This is the year when the Blair premiership comes to an end but it should also, barring a political earthquake, mark the end of the Brown chancellorship. Most of the attention, inevitably, will focus on the former; Tony Blair’s decade in charge. But Gordon Brown’s length of stay at the Treasury is, in many respects, no less remarkable.
It is nearly three years since Brown became the longest-serving chancellor of the modern era, beating David Lloyd George, who did the job for just over seven years from 1908 until 1915 (on his way, via the War Office, to 10 Downing Street).
The present chancellor is unlikely to beat Nicholas Vansittart, the 1st Baron Bexley, who served from May 1812 to December 1822. And he will not beat William Gladstone’s cumulative 12 years as chancellor, though that was achieved over a 30-year period in four separate spells.
Brown’s achievement has been to have lasted as long as he has in what is generally regarded, in today’s high-pressure world, as one of the most demanding jobs in government. In the post-war period, only Nigel Lawson – six and a half years from 1983 to 1989 – comes anywhere close.
Perhaps he (Brown) had an early inkling of the long haul ahead when he made the Bank of England independent within a few days of taking over at the Treasury. Not for him, from then on, the need to agonise over interest rate decisions and then tour the radio and television studios to explain them. And not for him something that had dogged every previous Labour chancellor – a sterling crisis. The two things are related; the pound’s stability owes much to the fact that the Bank, in its nearly 10 years of independence, has built itself a strong reputation in the financial markets.
How will history assess the Brown chancellorship? It is easy, and not a little cruel, to say that much of the action was, rather than being spread over 10 years, concentrated in the first 10 weeks or so. Did he know in May 1997 that nothing would surpass, in importance, the Bank decision? Perhaps not, but it is true.
Brown’s supporters would argue that announcing Bank independence was one thing; making it work was another. The chancellor has direct control over the appointment of the four “external” members of the monetary policy committee (MPC), and indirect control over the choice of the Bank governor and his deputies. As importantly, he has had to resist the urge to interfere, or even comment, on Bank decisions. That must have required some self restraint from a politician who likes to have fingers in most pies.
His supporters would also argue, less convincingly, that what has happened on the fiscal policy side, notably the two self-imposed fiscal rules, has been almost as important as monetary policy. They would also point to the decision to make competition policy independent of government, free from ministerial interference, with the Competition Commission inquiring into markets, mergers and regulation, usually in response to an Office of Fair Trading recommendation.
Whether it was just the Bank, or whether it was a bit more than that, it is hard to find too much to criticise in the macroeconomic record of the past 10 years. Any chancellor who leaves office having presided over growth in every single quarter can be proud (Kenneth Clarke did so too, but over four years, not 10). But unless the economy takes a dive in the next few weeks, that will be Brown’s achievement. Continuous growth has been accompanied by low levels of both inflation and unemployment.
But has he made the most of this benign economic environment, and has he left the economy in a better shape than he found it? Both public spending and the tax burden have risen sharply, and the public finances, despite the rules, have shifted heavily into the red. In effect we have seen two chancellors. “Austerity” Brown, the one in charge for the first couple of years, succeeded in reducing public spending to just 37.1 per cent of gross domestic product in 1999-2000, from the 40.8 per cent he inherited in 1997. “Expansionary” Gordon has pushed it back up to 42.5 per cent this year, an extraordinary rise in six years or so.
The picture on taxation has been more consistently upwards, from 34.8% of GDP in 1996-7, to an estimated 37.3 per cent in 2006-7 (with further increases built into the numbers). Austerity Brown appeared bent on repaying the national debt, running a budget surplus of 3.8 per cent of GDP in 2000-1. Expansionary Gordon, in contrast, is running a deficit of 3 per cent of GDP.
There is more, of course, to tax and spend than just the numbers. Critics would say that Brown’s legacy is a tax system of enormous complexity, in an economy that has been extensively re-regulated. They would also point to relatively poor return for taxpayers’ money in terms of improvements in public services.
Brown’s aides dispute claims that higher taxes have undermined the economy (though the CBI and others have highlighted the fact that the UK business tax regime is no longer internationally competitive). There is, however, a degree of exasperation at the Treasury that public services have not improved more, particularly as Brown’s last act as chancellor will be a comprehensive spending review that will impose a tough squeeze on departmental budgets. We are back to traditional Treasury thinking – the best way to achieve public sector efficiency is to keep the financial reins tight.
Is Britain more or less competitive, in general, than when Brown took over? Taxes and red tape would suggest not. But Britain remains an attractive location for foreign investors, even stripping out big takeover deals. There are areas of the economy, most notably the City of London, where Britain’s competiive advantage has increased.
As always, it is a mixed picture. The macroeconomic record is good but the rest is at best debatable. Mind you, Brown may yet have time to make amends. Even more than Margaret Thatcher in her heyday, Brown as prime minister will be his own chancellor, even if the job title goes to Alistair Darling or Ed Balls. In this respect, at least, he could have a few years running the Treasury left in him.
From Business Voice, February 2007
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Barely a week goes by without news of a new takeover of a British “asset” – a UK company – by a foreign firm. This year we have seen BAA, the airports operator, taken over by Spain’s Ferrovial, and O2 being acquired by Telefonica, also from Spain. Other recent instances of high profile firms falling into foreign hands include P & O, Pilkington and Associated British Ports.
Why is this spate of foreign takeovers occurring, and does it matter? The figures show that it is not just an impression that UK plc is being snapped up by foreign buyers.
Official statistics show that in the first quarter of 2006 foreign companies paid £19.4 billion in taking over businesses in Britain. On the other side of the balance sheet, overseas acquisitions by British firms were a mere £6.8 billion.
Figures like these are always likely to be distorted by large “lumpy” transactions and, sure enough, the first quarter numbers were significantly boosted by Telefonica’s £17.7 billion takeover of O2. In the other direction, there were few big deals, the most significant being Old Mutual’s £3.4 billion purchase of Skandia.
There is, however, a pattern here. In 2005 British companies spent £32.7 billion in 365 transactions buying overseas companies, but this was swamped by the £50.3 billion spent on acquisitions by foreign firms in the UK. Foreign takeovers are fewer in number - last year there were 242 in total - but they are typically bigger in size.
Britain went into “deficit” on mergers and acquisitions relatively recently, the shift occurring in 2004, when foreign takeovers in the UK were worth £29.9 billion, against £18.7 billion of British acquisitions abroad.
Before that, for many years, British firms had ensured that, in net terms, UK plc steadily built up its assets. Between 1996 and 2003, for example, British firms spent £469 billion acquiring overseas companies; an average of nearly £60 billion a year. Foreign acquisitions in Britain, in contrast, totalled only £234 billion. Each year, the balance was heavily in Britain’s favour – we were more predators than targets.
There is another element in the story. British firms with existing investments abroad are scaling back their overseas presence at a faster rate than foreign firms are in the UK. UK disposals overseas in 2005 raised almost £13 billion, against £8 billion of foreign disposals in Britain.
Why is this occurring? Part of the reason is the breakdown in the old cosy relationships between British firms and their institutional shareholders. Hedge fund managers tend to be less sentimental, perhaps, than shareholders were in the past.
The shareholder base of many quoted UK firms now tends to be both wide and varied, and usually includes a high proportion of foreign-based shareholders. Times have changed from the days when the old boy network meant that shareholders would stay loyal to the existing management, often through thick and thin. That is still the case in Germany, Spain and many other continental countries, but rarely in Britain. The loyalty of shareholders is to themselves and the clients for whom they are managing funds. That means, very often, firms are up for grabs by the highest bidder.
British firms are also often cheap relative their overseas competitors. The underperformance of the London stock market in recent years, coupled with the continued strength of sterling, has made British firms attractive to foreign predators.
The wave of foreign takeovers has also undoubtedly been helped by the green light provided by the government. Since it was elected in 1997, the Labour government has had a very different philosophy to its predecessors.
Ministers have argued that the only way to create a competitive UK economy was to expose all sectors to the maximum amount of competition. That has meant encouraging free trade at a global level; it has also meant free movement of capital. Foreign takeovers, on this view, have benefited the economy.
They also, argue ministers, benefit employees. Research from Nottingham University showed that workers in firms taken over by foreign firms enjoy 13 per cent higher wages, partly on the back of an improved productivity performance.
But how much is too much? Some in business are concerned that foreign predators have unfair advantages, to do with the structure of their shareholdings, borrowings and tax system. Telefonica and Ferrovial, for example, benefited from Spanish tax relief on the goodwill acquired in taking over foreign firms.
Business concern about the ease with which foreign firms can acquire UK targets is shared by voters. A Harris poll in June found that 68% of people in Britain though it was “too easy” for overseas companies to take over UK firms.
This was higher than in countries which have acted to block foreign takeovers. In Germany, 57% of people thought takeover controls were too lax, in France 52% and in Italy 50%. There’s a balance in these things. Perhaps we should indeed be asking whether we in Britain have got the balance right
From The Manufacturer, July 2006
The European Union has had five enlargements in its history, which now stretches to nearly half a century (slightly more if you date it from the start of the European Coal and Steel Community). From a British perspective the most important was in 1973, when the UK, along with Ireland and Denmark, joined the original six of Germany, France, Italy, Belgium, the Netherlands and Luxembourg.
That 1973 enlargement had a profound effect on the EU, and continues to do so, probably much more than the three subsequent expansions that took in Greece (1981), Spain and Portugal (1986) and Austria, Finland and Sweden (1995).
It is doubtful, however, whether any of the EU’s enlargements have had as big an immediate effect as the one that occurred in May 2004. That was when what had become the 15 were joined by Cyprus, the Czech Republic, Estonia, Hungary, Latvia, Lithuania, Malta, Poland, Slovakia and Slovenia.
Before this latest enlargement fears were expressed that the new members would impose a burden on the existing EU, through both the Common Agricultural Policy and the EU budget more generally. Some of the rich EU countries undoubtedly looked down on those joining the club. In fact, the impact has been almost wholly positive.
Not only does the new EU of 25 have a different dynamic than its smaller version (though this was of no help in the task of securing public backing for the Constitution) but the new members have been very influential in other respects.
In Britain, the most obvious impact of the latest enlargement has been on the labour market. Coming at a time when Britain’s job market was very tight and employers were complaining of serious skill shortages, the effect of the arrival of migrant workers from the new member states, particularly those in eastern Europe, was beneficial.
The Bank of England, in its latest inflation report, published in November, noted that new estimates suggested the working-age population was 136,000 higher than previously thought, and that much of the increase was to do with arrivals from the “new” Europe. Britain has had a more liberal attitude towards immigration from the new members than other EU countries and has particularly felt this effect. Direct migration from the 10 countries which joined the EU in May 2004 is officially estimated at 75,000.
Throughout this period the Bank’s regional agents have found in conversations with companies that business has been turning with enthusiasm to this new source of labour supply. The workers themselves appear enthusiastic to come to Britain, and with good reason. Not only has the government taken a liberal attitude to immigration but gross earnings in Britain are roughly six times those in Poland and Hungary.
Indeed, there is tentative evidence that employers prefer eastern European workers to the extent that some of the existing unemployed are being squeezed out. The Chartered Institute of Personnel and Development sees this year’s combination of rising employment and a steady increase in claimant unemployment as a reflection of this. Faced with competition from better qualified immigrants, some indigenous workers are missing out.
In the main, however, the effect is of benefit to Britain’s economy. According to the Bank: “Overall it seems likely that net migrant flows to the United Kingdom have acted to reduce inflationary pressure in the past. In the future, these flows might be expected to continue raising potential supply, and provide some further boost to demand.”
Low-cost labour among the new member states is, of course, having an impact even in those EU countries that have restricted migration. The threat of transferring jobs to eastern Europe has been a significant factor in allowing corporate Germany to push through changes in working practices.
Perhaps even more important than this for business, though, is the impact on taxation. Everybody by now knows of the flat tax revolution started by Estonia in 1994, with a flat tax on corporate and personal income, and followed by eight other countries, including not only Latvia and Lithuania but also Russia. Flat taxes have made governments and oppositions think again about the complexity of their tax systems. George Osborne, shadow chancellor at time of writing, has launched a tax commission to examine aspects of flat taxation that could be introduced in Britain.
The tax impact of the new member states goes beyond merely that of sparking a flat tax debate, however. For a start, the new members have lower tax burdens than existing EU countries. Lithuania and Latvia have tax burdens of 28.5 and 29 per cent of gross domestic product respectively. Most of the new members have burdens of less than 40% of GDP. This compares with almost 51 per cent in Sweden and typical burdens of 45 to 50 per cent in “old” Europe.
One possibility, clearly, is the new members will converge to the relatively high tax levels of longstanding EU countries. The signs are, however, that this is not occurring.
As far as corporate tax rates are concerned, the new members have long recognised that low rates are a surefire way of attracting inward investment. The average headline corporation tax rate in the 10 accession countries in 2000 was 27.4 per cent. Now it is 20.4 per cent. Driven by this tax competition on their doorstep the existing member states have respond. The average corporation tax rate in the old EU-15 has fallen over the same period from 30.5 to 30.1 per cent. The biggest cut has come in Germany, which is where it was probably needed most.
Some EU member states have been unhappy with this drive to lower tax rates. As Gaëlle Blanchard of Societe Generale in Paris points out: “The low-tax policies of the new states prompted some of old countries’ governments to call for an EU minimum company tax standard. Tax harmonisation appears however quite remote since the rejection of the European Constitution by France and the Netherlands.”
In place of harmonised corporate tax rates the Commission is pushing for a harmonised EU corporate tax base. Again, however, this appears quite remote, not just because of opposition from the new members but also from Britain and Ireland.
The new member states have, by and large, an economic philosophy built on low tax rates and flexible markets. The models they look to are those established by Britain (flexibility) and Ireland (low tax rates), rather than those of, say, France and Germany. Their impact is a breath of fresh air within the EU. Long may it continue.
From Business Voice, December 2005/January 2006 edition
When we look back on 2005, will we think of it as one of those odd years when oil prices temporarily spiked higher, to subside just as quickly? Or is this the beginning of a new era of expensive oil, with permanently high prices.
The record, $70.85 a barrel for crude oil at time of writing, may well have been broken by the time you read this. The American government has said that prices will top $70 a barrel again before the winter is out, and will average $63 next year. Morgan Stanley agrees, expecting a 2004 average of $64 a barrel (a barrel is equivalent to 35 imperial gallons).
If that sounds like an aggressively high forecast, what about Goldman Sachs, which has warned of the possibility of a “superspike” to $105 a barrel, and expects prices to average $68 a barrel next year and $60 a barrel over the next five years?
Or how about the Canadian Imperial Bank of Commerce (CIBC), which predicts an eye-catching average price of $84 a barrel in 2006 and $93 in 2007? The price, it says, will rise to $100 a barrel by the fourth quarter of that year and stay there.
These are big numbers. Some of them, it should be said, come from organisations that have taken large positions in the oil market. That does not mean their forecasts are wrong, or in any way coloured by those market positions, merely that some people have a vested interest in high oil prices, at least for now.
So plenty of people think this is indeed a new era of expensive oil. The arguments are familiar ones. Oil demand is increasingly rapidly, most notably from China and India – rapidly growing and speedily industrialising. But demand is also strong elsewhere; in America and in the Middle East, where oil producers are developing their own “downstream” activities such as petrochemicals.
Supply, meanwhile, is tight and precarious. The margin between demand and supply this year has sometimes been 1m barrels a day or less, compared with a normal level of 2-3m barrels or more. Oil supplies are threatened by war, revolution, pestilence and flood. The insurgence in Iraq hangs over the country’s oil industry, which a couple of years ago the optimists expected to be firing on all cylinders by now. The death this year of King Fahd in Saudi Arabia resurrected fears about the longevity of the country’s pro-western regime. Governments in many oil-producing countries, for example Ecuador and Venezuela, are either unstable or hostile to America.
America itself, of course, suffered severe supply disruptions when Hurricane Katrina struck in late August, wiping out oil production and refinery output. The effect was temporary but underlined the fragility of supplies.
There are those who think these supply disruptions, which have been coming thick and fast, are a symptom of a more general problem for oil. Is the stuff running out? The idea of a global peak for oil, a so-called Hubbert peak (after M King Hubbert, a geologist who in 1956 correctly predicted the early 1970s’ peak for US oil production) is a popular one. Oil production in the UK sector of the North Sea, which was extraordinarily useful to the British economy, has already passed its peak and is now in decline.
Some forecasters, however, see the risks of decline even among those states we generally regard as having limitless supplies of oil. Matthew R Simmons, in a book published this year, Twilight in the Desert: The Coming Saudi Oil Shock and the World Economy (John Wiley & Sons) argues that Saudi oil production comes mainly from mature fields that are looking long in the tooth, and that output is only being maintained by methods such as water injection. He argues that oil output from the Kingdom is at or near maximum sustainable levels and will go into decline in the near future.
So does this tell us that this is indeed a new era of expensive oil, and that $100 a barrel will soon become the norm? The first thing to say is that this has been said every time oil prices have spiked higher – in 1973-74. 1979-80 and 1990-91. Each time prices have subsided sharply, usually resulting in very low prices.
By 1984 the world had got used to the higher prices established by OPEC a decade earlier, but then prices collapsed, dropping below $10 a barrel. There was a similar sharp fall after the first Gulf War of 1990-91. The 1990s were largely a cheap oil era and the world economy benefited as a result.
The idea of unfettered demand also needs challenging. Last year saw an unusually big increase in oil consumption in China and America but that has not carried into this year. Nor, according to the International Agency, will it do so next year. Some of the more aggressive oil prices forecasts are based on an extrapolation of the 2004 demand rise. That looks unrealistic. For one thing, oil demand itself responds to high prices.
We should also tread warily on the idea of supplies running out. There are clearly geopolitical worries now and the threat of terrorist attacks directed at oil installations. But it is a stretch to move from these worries to the idea that the oil will no longer be there. Big supply increases are coming through from places like Russia. High oil prices are leading to a rise in exploration activity, including incidentally in the UK sector of the North Sea.
For all these reasons, part of the current high oil price looks speculative. History tells us that prices never stay very long above the equivalent, in today’s prices, of $40 a barrel. History is usually a pretty good guide on these things. The normal laws of supply and demand have not been suspended. I wouldn’t bet on prices getting to $100 and staying there. But I would bet on them dropping back below $40 a barrel.
From Professional Investor, November 2005
When it comes to “shocks” that could undermine the world economy most recent attention, understandably, has been on the oil price. As the price of crude hit new records over the summer questions were asked about the ability of the big economies to grow through it, particularly given the grim past relationship between oil and past global recessions.
All the caveats this time are justified. The advanced economies are less sensitive to oil than they were, thanks to the decline of big energy-using heavy industries. Those countries that still are highly energy-intensive, like China, genuinely do have enough momentum to grow through it.
Oil will have an effect. World economic growth will be weaker next year as a result of the rise in prices we have seen so far. If global growth was going to be 3.5 to 4 per cent, it will probably now be nearer to 2.5 to 3 per cent. That, however, is a long way, from recession.
Could something other than oil creep up on us and provide a recession-inducing shock to the world economy? For some time health experts have been warning that the world is overdue another major influenza pandemic, following the 20th century’s notable episodes.
Most people are familiar with the Spanish flu pandemic of 1918-19, easily the most serious, which killed an estimated 50 million people worldwide, including half a million in America. The worldwide death toll, famously, was roughly three times the number of military and civilian deaths in the First World War.
Other notable 20th century pandemics, the Asian flu of 1957-58 and the Hong Kong flu of 1968-69, were less serious but still represented major public health challenges. In America, for which detailed data is available, Asian flu killed 70,000, Hong Kong flu 30,000.
Are we due for the next big one? According to the World Health Organisation, influenza A type H5N1, usually known as bird flu or avian flu, is endemic among birds and animals in Asia. In August, in response to its spread to migratory birds in Russia, the Dutch government instructed all farmers to take their chickens indoors, to help protect them from the disease. Other European governments also took preventative steps.
As far is as known, more than 100 humans in Asia have contracted the disease, and half of these have died as a result. As far as is also known at time of writing, all caught it from animals or birds, rather than in human-to-human transmission. A degree of scepticism is, however, in order; reporting and disclosure standards in Vietnam, North Korea and China may not be what they should be, as was discovered in the case of SARS (severe acute respiratory syndrome) two years ago.
Already governments are stockpiling vaccine for use against avian flu. Significantly perhaps, because there will not be enough to go around, the priority in any vaccination programme in Britain and elsewhere will be key government workers, including some politicians, those working in essential services and others concerned with maintaining the basics of society. The implication is that if the flu strikes in a big way, the economy will be effectively wound down to operate on a skeleton basis. Even that may be easier said than done.
As one WHO official put it, talking about what could happen on a global scale: “Billions would fall sick; billions more would be too afraid to go to work, leading to a collapse of essential services.” This is not, it should be emphasised, the usual kind of winter flu we are familiar with in Britain.
All this suggests that the economic impact could be huge. According to a recent report by BMO Nesbitt Burns, a Canadian stockbroking firm, this could indeed be the case. The headlines about its report, An Investor’s Guide to Avian Flu, suggested a publicity-grabbing exercise but this is not so. It is a sober, well-researched exercise. And Canada, which was hit hard by the SARS outbreak in Toronto in 2003, is perhaps more attuned to the dangers than we tend to be in Britain.
Dr Sherry Cooper, the firm’s chief economist, says that the prospect would be of a vicious circle of declining activity. In the case of SARS, Hong Kong’s economic growth rate was halved and Ontario suffered 28,000 lost tourism jobs and a £1 billion drop in revenue. A mass outbreak of avian flu in humans would dwarf these effects.
She writes: “Businesses would voluntarily quarantine a meaningful proportion of their essential staff at remote locations to have a stand-by team in case of emergency. Large cities with dense populations in residential, shopping and office space would be most harshly impacted. People would shun high-rise office buildings and large condos, not because of terrorism but instead because of nature’s microbial attack. Stockpiling of basis food, drug, water, energy and safety supplies would initial lead to shortages and skyrocketing prices.
“In relatively short order, the deceleration of almost all non-essential economic activity would trigger a rampant decline in spending. Then, deflation and high levels of ‘involuntary’ unemployment would set in. Households would be unable to make their mortgage and credit card payments. Businesses, as well, would default on their debt.”
The really scary thing about a global flu pandemic, of course, is that we have a global economy. The interconnectedness of the world would multiply the vulnerability of countries to the economic effects of any pandemic.
Cooper likens the possible effect, in terms of hitting world trade and the movement of people, to America’s Smoot-Hawley Tariff of 1930, notorious for helping plunge the global economy into slump. Indeed, as she puts it: “Its economic impact could be comparable, at least for a short time, to the Great Depression of the 1930s.” China and India, the two fast-growing emerging giants of the world economy, would be particularly hard hit because of the close proximity of many people to their animals and birds in these countries.
It may never happen. Experts have been warning of a global flu pandemic for a long time; one day they will be right but not necessarily yet. The economic effects of SARS, it is fair to say, were widely predicted to be worse than they turned out to be.
Even though, this is one to be watched closely. We tend to look for the economic dangers emanating from economic sources. Sometimes those dangers come from elsewhere. And the potential dangers from avian flu are not to be sneezed at.
From Business Voice, October 2005
Another look at the UK's fiscal situation, written for Professional Investor.
From well before the general election last May until just before the politicians disappeared for their holidays in late July one question dogged Gordon Brown. Would he repeat the tactic he used after Labour’s two previous election victories and raise taxes after a decent interval has elapsed?
Or, as the chancellor insisted repeatedly during the election campaign – and continued to insist after it – would it be different this time? Could the public spending plans really be affordable so the £10 billion of tax hikes long regarded as necessary by the Institute for Fiscal Studies and others will not be needed?
In July we had part of the answer to that question. There had been a big risk that the chancellor would break his own “golden rule” of only borrowing to fund investment. The consensus among analysts was that an economic cycle beginning in 1999-2000 and ending in 2005-6 – the Treasury’s working assumption – would see an overall deficit when it came to the balance between current spending and receipts.
Brown, however, neatly extracted himself from that one, albeit at considerable cost to the credibility of his golden rule. By seizing on revised growth figures from the Office for National Statistics, he was able to put the start of the economic cycle back to 1997-8, add in the healthier public finances for that period, and give himself a margin of error for meeting the rule. At the stroke of a statistician’s pen, his tax dilemma appeared to be solved.
Or was it? The bigger issue has always been not the narrow question of whether the golden rule will be met in the current cycle but whether tax revenues will rise by enough to fund the government’s spending pledges going forward.
The public finances are not obviously getting much worse. But they are not getting better, as the Treasury predicted. Nor has the chancellor had much help from the economy. The sharp slowdown in consumer spending and the housing market is directly reflected in lower indirect tax revenue – VAT, stamp duty and the rest. High oil prices are benefiting the Treasury, by enough for Brown to be able to postpone the excise duty hike on petrol and diesel which had been due on September 1. But the net effect is that revenue growth is weaker than the Treasury was counting on. Meanwhile, there is no let-up in the growth in public spending.
A budget deficit that owes something to weaker economic growth is not in itself a reason to put up taxes. Even so, and after his statistical sleight of hand, Brown faces a predicament. He is the runaway favourite to succeed Tony Blair if the prime minister sticks to his pledge not to fight another election (a pledge it would take a Houdini-like escape to get out of). Would the British public warm to Brown when he has just put up their taxes?
That is why I don’t think we will see another highly visible tax hike like the 1 per cent NI increase, for both employees and employers, announced in 2002, worth an extra £8 billion a year to the Treasury.
Instead we’ll see a lot of reliance by the Treasury on fiscal drag – raising extra tax from people as they move into higher tax brackets. We will also see a huge amount of emphasis on closing tax loopholes, for both individuals and companies, some of which will involve tax hikes in all but name. There will also be an emphasis on value for money throughout government. If public spending does not quite increase in line with plans from now on, that will be attributed to efficiency savings, not going slow on programmes. The next spending review, now postponed until 2007, will be tough. The watchword, I think, will be to avoid a big upfront increase in taxes. Stealth taxation is back – if it ever went away.
Will it work, as both an economic and political strategy? George Osborne, the shadow chancellor, argues that even without further tax increases Britain is losing tax competitiveness. Five years ago only 10 of the 30 advanced industrial countries had corporate tax rates lower than in Britain. Now 20 countries do and others are examining the possibility of reducing their rates.
Osborne has been studying the flat tax revolution sweeping through former parts of the Soviet empire. The flat tax, discussed here in June, is not easily transferable to economies such as Britain’s. But it provides a good indication of the way things are heading. Countries see low taxes as a way of attracting inward investment, and of positioning themselves in the global economy. In Britain, in contrast, tax rates are largely seen as a domestic matter.
The Treasury’s counter to this is that there is no evidence yet that changes in Britain’s tax regime are having an adverse effect. Recent official figures produced by UK Trade and Investment, the body responsible for attracting projects to Britain, show that a record number of new investments came from overseas during 2004-5.
Nearly 40,000 jobs were created from 1,066 projects, an increase from the previous year’s figure of just over 25,000 jobs from 811 projects. Nearly a quarter of the projects, 240, were in IT and software, up 61 per cent on the previous year.
Alan Johnson, the trade and industry secretary, said: “International comparisons continue to show the UK as Europe's top investment destination.” But he warned that the challenges would grow. Britain, he said, had to move forward by “adding value and exploiting technology”.
All this is true. But tax is important too. International firms are increasingly footloose, as they have shown by migrating to countries with low labour costs. They will also move toward countries with the lowest tax rates. It is not, by any stretch, the only factor that drives international investment. But it is an important one. The risk is that, both for the great bulk of firms operating in Britain, and those thinking of coming here, tax will become a significant handicap.
Add to that the risks to the wider economy of higher taxes and the inference is clear. We all have an interest in avoiding another round of tax hikes – and of taxes going up too much by stealth.
From Professional Investor, September 2005
A lot of ink has been used up, and airtime wasted in the past few weeks, analysing the decision by the people of France and the Netherlands to reject the proposed constitution for the European Union. The “no” votes from two of the EU’s six founder members, in late May and early June, which effectively killed off the constitution, were attributed variously to concern over the “Anglo Saxon” nature of the treaty to protest votes against national governments.
Such complicated explanations are, however, unnecessary. All elections are, in the end, “pocketbook” elections. People vote, in other words, according to the state of their wallets and purses. In France and the Netherlands they voted against the constitution because the EU, far from bringing the prosperity associated with its early decades, has become synonymous with economic failure.
Ask the man or woman in the street in Paris or Amsterdam, or for that matter London or New York, for a thumbnail sketch of the European economy and you can bet they will give you a description that includes high unemployment and slow growth. Not all of them will correctly diagnose the cause of this as the rigidities of the EU economy, and in particular its labour market, but they will know that Europe, once an economic success story, is now struggling.
A decade ago, there was little to choose between unemployment in Britain and the 12 countries that make up “euroland”. Both had jobless rates of around 10 per cent of the workforce. Since then, however, UK unemployment has more than halved and stands at 4.7 per cent on an internationally comparable basis, while the euroland rate is still close to 9 per cent. In a generally benign period for the global economy, Britain has created three million new jobs, overwhelmingly in the private sector. The “old” European economies – France, Germany, Italy – have created barely any.
Lord Layard of the Centre for Economic Performance at the London School of Economics has just published a new edition of his book Unemployment, co-written with Stephen Nickell and Richard Jackman. In it he looks at why unemployment has diverged so sharply in the past decade or so.
The difference, he says, is between those countries who reformed their labour markets, as Britain did in the 1980s (as a Labour peer he pays tribute to the Thatcher reforms) and those that did not. The three big economies of “old” Europe fall into the second category and are suffering for it.
It is not just, of course, in the unemployment figures that the damage is being done. The longer that people are unemployed the more they become distanced from the world of work and the harder it is to re-engage them with it. High unemployment breeds high unemployment.
It damages in another way. The big difference between the growth performance of the euroland economies and those of Britain and America is the behaviour of domestic demand. Anglo-Saxon consumers have been willing to spend; those in Europe have not. The fear and the reality of unemployment, and the reluctance in consequence to take on debt, explains much of this. In the past 10 years the UK economy has grown by an average of 2.7 per cent annually. Germany has expanded by barely more than a third of that rate, at just over 1 per cent. The difference is accounted for by the behaviour of domestic demand – strong in Britain, weak in Germany – in the two countries.
Euroland is caught in a vicious circle. The Paris-based Organisation for Economic Co-operation and Development recently revised down its growth forecast for the area for this year from 1.9 to 1.2 per cent, warning of depressed consumer and business confidence, and arguing for a cut in interest rates by the European Central Bank (ECB). The very credibility of monetary union was threatened by economic stagnation, the OECD warned.
This was what the people of France and the Netherlands were voting against. Like the character played by Peter Finch in the film Network, they were saying: “We’re not going to take it any more.” Europe was supposed to be about rising prosperity – as indeed it once was – not about becoming permanently becalmed in the economic doldrums.
What has happened to peg the EU economy back? A large explanation for the problem is that provided by Layard. The turning point came a decade or so ago. Instead of promoting reform and flexibility, EU leaders focused on the task of achieving monetary union and promoting closer integration. These aims were perfectly laudable on their own but, in the absence of flexibility, were doomed to difficulty.
Otmar Issing, chief economist at the ECB, has recently admitted something I have long argued; that Europe was not an “optimal currency area” when the euro came into being at the beginning of 1999. An optimal currency area, which was the focus of my book ‘Will Europe Work?’ was introduced by the Nobel prize-winning economist Robert Mundell. He said that for a currency area to work it had to have wage flexibility, geographical mobility of labour and a large enough central budget to offset economic shocks. The EU had none of those things.
According to Issing, perhaps only five of the original 11 (later 12) euroland economies were sufficiently converged for monetary union to work. It went ahead anyway, for political reasons, on the assumption that convergence would follow and an optimal currency area evolve. That has not happened.
Flexibility was not just an add-on for Europe, therefore, it was essential. It was essential for the euro to work and it was essential if the EU economy is ever going to be able to compete with America, let alone China and India.
Flexibility was the aim of the Lisbon agenda but at its halfway stage, as even a sympathetic high level committee of experts concluded, progress was dismal. Now the constitution is gone, the priority for Europe, and more particularly for national governments, has to be to urgently pursue economic reforms and achieve that necessary flexibility.
Will it happen? It would be unwise to bet on it. Europe has had a wake-up call. Experience would suggest it will not necessarily respond to it.
From Business Voice, July-August 2005
It has been a hell of a party. We’ve enjoyed ourselves for years. But now it is the time to count the cost. That, it seems, is going to be the story of the next few years. Consumers have had an unprecedented time, household spending rising at a faster rate than overall gross domestic product (GDP) in every year since 1997. There is no record of that happening over such a prolonged period before.
Consumers have been the beneficiaries of a number of factors. Combine low interest rates and a strong pound, not something that Britain has experienced very often, and households are already on to a winner. Low interest rates directly encourage credit-hungry consumers, boost the housing market and reduce the incentive to save. The strong pound improves Britain’s terms of trade – cutting the cost of imports relative to exports. Consumers are the main beneficiaries of these lower import prices.
There’s more. In the past consumers have taken fright when fears of redundancy increase, and actual unemployment starts to rise. That has not been the case for the past decade. Some three million more people are in work and unemployment, on the claimant count measure, is in the 2 to 3 per cent range traditionally defined by economists as “full” employment.
Why should any of this change? Interest rates, at time of writing, are a mere 4.75 per cent and appear to be at or close to their cyclical peak. True, they dropped to just 3.5 per cent in 2003 but that was exceptionally low. Prior to 2000 they had not been below 5 per cent for nearly four decades.
What we have seen, however, is a build-up of personal sector debt, and that is starting to impinge on people’s spending decisions. While the debt-servicing burden remains relatively light – 9 per cent of disposable income compared with 15 per cent in the recession of the early 1990s – capital repayments are beginning to creep higher. The burden of interest plus capital repayments is already 17-18 per cent of disposable income, compared with a recession-inducing 20 per cent back in 1990.
That is not the only thing missing. The boost to consumers from a strong pound is unlikely to be repeated. Sterling is not expected to collapse, but the big rise that gave households such a terms-or-trade boost will not happen again.
What about the labour market? Private sector employment has been weak for the past 3-4 years, the labour market gap being filled by the rise in public sector jobs and by self-employment. Some of the latter is almost certainly involuntary – people who have left employment but are retained as consultants, often on a part-time basis – and the rise in public sector employment is tailing off.
It is possible, indeed, to scare up a very nasty scenario, in which consumers’ reluctance to spend results in lay-offs among retailers and other consumer market providers, with the resulting rise in unemployment making consumers even less willing to spend, and so on. They call it a vicious circle.
There is another factor. Gradually the realisation has sunk in that pensions are not what they were. People may not be aware of the four options set out by Adair Turner’s Pensions Commission for filling the pensions’ gap – later retirement, higher taxes, compulsory savings or an increase in voluntary savings – but they will be increasingly aware of it when the Commission publishes its final report later in the year. Many people meanwhile have already had direct or indirect experience that tells them the income they can expect in retirement will be lower than they would have expected even a few years ago.
This will be a significant factor tilting the balance back towards saving – compulsory or voluntary – over the next few years.
Not everybody agrees that consumers have pushed the boat out too much. Some economists argue that the rise in debt, to nearly £1,100 billion (£1.1 trillion) is impressive but is mainly a response to the ability of households, at lower interest rates, to finance it. Household sector assets, after all, are six or seven times household liabilities, not least because of the house-price boom.
The drop in the saving ratio, those economists argue, is also mainly a response to changed economic circumstances. When unemployment is low and people are reasonably confident about prospects, they see less need for “precautionary” savings. Low savings, therefore, are less a sign of irresponsibility, more a sign of what individuals see as the new reality.
Those who spring to the defence of the consumer also point out that consumer spending looks much less robust in cash terms than in “real” terms. One of the big stories of recent years has been the decline in goods prices – as a result of competition from China, the strong pound and, in areas like car prices, official and consumer pressure to move into line with international, and in particular European, pricing.
Consumers have been quick to take advantage of these lower prices. They have been quicker to respond, in fact, than the official statisticians. So while the spending numbers look high in real terms, they look rather less concerning in cash terms. Last year, for example, household spending was 65 per cent of GDP when measured in real terms (constant 2001 prices), but only 62.5 per cent in cash terms, that is in the prices prevailing during 2004.
These are fair points. The consumer boom of the past few years has not been a runaway affair like that of the late 1980s, when households had their first experience of unrestricted access to credit and behaved like greedy children let loose in a sweet shop.
At the same time, however, consumer spending has undoubtedly had a strong run and for the factors outlined above needs to slow. Whether that slowdown can be achieved gradually rather than suddenly will be one of the interesting questions for the next few months. The other is whether, as consumers scale back, something else can take up the growth slack.
From Professional Investor, July-August 2005
One of the constant refrains about Britain’s economy in recent years has been its over-reliance on the consumer and, in consequence, the unbalanced nature of growth. The figures speak for themselves.
Over the period 1997 to 2000 consumers accounted for 80 per cent of the rise in total economic activity. The share dropped slightly after that, but only because of the sharp rise in public spending. Growth in Britain has been on a record run – 51 quarters and counting – but “productive” growth, in the form of investment and exports, has been in short supply.
Lately, however, there are signs that not all is well for Britain’s once-unstoppable consumers. Since before Christmas retailers have been grumbling about the reluctance of shoppers to spend, irrespective of the inducements that are put their way.
For once the retailers, who are given to moaning, have a point. Consumer spending did indeed slow sharply at the end of last year; in the fourth quarter of 2004 it rose by just 0.7 per cent at an annualised rate, compared with nearly 5 per cent at the beginning of the year.
Regular reports from Britain’s high streets and shopping malls so far this year suggest the malaise has continued. The British Retail Consortium said year-on-year performance in April was the worst since 1992, when the economy was just emerging from the last recession. Several retailers have posted profits warnings or grim trading statements. Shoppers, it seems, have gone on strike.
It is not obvious why this should be happening, as John Butler, UK economist at HSBC, points out. “Consumer spending has been slowing in a background in which employment and financial wealth has been rising,” he says. “And if the consumer is tired, what parts of the economy will take up the growth baton?”
The slowdown in spending, as Butler points out, is intimately related to what has been happening to the housing market. Last year the Bank of England created controversy by suggesting that even if house prices fell, consumers would not respond by cutting their outgoings. House prices have not fallen, at least nationally, but the market has stagnated and that has had a significant impact, it seems, on consumers.
The direct effects of a loss of momentum in the housing market are well known. When people aren’t moving they don’t spend as much on carpets, curtains, furniture and redecoration. And, while few tears will be shed, they also deprive a whole range of service providers, from estate agents and solicitors through to removal firms, of business.
The indirect effects are, however, arguably greater. Mortgage equity withdrawal, the act of taking out housing wealth to use for other spending, happens most when property transactions are booming. When lending slows sharply, as it has, there is far less of it. Equity withdrawal dropped from £16 billion in the final quarter of 2003 to £6 billion a year later. There are probably more falls to come. The upshot is that you did not need a house-price crash to produce a spending slowdown.
Tied to that is another factor. The rise in debt has been going on for so long that we have begun to take it for granted. Household debt has soared to nearly £1,100 billion (£1.1 trillion) and from 100 to 140 per cent of annual household income.
Most of that debt is in the form of mortgages. This spring, however, something curious happened. Consumers paid off more non-mortgage debt (credit cards and other loans) than they took out. Net borrowing fell. Was the penny dropping on debt?
We haven’t suddenly switched from being a nation of borrowers to being newly thrifty. Maybe, though, the past rise in debt is catching up on households. While the debt-serving burden remains low, because interest rates are modest. The picture changes dramatically once capital repayments are factored. On that basis the squeeze on indebted households is not far short of what it was in the early 1990s, when interest rates were two or three times present levels.
You write Britain’s consumers off at your peril. But what about that other question: What will take up the growth slack? That is not immediately clear. As Butler points out: “The global economy also has problems, which means the cavalry in the form of a strong export or investment recovery is unlikely to arrive.” A consumer slowdown may mean an overall growth slowdown.
One bit of good news in all this, of course, is that for once the interests of consumers and manufacturers are neatly entwined, at least in one important respect. In the past interest rates had to be higher than was comfortable for industry to keep rampant shoppers and homebuyers in check. That is no longer the case. Both firms and individuals need lower interest rates. With 4.75 per cent looking like the peak for base rates, they should get them before too long.
From The Manufacturer, June 2005
It barely seems like any time at all since we were all abuzz with the question of Britain’s entry into the euro. The issue, often said to be at the heart of the long-running dispute between Tony Blair and Gordon Brown (although personal rivalry explains it better), was expected to dominate Labour’s second term in office.
As it was, that term was dominated by Iraq and the drive to improve public service delivery. That did not mean, however, that nothing happened on the euro. Before the 2001 general election the prime minister committed Labour to publishing a full assessment of whether Britain was ready to join the single currency; an assessment of whether the famous five economic tests were met.
Those tests, to remind you, were, first, are business cycles and economic structures compatible between Britain and Europe to permit the UK to exist comfortably in the euro; second, is there sufficient flexibility to deal with problems?; third, would joining improve the environment for long-run investment decisions in Britain; fourth, what would be the effect on financial services; finally, would entry be good for growth, stability and jobs?
That assessment, together with 18 accompanying studies, was published in June 2003. But the Treasury did not close the door completely. It conceded that progress had been made towards convergence with Europe. It announced a change to the Bank of England’s inflation target to the new, euro-compatible consumer prices index – a similar measure to that used by the European Central Bank (ECB). It also adopted the same target, 2 per cent, as the ECB.
Blair did not give up without a fight. He insisted that his entire cabinet was involved in the decision, and that all ministers were able to study the 18 technical studies in advance (whether they understood them was another matter). He made sure that the announcement was a full and separate parliamentary occasion, while Brown had wanted to get it out of the way in his budget. He also insisted that the Treasury review progress towards convergence with “euroland” and therefore entry into the single currency, each year.
So why has it all gone quiet? It used to be said that Blair’s ambition before he left Downing Street was to get Britain into the euro. It still is, but another European priority has jumped the queue. This is the referendum vote on the proposed EU constitution, due to take place next year. This presumes, I should say, Labour’s return to office in the general election.
While euro entry would involve deepening the degree of integration between Britain and Europe, a failure to approve the constitution could threaten Britain’s whole future in Europe. That may overstate it, but it would certainly represent a crisis in UK-EU relations.
How will the constitution referendum go? Until recently, the general view was that voters would overwhelmingly reject it, scared by talk of a giant step towards a federal Europe. However, recent polls conducted on the basis of the actual question that will be asked in the referendum have suggested a pretty evenly split vote. The question is: “Should the United Kingdom approve the treaty establishing a constitution for the European Union?” It sounds less than alarming, much to the disgust of the anti-constitution campaigners, A bigger fear than federalism may be the worry that Britain will be left behind, which the government will play on.
Would not a “yes” vote on the constitution enable an emboldened Blair to go for “one more heave” into the euro? After all, the Treasury probably cannot keep saying no to entry for ever. Privately, officials concede that the next assessment, if there is one, will have to come up with a positive verdict.
It could happen, so that by the end of the parliament Britain would have both signed up to the constitution and be happily ensconced in the single currency, the European Central Bank (ECB) taking our interest rate decisions.
But that seems unlikely, for several reasons. The first is that to secure a yes vote in the constitution referendum, the government will have to provide certain reassurances. One of those, most probably, will be that backing the constitution will not mean a rush into the single currency. Any suspicion among voters that this is the case could easily swing it towards a no vote.
Secondly, hostility to the euro goes deeper than to the constitution. There was a time when many British people thought the only argument about the euro concerned issues such as whether the Queen’s head would be on the notes, versus the convenience of not having to change currency at each European border crossing.
Things have moved on. There is now an implicit understanding amongst a large swathe of voters that adopting the euro means more than changing the currency you carry in your wallet. People are aware of the fact that Euroland appears stuck with slow growth and high unemployment. This many not be the fault of the euro and the ECB, but it is a reality, Voters may also be dimly aware that the euro’s fiscal rules, embodied in the stability and growth pact, have been flouted by Germany and France, and may never achieve credibility again.
All this is important. To argue the case for the euro, the government has to believe it. As far as the chancellor (who was once a believer) is concerned, that requires two things. One is a belief that the ECB and stability pact would be at least as good as his own fiscal rules and the independent Bank of England. He is a long way from believing that.
The second is that Europe is serious about increasing its flexibility, particularly in labour markets. A recent report by a high level group of experts under the chairmanship of Wim Kok, the former Dutch prime minister, concluded that this is far from the case, and that the EU is proceeding at a snail’s pace in this area. And as long as that is the case, the euro is off the UK agenda.
From Professional Investor, May 2005
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
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
For the technology sector the past few years have been like the proverbial rollercoaster. The upward climb during the 1990s was dizzying, the subsequent drop both nerve-racking and sickening.
Technology has been through a torrid time, the bursting of the internet bubble being followed by a post-millennium (Y2K) downturn in investment and a US/world recession that began in 2001 and was not really shrugged off until last year. Pride came before a long fall. The Nasdaq’s rise and fall – even now it is at barely 40 per cent of its spring 2000 peak – tells the story.
Those in the sector could be forgiven for thinking this is the way it always has to be. They, in other words, are doomed to experience a much more volatile cycle than the rest of the economy. It can be exhilarating, but it can also be damaging and dispiriting.
In fact, there are reasons to think the current upturn in the technology sector is more durable than its predecessor in the 1990s. Carly Fiorina, the then chairman and chief executive of Hewlett Packard, said at last month’s World Economic Forum in Davos that she expected turnover this year to rise at twice the rate of gross domestic product. That may be a pale shadow of the performance of HP and other companies in the late 1990s, when turnover rose at five times the rate of GDP, but it looks rather more sustainable.
To put that in perspective, US and world GDP will rise by 3-4 per cent this year. And to achieve a turnover gain of double that, HP has to offset annual price deflation of between 20 and 30 per cent. That means pumping through a lot more volume.
Technology, according to Rob Lloyd, European president of Cisco Systems, is benefiting from a number of forces. The first is that the replacement cycle is kicking in, particularly when it comes to corporate investment, the last good year for which was 2001.
Second, businesses are upgrading and improving systems, not least to guard against online security threats. The battle to keep ahead of the internet vandals and their increasingly sophisticated viruses is an ongoing one.
Third, firms are increasingly using IT as a tool for raising productivity, whether it is through improving internal processes, or via outsourcing. And fourth, particularly for firms like Cisco, important new markets are opening up in fields like education. This is not just in the advanced economies. Countries like Jordan and Egypt in the Middle East, and Hungary and the Czech Republic in Eastern Europe are realising that IT is the quickest route to catching up when it comes to education and skills.
Tie this is to the fact that we are in an interesting phase of the consumer product cycle, with huge demand not only for the latest generation of mobile phones and Ipods, but also for Blackberry-style mobile devices. This has a lot further to run.
What does the technology upturn tell us about the economic outlook more generally? It tells us that business optimism is in pretty good shape, and indeed this was the message emerging from the Davos forum. It also tells us that business investment is picking up, and that this recovery will probably last. It is also a vote of confidence in firms that have continued to innovate even during a period of relatively weak demand.
The news on technology combines with another optimistic pointer for Britain’s economy. Michael Saunders, an economist with Citigroup, has looked in detail at some data from Eurostat, the European Commission’s statistical agency. They show that so- called knowledge-intensive sectors account for 41% of employment in Britain, higher than in France, Germany, Italy and Spain and well above the EU average of 33%. This is fascinating, and runs against the usual perception that we have too many workers stuck in low-value areas.
These knowledge-intensive sectors include computing, telecoms, financial and business services as well as legal and technical services, education and healthcare. They tend to be the parts of the economy growing fastest. The fact that Britain has a higher proportion of people in these areas is, says Saunders, one reason why economic growth in Britain has exceeded that in the eurozone for 11 consecutive years.
The message that has been drummed into us for many years is that the only way economies like Britain can compete with the emerging giants of China and India is to move up the value chain. That, it seems, is precisely what the UK has been quietly achieving for some time. The technology upturn is good news and it is not the only bit of good news around just now. Let us hope it lasts.
From The Manufacturer, February 2005
FOR those of us who have, over the years, monitored regional differences in the United Kingdom, one constant stood out. This was that the people of the north-east felt most let down by the way the economic cards had been dealt.
The north-east, having borne the brunt of successive industrial declines, and most notably the loss of coal, steel and shipbuilding, has always felt itself of the receiving end of the rough end of national policies.
Lord “Eddie” George, the former governor of the Bank of England, was once persuaded by a journalist to concede that high unemployment in the north-east was “a price worth paying” for low inflation in the rest of the country. The resulting headlines were some of the worst the Bank has had in recent years.
Going further back, to the dying days of the Macmillan government in the early 1960s, Lord Hailsham was appointed minister for the north-east in addition to his several other ministerial responsibilities and, on a visit to Darlington, symbolically donned a cloth cap. Later, at a “ten shilling a head” roast beef dinner, Hailsham promised speedy regeneration for the region. It did not happen, at least not in the 1960s and 1970s.
The north-east has, to add insult to injury, had to put up with the fact that Scotland, its neighbour, has always done better in terms of political representation at Westminster, the ability to attract inward investment through its own development agency and significantly higher levels of public spending per capita. More recently, of course, Scotland has had her own parliament.
If anywhere if the country was going to vote in favour of a regional assembly, therefore, it would be the north-east. That was why last autumn’s referendum result was so extraordinary. In a 47.8 per cent turnout, the north-east voted by 696,519 to 197,310 – more than three to one – against the assembly championed by John Prescott, the deputy prime minister. Every district in the north-east, from Alnwick to Wear Valley via Durham, Gateshead and Sedgefield (where Tony Blair is MP), voted an overwhelming no. This had the effect of persuading the government, sensibly in the circumstances, that it was not worth pursuing assembly plans for other regions.
And, while opponents of the assembly had successfully persuaded voters that the north-east assembly would be an expensive talking-shop, and an unnecessary layer of bureaucracy, the “no” vote may also have reflected subtle but important changes in perceptions about the north-south divide.
Take unemployment, the most enduring measure of regional economic differences. Which part of the north has the highest unemployment rate in the UK? None, in fact. The Labour Force Survey has unemployment in London at 7.1 per cent, compared with a national average of 4.6 per cent. The north-east, to be fair, comes next on 5.9 per cent, followed by Scotland (5.2 per cent), Northern Ireland (5.1 per cent), the West Midlands (5 per cent) and Wales (4.9 per cent). But even these higher unemployment regions are not that much above the average.
The same is true, incidentally, of the claimant count, which comes up with lower levels and rates of unemployment. On this measure the north-east is at the top of the unemployment league. But its rate, 3.9 per cent, would have been regarded as extraordinarily low even a few years ago, and it compares with a national average of 2.6 per cent. The days when the north-east had 12, 13 or 15 per cent unemployment are long gone.
The narrowing of the unemployment gap does not tell the whole labour market story. There has been an increasing focus in recent months on economic inactivity, and the rise to eight million in the number of economically inactive people of working age.
Employment and activity rates tend to be higher in the south. In the south-east, East Anglia and the south-west around 82 per cent of the population is economically active, compared with 78 per cent in the north-west and Yorkshire & Humberside, and just over 74 per cent in the north-east. Here again, however, the differences are not what they were and Greater London, with an activity rate of 75 per cent, is in a similar position to the northern English regions.
Nobody would pretend that regional differences have been eliminated in the UK. On many of the measures, however, whether it is gross domestic product per head, disposable incomes, per capita consumer spending or relative wages, there is evidence that the gap has stabilised. In 1990, for example, the north-east’s disposable income per head was 88 per cent of the UK average, a decade later it was 89 per cent. In the case of the north-west, it remained at 94 per cent of the UK average.
More recently, too, the house-price boom has spread from south to north. Figures from the Office of the Deputy Prime Minister show that in the 12 months to mid-2004 there was a 12 per cent rise in UK house prices. Prices in the south-east rose by less than 5 per cent over the period, while in the north-west there was a 23 per cent increase, and in the north-east one of 26 per cent. This south-to-north “ripple” effect has, of course, been a feature of the mature phase of previous house-price booms.
Perhaps the biggest change, though, is not in the statistics but in perception. It is now widely recognised that there are two economies in Britain. The one centred on London and the south-east is increasingly international in outlook and influence, dominated as it is by sectors such as financial services. Then there is the rest of the UK, what Kenneth Clarke, the former chancellor, used to call the real world. This no longer means an economy dominated by metal-bashing or heavy industries, although it does imply a productive economy in a more general sense.
Government policy can affect the distribution of economic activity between the London and south-east economy and the rest of the UK at the margin, for example by transferring civil servants to the regions from Whitehall. But, and this is now central to Labour’s policy approach, there would be no gains for the north by restricting growth inside the M25. Meanwhile, London’s labour market problems are testimony to the fact that not all its streets are paved with gold.
The proposed regional assemblies were an idea left over from the days when regions competed with one another for jobs and prosperity. That has changed. What is good for one region is good for others, and for the UK economy as a whole. This is not a zero sum game. And that, instinctively, is what the people of the north-east believed when they buried the idea of regional assemblies.
From Business Voice, December 2004
Whenever I talk to audiences about the UK economy, particularly younger ones, I find it necessary to remind them that it has not always been like this. Such as been the stability of recent years that, not only do I have to pinch myself to be sure it is not a dream, but the memories of the wild volatility of the past start to fade, even for me.
Thus, the economy has grown consistently, quarter-on-quarter, since as long ago as the spring of 1992. By next spring, barring accidents, the recovery will have been in place for 13 years. Thinking about it in terms of the lengths of parliaments – assuming we have a general election about then – the upturn will have lasted three. Put another way, the Tories still had another five years to run in government when the economy emerged from its last recession.
This success is not purely a New Labour phenomenon. The current long run of growth was well-established well before Gordon Brown took the helms at the Treasury, although the Conservatives and Kenneth Clarke were unable to take political advantage of it.
The current run of growth is, as the chancellor keeps reminding us, the longest since quarterly records began in the 1950s, and since annual records started 200 years ago. It is likely, given the natural volatility of the economy in pre-industrial days (the vagaries of climate and harvests) that we are living in the most enduring recovery ever.
Not only that, but it has been combined with stubbornly low inflation. When the Conservative government, in the guise of Norman Lamont, Clarke’s predecessor, gave us an inflation target in the autumn of 1992, it was well chosen. The target was for 1% to 4% inflation on the retail prices index (excluding mortgages). Since then, while the target measure has recently changed, inflation has averaged within a whisker of 2.5%, bang in the middle. Britain’s formerly recession-prone, inflation-prone economy has changed its ways.
The question, as we look into 2005, is whether it can last. In theory, the answer should be straightforward enough. With each quarter, and each year, of economic stability, it becomes more ingrained. This is important. If businesses and consumers think that in general things will turn out fine, and have the confidence to take decisions on that basis, there is a good chance that, indeed, things will turn out fine.
The alternative argument, of course, is that the longer it goes on, the greater the risk that the economy’s run of luck will come to an end. So what are the risks for 2005?
The first set of risks relates to the global economy. Terrorism, global economic imbalances, China’s overheating, and Europe’s sluggish performance are ever-present dangers. The biggest uncertainty, however, emanates from oil prices, which rose to more than $50 a barrel in the autumn.
This is uncharted territory. Oil prices have been higher than this in real terms before, most notably in the early 1980s. Advanced economies are less oil-sensitive than they were in the past, because of the decline of heavy, energy-intensive industries and the rise of more energy-efficient vehicles (although this is offset by the rise in vehicle numbers). That should mean that the effects of high oil prices are to dampen global growth rather than bring it shuddering to a halt. But the risk is of something worse.
Nearer to home, the second big risk relates to house prices and debt. For several months now the Bank of England and others have been working hard to argue that a fall in house prices would not be devastating for the economy. Consumer spending and house-price inflation are linked, but not mechanically. Consumers will carry on, the argument goes, even if there is a crash in housing values.
My view remains that there will not be a crash, although we have already entered what could be a long period of housing stagnation, necessary if incomes are to “catch up” and reduce the extent of the property market’s overvaluation. Housing stagnation is consistent with slower growth in spending by individuals.
But could it be worse? The virtuous circle supporting housing has been one of low interest rates and a strong job market. Remove those props and things could look rather different. Interest rates have already risen significantly. How strong is the underlying picture in the job market?
This, conveniently, brings me to my third point. Fiscal policy in Britain under Brown has fallen neatly into two halves. For the first three years after 1997, when the economy was benefiting from the 1990s’ global boom, he ran a tight ship, keeping public spending under control. After that, however, things changed.
As the global economy slowed, and America slipped into recession, the chancellor’s big relaxation of spending, particularly directed towards the National Health Service but also affecting other public services, came through. That has been the story for the past four years, and the effect has been to add to growth, and transform what would have been a dull job market picture into something very buoyant.
That will change this year. Slower growth in public spending will coincide with a tougher attitude on public sector recruitment, with some 80,000 (net) civil service jobs due to bite the dust.
That is not the only fiscal policy question. There is still a big debate about whether taxes need to rise to pay for past spending increases, and that will become clearer after the general election. Even without new taxes, some fear the damage has been done. Derek Scott, for 10 years Tony Blair’s economic adviser, believes higher taxes and the re-regulation of the economy under Labour will soon begin to have a serious impact on growth.
The headwinds are there. The likelihood is that in a year’s time we will look back on another year of this remarkable recovery. But we might also look back and conclude that it was more disappointing than it might have been.
From Professional Investor, December 2004/January 2005
Economy-watchers have always been fascinated by cycles, the idea that the ups and downs for businesses and consumers follow regular patterns. Economic cycles, like stars, are named after their discoverers. The standard business cycle, the Kitchin cycle, goes from peak to trough to peak again within the space of five years.
A longer cycle, the Juglar cycle, has major peaks separated by around 8-10 years. Think of the top of the global economic cycle at the end of the 1980s and then at the end of the 1990s.
These are bread and butter cycles. There is nothing pre-ordained about them but they have a habit of coming back. They are driven by economic behaviour – businessmen and consumers becoming over-optimistic and gearing up too much for the upturn, then cutting back when they discover they have over-committed. Governments and central banks also have a clear influence on the cycle, applying the accelerator when the economy has cooled too much and the brakes when it is overheating.
Importantly, the fact that there are cycles does not mean that booms have to be followed by recessions. A “growth recession”, a period of slower growth within a period of overall expansion, is more usual. Britain has had a couple of these since emerging from the last proper recession in 1992.
More interesting than these economic cycles, however, are the extended cycles or “long waves” most associated with the Russian economist Nikolai Kondratiev. Kondratiev was an official in the Soviet finance ministry under Stalin and had politically incorrect economic views. He thought, for example, that the Soviet regime should see what it could learn from market economies and, for his troubles, ended his life in the Gulag just before the Second World War.
Before that, however, he had put forward the idea of long cycles in economic activity, their peaks separated by 50 or 60 years, dating back to the 18th century and the dawn of the industrial age. Kondratiev’s long waves – 25 to 30 year upswings followed by downswings – offered a pretty good explanation of the depression of the inter-war years and, while he was not around to see it, the global economy’s “golden age” from the 1950 to 1973. His work was popularised by the great economist Joseph Schumpeter.
Does Kondratiev have any relevance for the modern age? Some think so. A couple of years ago, explaining what was then Japan’s long period of stagnation, an official from the country’s central bank told journalists that: “We have the bad luck to be in the downward phase of the fourth Kondratiev cycle.”
Now Brian Reading of Lombard Street Research, in a paper entitled “Synchronised Sinking”, has examined the relevance of cycles to the global economic outlook. He notes that to the extent that Kondratiev long waves have been identified, they are – as Schumpeter also argued – largely a product of technological innovation. Thus, the upswing from 1790 to 1814 was largely the product of developments in the cotton industry, that of 1845 to 1870 by steam and the railways, the upwave of 1896 to 1929 as a result of cars and electricity, and the post-World war Two upswing happened as a result of innovation across a range of fronts, including plastics, chemicals and the jet plane. The 1990s appeared to see the beginning of another such upswing, on the back of the IT revolution.
But will it end in tears? Reading, without being a paid-up member of the Kondratiev club, which he thinks is largely a technological phenomenon, argues that there are reasons to expect the two motors of the global economy – America and Asia – to have a prolonged correction.
The 1990s, apart from the IT revolution, saw the emergence of a “new dollar area”, in which half the world returned to something like the post-war Bretton Woods system of fixed exchange rates. This was driven, of course, by the desire of the Asian economies, and in particular China and Japan, not to allow their currencies to rise against the dollar.
As he argues: “The new dollar area comprises the US, an inner circle of countries whose currencies are pegged to the dollar and an outer circle of currencies managed against it.” The circles take in China, Hong Kong, Malaysia, Japan, India, South Korea, Taiwan, Thailand, Indonesia, Singapore and Russia – half of global gross domestic product.
The consequences of this are well known. The dollar has not been allowed to depreciate in a way that would begin to correct America’s widening trade deficit. The quid pro quo for the stable dollar policies of Asia has been that they have been prepared to finance the twin deficits – current account and budget - of the United States.
The outcome, according to Reading, is not in doubt. “The new dollar area, like Bretton Woods, must end in tears,” he writes. “The synchronised boom it has created cannot continue. There can be no soft landing for either the US or China. Quite simply, Americans save too little and must save more, meaning demand and incomes will contract. The Chinese invest too much and must invest less, meaning demand and incomes will contract. This is the recipe for synchronised sinking.”
Is he right? Stripping away the elegant gloss of economic cycles – short and long – the argument is a familiar one; US imbalances can’t last and unwind nastily. Against that is the view that American and Asian economic dynamism (perhaps itself a Kondratiev upswing) will always trump Europe and that, as a result, the scope for working through these imbalances is far greater than the pessimists would allow. The outcome of that debate will profoundly affect prospects for the global economy for years to come.
From Professional Investor, November 2004
A feature I wrote for non-economists for The Geographer magazine
Every day, thanks to tens of thousands of mouse-clicks in London, New York, Tokyo, Singapore or Sydney – or as many shouted telephone instructions – tens of billions of pounds, dollars, yen and euros move around the borderless world that is the global financial system. What is the effect of this vast flow of money?
Daily turnover in the world’s currency markets is $1,210 billion (£670 billion). That, leaving aside weekends and public holidays when the markets are closed, is roughly $302,500 billion (£168,000 billion) annually.
These are big numbers. To put them in perspective, the UK’s annual gross domestic product – the combined value of all we produce, or spend, or earn – was £1,100 billion in 2003.
That is not all. The fastest growing financial market sector is so-called derivatives trading. Derivatives sound more complicated than they are – they are merely financial instruments derived from a basic financial instrument. The most common derivatives are futures – instruments that are based around a transaction that will occur at some future date. Currency futures, for example, are based around the notional purchase or sale of a currency at some defined date in the future. Trading in derivatives globally was $600 billion (£330 billion) a day at the latest estimate, and is rising rapidly.
The size and the power of global financial flows are not in doubt. On September 16 1992, “Black” Wednesday, when the UK government was trying to keep the pound within the European exchange rate mechanism (ERM), the euro’s forerunner, the authorities were overwhelmed by the markets. The speculators amassed enough funds aimed at driving the pound down to make Britain’s entire foreign exchange reserves look puny. The pound was forced out.
Or, to take a more recent example, a few months ago, the dollar came under heavy selling pressure because of concerns about the American economy and Iraq. Asian central banks, particularly China and Japan, were reluctant to see their currencies rise against the dollar.
They were more successful than the Bank of England in 1992 but only as a result of buying tens of billions of dollars. More importantly, they diverted the selling pressure on the dollar to Europe, so that the euro rather than Asian currencies rose strongly.
What drives these flows of international capital between countries and continents? It is not international trade. It used to be the case that the only reason for anybody to want to change currencies was for exporting and importing purposes. This is not so any more. A week’s trading on the currency markets is equivalent to a year’s world trade. Even adding tourism does not begin to square the circle.
Capital is driven around the world by two factors – risk and return. International investors are looking for the best return, and do not mind where they get it. Return can mean chasing the highest interest rate or the best performing stock market. But return has to set against risk. There may be a reason why a developing country (an emerging market to investors) has 30% or 40% interest rates, and that is because its currency and its economy are wobbly.
In seeking the best return, investors do not want to be left holding the baby of a collapsing currency. In times of international tension, or when concerns about inflation re-emerge, investors seek “safe haven” currencies such as the Swiss franc, or safe-haven assets such as gold.
Is all this money flowing around the world healthy? James Tobin, the late American Nobel prize-winning economist, proposed a “Tobin tax” on currency trading to curb speculative buying and selling of currencies. There is no doubt some such trading is destabilising.
The problem is in distinguishing between the speculative and the beneficial. Developing countries cannot generate the savings they need to invest for the future. Inward investment, either direct (new factories built by multinationals) or indirect – foreign money that enables locals to invest is needed. This year, according to the Institute of International Finance in Washington, long-term capital flows to developing countries will reach $225 billion (£125 billion), their highest since 1997. But emerging economies can find themselves on the wrong side of the vagaries of short-term capital. In the 1990s, international investors favoured the so-called mini-tiger economies of Asia, like Thailand, Taiwan, South Korea and the Philippines. There were long-term capital flows into these countries but also plenty of short-term speculative capital, chasing stock market returns. When such capital suddenly took flight, on fears that economic risks had increased, it created the problem investors had feared – the Asian financial crisis of 1997-8.
It is not just developing countries that are in need of foreign capital. America has a trade gap, a current account deficit, of $500 billion (£280 billion) and needs foreign capital inflows to fund it. One of the big risks to the global economy is the over-reliance of the United States on foreign capital and the danger that a sudden loss of international appetite for American assets could lead to a dollar collapse.
From The Geographer, September 2004
Another part of the The Geographer feature
The world economy is dominated by the G7 (Group of Seven) countries – the United States, Japan, Germany, Britain, France, Italy and Canada – who gather at the top table for their regular summits. But the world is changing, and we are witnessing the rise of some economic giants of the past.
In the early 19th century, when Europe was in the full throes of the industrial revolution, which two countries dominated the world economy? The answer is perhaps surprising. Two hundred years ago China and India accounted for 45 per cent of global gross domestic product. With their huge populations, even then, their economic weight was enormous.
The story of most of the two centuries since then, of course, has been the economic rise of Europe, followed by the United States and Japan. The European century may have given way to the American century but both continents were where the economic action was.
Today, the world’s biggest economy is America, accounting for more than fifth of global GDP, followed by Japan, Germany, Britain and France. America, Europe and Japan, as well as dominating trade and investment, are the domiciles for most of the big multinational companies. Big negotiations on world trade are hammered out between these three blocs. Talks on agriculture founder because of the power and influence of Japanese rice farmers or modern French peasants. The G7, which has taken to inviting Russia to its gatherings, makes its declarations on the big economic and geopolitical issues of the day from the lofty heights of its summits.
But the world is changing, and it is not fanciful to believe that we could be on the way to a revival of the status quo of the early 19th century. “Through the 19th century, China shunned progress and closed its economy to the outside world, distrustful of foreign traders,” points out Gerard Lyons, head of research at Standard Chartered, a bank which has long operated in both China and India. This continued, and was reinforced, by Communist rule in the 20th century.
China and India are now, however, open to the world, and the effect is dramatic. In 2002 and 2003, when global economic growth was subdued, China’s contribution was vital, accounting for more than a third of the rise in world GDP. India, while smaller in both population (1.05 billion versus China’s 1.3 billion) and GDP, is also coming up fast. India has also raised deep concerns in Britain and elsewhere about a newly-named global economic phenomenon, so-called “offshoring” of call centre and other jobs.
Projections from Goldman Sachs, the investment bank, put some flesh on the likely rise of China and India. They took the four biggest and fastest-growing emerging economies - Brazil, Russia, India and China, which they call the BRICs - in a paper by Dominic Wilson and Roopa Purushothaman entitled ‘Dreaming with BRICS: The path to 2050’.
The exercise was not mere straight-line extrapolation, factoring in some slowdown from present rapid growth rates (China has grown by more than 8 per cent a year since the late 1970s). Even so, the results were intriguing.
China has already overtaken Italy (which has a seat at the G7 table), and will this year overhaul France. Chinese GDP will be bigger than Britain’s next year, and by 2007 China will be bigger than any European economy, leaving behind Germany. The Goldman Sachs’ projections foresee Chinese GDP becoming bigger than Japan in 2016 and, finally, America in 2041.
This does not mean, of course, that in 40 years time the Chinese will be better off than Americans. A large population is an advantage in terms of economic weight but it also means there are more people around whom the wealth has to be spread. Even by 2050, per capita GDP in China will be less than half that projected for Britain at that time, and under 40 per cent of that in America. On that basis, the real Chinese catch-up may not occur until the 22nd century.
Similar caveats apply to India, projected to become the world’s third biggest economy, behind America and China, in the 2030s.
Is this tilting of the world economy to the east preordained? Demography is as big as a disadvantage to Europe – Spain, Italy and Germany will see their working populations drop by a third by 2050 – as it is an advantage to China and India. As long as these countries, with their huge populations, remain engaged in the world economy, a prolonged period of growth seems guaranteed.
The challenges go beyond those of economic diplomacy. China and India will be massive consumers of world resources. They will also pose a significant environmental risk, not least if they want to emulate America in this respect too.
From The Geographer, September 2004
The approach of autumn is a good time to be looking forward. Many of the trends for next year are already in place. By the time autumn turns to winter they will be rock solid. So how is 2005 looking?
The starting point for looking into our crystal ball has to be the fact that 2004 has turned out to be a pretty good year for the world economy, easily the best since 2000. Between 2000 and now, of course, plenty of water has flowed under the bridge – the bursting of the stock market bubble, the 9/11 attacks on America, a US (and global) recession, the Iraq war and the return of high oil prices.
World economic growth will be around 4.2 per cent this year, up from 2.9 per cent last year and 2.1 per cent in 2002. America is leading the way, with a likely growth rate of nearly 4.5 per cent for the year. Next among the G7 countries, perhaps surprisingly, is Japan, where growth should top 4 per cent. For an economy not long ago apparently condemned to permanent stagnation, Japan’s revival this year has been quite a story. I’ll come on in a moment to the question of whether it can be sustained.
Britain can hold her head up high, with likely growth of 3.5 per cent this year – in line with the upper end of Gordon Brown’s forecast range – up from 1.7 and 2.2 per cent in 2002 and 2003 respectively. That ranks as a stellar performance among Europe’s bigger economies. Germany and Italy will grow by less than 1.5 per cent; France by around 2 per cent. Euroland, which has been crawling along at growth rates of below 1 per cent a year for the past 2-3 years is doing better though not dramatically so. This year’s expansion will be about 1.75 per cent.
The story of 2004 has thus been one of good growth, although it has been unbalanced, with the euro countries lagging behind, Britain doing very well but the real growth action being in America and Asia. I have not mentioned China, which should grow by 8 per cent this year or India, not far behind on about 7 per cent. So what about 2005?
Let me start by listing what economists describe as the “headwinds” facing the global economy. The first is monetary policy. Central banks, particularly in the wake of 9/11, decided that their economies needed a substantial tailwind in the form of very low interest rates. Now they are in the process of removing that stimulus, for fearing of allowing inflation back into the system.
The Bank of England started the ball rolling in November last year and has continued raising rates in a steady way since. It was followed by the Federal Reserve in June, which also seems set on a course of raising rates steadily, admittedly from the very low level of 1 per cent. In China the authorities have also taken action, by squeezing bank lending and liquidity in an attempt to cool an overheated economy. Higher rates in Europe and Japan will come, though perhaps not for a while.
If the monetary stimulus is being removed, so is that provided by fiscal policy. Most countries have larger budget deficits than they would like. In the case of Britain and some of the bigger Euroland economies, the fiscal rules have either already been broken or under threat. A tightening is therefore in progress. Whoever wins the November presidential election in America, it is hard to see them not taking action to cut the deficit.
A third headwind is provided by high oil prices. One of the surprises this year has been the failure of oil prices to lie down. The ingredients are familiar – high levels of demand from a strong global economy (boosted by the China effect), supply worries directly and indirectly resulting from the