared with its predecessor, led by John Major (1990-97). Under Labour, mean after-tax real household incomes have grown by an average of 2.5% a year, compared with just 0.8% under Major. The recession of the early 1990s took its toll. But mean incomes grew faster, 2.9% a year, under Margaret Thatcher (1979-90).

How does this fit in with our story of an economy that does not feel as good as it should after 50 quarters of growth and with unemployment at its lowest for three decades? And how does it square with the latest evidence of retailing woes and a cooling housing market? There were two elements to the political calculation underlying Labour’s tax hit highlighted by the IFS. The hit, in the form of the higher National Insurance contributions announced in 2002 but implemented in 2003, was judged by Labour to be saleable as a price worth paying for extra spending on the NHS (although the money went into the general public spending pot). It was also thought it would be forgotten, as a one-off, by 2005.

Whether or not a permanent tax hike should ever be viewed as a one-off hit is debatable, but even after its maximum impact had passed, another force was taking over. The Bank of England, having cut interest rates to a modern low of just 3.5% in July 2003, began to hike them in November of that year, and continued to do so until last August.

These things take time to feed through, but a large part of the explanation for the absence of any genuine feelgood factor is the cumulative impact of this and other tax hikes and higher interest rates, albeit from a low base. Tied to this, however, are some longer-term “downers”, some of which leave people with a feeling of mere disquiet, and some of which create outright misery. Feedback from readers, for which I am grateful, has confirmed which of these are most important.

Pensions/financial insecurity
Britain’s occupational pensions were the jewel in the crown in 1997, and the envy of Europe. Eight years later, after Brown’s tax raid, the bear market and the apparent revelation to actuaries that people were living longer, and the spell has been broken. Trust, most obviously squandered in the case of Equitable Life and companies that have failed and left beneficiaries penniless, has been dissipated, as has access to many final-salary schemes. Without trust, pensions are nothing.

Tie that to the general loss of public confidence in even the most solid names in financial services, a legacy of mis-selling and inept management of funds, and it is hardly surprising people do not look forward with confidence.

Borrowing fit to bust
The jury is still out on whether public borrowing will fall in line with the Treasury’s projections. It clearly has already significantly overshot and is making people understandably nervous about their future tax bills. We should not be surprised by this; the great classical economist David Ricardo predicted such an effect. It is also true, however, that there is a lot of nervousness about private borrowing. That £1 trillion (£1,073 billion to be precise) of consumer debt has its counterpart at the micro level. Everybody, it seems, knows somebody who is about to be made bankrupt by credit-card or mortgage bills. That overstates it a great deal, but it explains why many think this long upturn has been built on sand.

Housing madness
You don’t have to expect a house-price crash to believe there has been something unhealthy about the trebling of prices since the mid-1990s. Lower interest rates could have had an enormous feelgood effect on people’s free incomes (although balanced by the losses to those dependent on interest for their income). Instead, much of the benefit has been squandered in the scramble to trade up, via larger mortgages, in the housing market. Has this created much economic benefit or consumer satisfaction? I think not.

I could go on. Squalor in public places, poor public transport, roads unnecessarily clogged by inept traffic management, the petty legacy of Callaghan-era industrial relations (everybody has an airport story to tell) add up to an economy that still feels more like an old banger than a well-oiled machine. None of this will do much harm to Labour which, as I noted last week, is miles ahead of the Tories when it comes to public perceptions of economic competence. The trouble, perhaps, is that we don’t expect any better.

PS The debate over whether interest rates should rise, and when, had me bemused even before the latest figures for retail sales and house prices (although the Nationwide figures, showing a 0.6% March fall, were not nearly as scary as some reports suggested). Now, even more so, it seems to me that higher interest rates are the last thing the economy needs. But I am here to report as well as opine and that is by no means a universal view.

What will the real MPC be thinking this week? Not about an immediate rate hike; it would be surprising if anybody else joined Tucker and Large at this stage. Longer-term, a significant split will remain between those who argue that the case had already been made for a pre-emptive increase, and those who will not be budged until the data justify it.

From The Sunday Times, April 3 2005

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