David Smith's other articles Archives
Sunday, December 09, 2018
Be braced for more chaos, but give thanks to the Bank
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

How do you like your uncertainty? Like bad luck, it comes in threes. There is the uncertainty of whether the prime minister can survive this week’s House of Commons vote on her EU withdrawal agreement, assuming it takes place, and what happens to the Brexit process if, as overwhelmingly expected, she loses.

There is the uncertainty of the prospect, which is greater than it was, of a Labour government under Jeremy Corbyn. Most people in business I speak to think Brexit will be a big enough disaster. Combine it with a Corbyn government, the only virtue of which might be that it would not be for ever, and you crank up the disaster dial to Titanic levels.

And then there is the risk of crashing out of the EU without a deal next March, the madness of which I discussed last week. In this you combine uncertainty effects with the real impact on supply chains for the most dangerous of cocktails.

There is, I should say, a glimmer of light on this. The advocate general’s recommendation to the European Court of Justice on Britain’s unilateral revoke article 50 unilaterally, together with one of Theresa May’s parliamentary defeats last week, on the Dominic Grieve amendment, has reduced the chances of a no-deal Brexit.

Malcom Barr of J P Morgan, who has been following the twists of turns of Brexit very closely, had put the probabilities as 20% for no-deal, 60% on an orderly exit along the lines proposed by the prime minister or something similar, and 20% for no Brexit. Now he puts the probabilities as just 10% for no deal, 50% orderly Brexit and 40% no Brexit. A no-deal Brexit could still happen, but the chances have fallen, which is good news, and it was this which helped sterling recover from its lows for the year against the dollar a few days ago.

How is the uncertainty playing out? The latest purchasing managers’ surveys, which are closely watched, suggested that the construction industry had a good November and manufacturing held up better than feared. But the alarm bells are ringing for the service sector, with its index dropping to its lowest level since July 2016, the immediate aftermath of the referendum, with Brexit mainly to blame.

As Chris Williamson, chief economist at IHS Markit, which produces the surveys, put it: “The surveys are so far consistent with 0.1% GDP [gross domestic product] growth in the fourth quarter, thanks to the expansion seen back in October, but growth momentum has since been lost and risks are clearly tilted to the downside.” Instead of striding confidently into departure from the EU, Britain will be getting there on hands and knees.

It is in this context that the Bank of England has been coming in for some undeserved flak, including from the previous governor Lord (Mervyn) King. While the reputations of many institutions have deteriorated in recent years, including parliament, the Bank’s I would say has been enhanced. Mark Carney, now more than five years into the role as governor, made it his job to reorganise and professionalise the Bank.

And, while some of us have had run-ins with him, few can doubt his attention to detail. The Bank did not want to publish its internal work on Brexit scenarios but did so in response to a request from the Commons Treasury committee. Not to have published the scariest stress-test scenarios in response to that request would have been dishonest.

Nor was this, as the American economist and New York Times columnist Paul Krugman has argued, a product of “black box” modelling. The Bank has done the work, involving 20 senior economists and the expertise of 150 other professionals over two years.

And, as Krugman also pointed out: “It’s truly amazing that Britain finds itself in this position. If the downsides are anywhere close to what the BoE asserts, given the risk — which we’ve known for a long time was substantial — of a hard Brexit, it was an act of utter folly not to have put in backup capacity at the borders.”

The Bank has dug into the detail, as anybody watching Carney’s tutorial on how the port of Dover works. given to the MP for Dover, can testify. As he pointed out, you cannot easily shift freight from a roro (roll on, roil off) port like Dover to a lolo (lift on, lift off) port like Southampton without a big investment in new port infrastructure, for which it is too late.

The Bank’s worst-case scenarios on Brexit were also in part informed by its own survey evidence. The Bank’s regional agents, together with its decision-maker panel survey, asked businesses about their state of readiness for a no-deal Brexit (just under a third had made some changes) and about the impact on output over the next 12 months in the event of an exit without a deal. The expected fall in output ranged from 2.5% to 6.9%, compared with a rise of between 0.8% and 2.7% under deal and transition. The difference between the two, which is what matters, reaches a maximum of 9.6%, almost 10%.

The Bank, as I say, has done the work, whereas its critics have not. Is it institutionally anti-Brexit> The Bank’s mission statement is that its purpose is “promoting the good of the people of the United Kingdom by maintaining monetary and financial stability”. Anything that threatens that stability, as a no-deal Brexit would so, will clearly not meet with its approval.

But if the Bank was “remainer central” as some accuse it of being, in common with the Treasury, it would presumably favour what many remain supporters regard as the next best thing to staying in the EU, the Norway option of remainingin the single market via membership of the European Economic Area (EEA).

The Bank has however made it crystal clear that such an outcome would be a threat to Britain’s financial stability. As Sir Jon Cunliffe, a deputy governor, told the Treasury committee: “Our financial sector is about 20 times bigger than Norway’s. It is much more connected internationally and more complex … That scenario of being a complete rule-taker for a financial sector this large and complicated would be … quite uncomfortable.” Carney added that “the risk of being a rule-taker goes up with time” and “from a financial stability perspective, it is highly undesirable to be a rule-taker and to lose supervisory autonomy for any considerable length of time”.

It is possible that the Norway option could be modified to allow a significant UK input on the rules affecting financial services. To come close to satisfying the Bank it would have to be.

The other reason for being thankful for the Bank is its conduct since the referendum. In the political vacuum that followed the vote to leave on June 23 2016, it was Carney who stepped into the breach to offer reassurance. This was followed by a calming series of measures from the Bank, including a cut in interest rates, more quantitative easing and a term funding scheme to keep money flowing into the economy from the banks.

Since then, while the government has spent all its time coming up with an agreement that nobody much likes, the Bank has got on with the job of ensuring that the financial sector for an eventuality, including those in its worst-case scenarios.

If we did succumb to the madness of no-deal, meanwhile, the Bank would respond. Its financial policy committee saying last week that by lowering the banks’ so-called countercyclical buffer rate, it could enable to banks to absorb losses of up to £11bn and provide £250bn of lending capacity to households and businesses. The Bank has warned of the adverse impact of a disruptive no-deal, but it would first on hand to attempt to mitigate its effects.

Saturday, December 01, 2018
In or out, we really need to shake things about
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

When does a flurry turn into an avalanche? We have certainly had a flurry of economic assessments of the consequences of leaving the European Union in recent days. Any more and I will have to conclude that it is something more powerful.

Let me start today by offering a little guidance on the assessments we have had from the government, the National Institute of Economic and Social Research, the UK in a Changing Europe (UKandEU) and the Bank of England.

The first three look at the long-term consequences of Brexit under different scenarios; where the economy will be in 2030 compared with where it would have been in the absence of Brexit, looking purely at the impact of leaving the EU. The Bank’s assessment, which was drawn up to inform its banking stress tests, is different in that a short-term exercise, looking at only the next few years.

Two of the assessments, from the government and the Bank, would have been kept private if not for the insistence of parliament, and in particular the Commons Treasury committee. All show the economy faring worse than had Britain voted to stay in the EU, though by differing degrees.

To fill in a little detail. The National Institute, attempting to model the government’s proposed deal, finds that the economy will be 4% smaller under it than by remaining in the EU, with gross domestic product per capita down 3%. The UKandEU assessment is that GDP per capita will be between 1.9% and 5.5% lower than otherwise

The government’s assessment is that by 2030 GDP will be between 0.6% (the government’s proposed deal) and 9.3% (no-deal) lower compared with staying in. Its numbers are close to those of others for no-deal but flatter the government’s proposals by assuming that it will be possible to negotiate trade deals with many other countries as well as frictionless trade with the EU by 2030.

As for the Bank, it is not all doom and gloom. If parliament agreed on the government’s proposals, growth could be slightly better in coming years than it projected last month, though still weaker than it thought in May 2016, before the referendum.

The headlines it has generated relate to its “disruptive” no-deal (“tariffs introduced suddenly, no new trade deals, disruption in financial markets) and “disorderly” scenarios (border infrastructure cannot cope, EU trade agreements with third countries are not carried over and UK assets are sold off heavily). Under these, GDP falls by between 7.75% and 10.5% relative to the May 2016 growth path, and by 4.75% to 7.75% relative to the Bank’s latest forecast. This implies, as well as a deep recession and a big rise in unemployment, higher inflation, a sharp sterling sell-off and a 30% fall in house prices.

Would it happen? A lot of people have difficulty with the idea that in the circumstances the Bank would raise interest rates to 5.5%, from 0.75% now. There are plenty of reasons for it not to do so, most obviously a profoundly weak economy. But a sterling rout could also force the Bank’s hand and, for the purposes of stress tests, it cannot assume it would not do so.

So what do we know? We know, and have known since well before the referendum, that on its own Brexit will leave the economy smaller and British people poorer than would otherwise be the case. All credible analysis confirms this. If you make it harder to trade with your main trading partner and reduce economically beneficial EU immigration, your economy will suffer relative to the base case. There are gains from trade deals elsewhere but they are tiny by comparison.

We also know that if you take the Mad Hatter, a field full of March hares, a box of frogs and the pop group Madness, a no-deal Brexit is madder than all these combined. That should come as no surprise to regular readers. Those who talk blithely about flouncing off without a deal are engaging in the height of irresponsibility. Voters will never forgive the politicians who submit them to chaos, which provides a warning to the Tory party and an opening for Labour.

But, and there is a but when it comes to Brexit, we should be fully aware of what the material produced in recent days tells us. Lazily attacked as “Project Fear” forecasts by second-rate politicians who would not know a forecast if it bit them in the leg, and by economists who should know better, the scope of these assessments should be very clear.

As far as the government’s new assessment is concerned, it says on the first page of its executive summary, in bold letters: “This analysis is not an economic forecast for the UK economy”. It could not be clearer in saying that its analysis looks only at factors specific to Britain’s exit from the EU. The outlook, in other words, will be determined by more than just Brexit, including “future UK government decisions and responses”.

The Bank’s analysis, similarly, comes with the important caveat that: “Our analysis includes scenarios not forecasts. They illustrate what could happen, not necessarily what is most likely to happen.” “Our stress scenarios are not predictions,” said Mark Carney in his letter to Nicky Morgan, chairman of the Commons Treasury committee. A no-deal Brexit would be bad, though it might not pan out in precisely the way the Bank has set out; and it would be a surprise if it did so. But it is good that the Bank is prepared for all eventualities, in contract to its lack of preparedness for the financial crisis a decade ago.

And, as it also said in publishing these scenarios: “The economic consequences of Brexit over the longer-term will depend on the nature of the UK’s future trading relationships, other government policies, and ultimately the ingenuity and enterprise of the British people.”

That is the challenge. Assuming that we avoid the madness of a no-deal Brexit, the danger is that the economy slips into the slow growth projected by the Office for Budget Responsibility (OBR) over the next few years, averaging no better than 1.5% a year, and stays there.

The danger then is that, assuming we do leave the EU, we fall into a new “blame somebody else” culture. During 40-plus years of membership, the EU was often blamed for our own failings, a phenomenon that led us towards the Brexit vote. Now the danger, if it goes ahead, is that Brexit will be blamed; by Remain supporters who think it should never have happened, and by Leavers because it was not the pure Brexit they could never quite define.

Brexit has always been about making the best of a bad job, which Theresa May has tried to do so. Our long-term success depends, as the Bank says, on our “ingenuity and enterprise”. This means investment, invention, innovation, skills, productivity and the rest, and I am aware that these things trip more easily off the tongue than convert into practical action.

But such action will be needed to re-set Britain’s economy. And in coming weeks, the Brexit rollercoaster permitting, I shall try to set out how.

Sunday, November 25, 2018
We need to talk about Britain's growing north-south divide
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

One of the most enduring characteristics of the UK economy is its regional imbalances. I should know. I wrote a book about North-South divisions as long ago as the 1980s, which I will not be as vulgar as to plug here, to be told by some at the time that any such imbalances were fast disappearing, and that it was all old hat.

Well, that hat may be old, but it is still being worn. Regional imbalances can be seen at the heart of the discontent many feel with the country’s economic performance, even with near full employment and nine years into the recovery. It was a factor, possibly quite a significant one, in both the Brexit vote and last year’s inconclusive general election. It is why the most commonly used economic slogan for politicians, including Theresa May, is to create “an economy that works for everyone”

So I noted with interest some new figures from the Economic Statistics Centre of Excellence (ESCOE), which has begun to produce up to date or “nowcast” estimates of regional economic growth, on a quarterly basis. Such estimates have until now only been available on an annual basis and after a time lag. ESCOE is a consortium made up of the National Institute of Economic and Social Research, King’s College London, Nesta, the innovation foundation, Cambridge University and, Warwick and Strathclyde business schools.

The research has a purpose. As the researchers remind us, Harold Macmillan, when chancellor, once complained of statistics being too late to be useful, saying: “We are always, as it were, looking up a train in last year’s Bradshaw.” For those of you who have not succumbed to the delights of Michael Portillo’s colourfully-jacketed railway journeys, a Bradshaw was a hardback railway timetable

ESCOE’s estimates tell us that over the past year – running to this year’s third quarter – there are significant regional differences in economic growth. London tops the UK league, with growth of 1.8%, followed by the south west 1.51%, the south east 1.49%. Northern Ireland 1.41%, east midlands 1.32%, Scotland 1.29%, east of England 1.24%, Wales 1.17%, north west 1.07%, Yorkshire & the Humber 1.06% and the poor old north east, just 0.83%.

Northern Ireland is a bit of an outlier, and Scotland has always done better than the regions of northern England, but otherwise the picture is reasonable clear. London and the southern regions of England have been blessed with stronger growth than the rest, and certainly than the regions of northern England. London has grown at more than twice the rate of the north east.

The figures set me digging into ESCOE’s database, which goes back to 1970. Bear with me while I give you a few more numbers. Since annual growth turned positive in 2010, after the financial crisis, the average growth figures are London 2.99%, west midlands 2.21%, south east 1.96%, east of England 1.86%, east midlands 1.81%, Wales 1.73%, south west 1.69%, Scotland 1.67%, the north west 1.35%, notwithstanding the Northern Powerhouse, Northern Ireland 1.27%, Yorkshire & the Humber 0.95% and the north east 0.76%. London was at the heart of the crisis, indeed what happened in London helped cause it, but it has prospered since.

These small differences in growth rates may not sound like very much but compounded, they add up to a lot. The London economy, for example, is over 26% bigger in real terms than at the start of the recovery, compared with 6% for the north east, just under 8% for Yorkshire & the Humber and 11% for the north west.

Over time, regional differences in growth rates matter a great deal. The London economy is more than 3.3 times its size, in real terms, than in 1970, the start of the data, while the south east’s economy is 2.7 times its size back then. The economies of the north east, north west and Yorkshire & the Humber are bigger than they were, but only about double their 1970 size, and thus lagging well behind.

Growth figures tell us a lot, but do they tell us everything? After all, in an economy operating at close to full employment, huge regional unemployment differences are a thing of the past. Southern regions do have lower unemployment but the range in unemployment rates between the lowest, the south west at 2.9%, and the highest, the north east and Yorkshire & the Humber, 5%, is quite small.

For a full picture, however, it is also necessary to look at employment rates; the proportion of 16-64 year-olds in work. In the north east this is just 71%, and lower at 68.5% in Northern Ireland, compared with 77.8% in the south east and 78.9% in the south west.

Most tellingly of all are the spectacular regional differences in productivity; the ultimate driver of living standards. Output, measured by gross value added per hour worked, is 33% higher than the national average, according to the Office for National Statistics. Only London and the south east, 6% above, have productivity higher than the national average.

London’s productivity is between 50% and 60% higher than Wales, Northern Ireland, Yorkshire & the Humber, the east and west midlands and the north east. It is 44% higher than the north west. These are staggering figures.
So that is the problem, the question is what can be done about it. It is a question, it should be said, that has occupied policymakers for many decades, through the high and low watermarks of regional policy.

The simple answer is that most of the country, but particularly the northern regions, need to move up the value chain. If only London has the kind of diversified economic structure, skills and high value-added activity that allows it to compete and often beat the world’s productivity leaders, there has to be something for the rest of the country to elarn from it.

But how? The government has an industrial strategy, though like everything else it has been overshadowed by Brexit, and it has just established an industrial strategy council, under the chairmanship of Andy Haldane, the Bank of England’s chief economist. Membership includes Kate Barker, Archie Norman, Emma Bridgwater, Hayley Parsons and Rupert Harrison, George Osborne’s former economic adviser.

The Institute for Public Policy Research’s Commission on Economic Justice called for “a strategy of ‘new industrialisation’, focused on building regionally distinctive high-tech clusters around the UK’s research-based universities”.

The Centre for Cities has called for a focus on driving productivity improvements in cities outside the “Greater South East” by focusing on the potential for developing high-skilled export businesses across the country. The CBI’s Unlocking Regional Growth report looked at four main areas: skills, better transport links, better management and pushing a higher proportion of firms into exporting and innovating.

These are good ideas which, if enacted would help, though you would not necessarily want to start from here. Whether they are enough must be questioned. And, as the regional growth figures show, these imbalances have built up over very many years, which will take years to solve. That they have to be solved should not be in doubt. We really cannot go on like this.

Sunday, November 18, 2018
Britain does not need this new wave of Brexit uncertainty
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

It is easy these days to think that you have wandered into a strange nightmare from which there is no waking up. For many of our business leaders, Wednesday evening brought a call from Philip Hammond and Greg Clark, the business secretary, outlining the proposed withdrawal agreement from the EU and encouraging them to support it.

That was not too nightmarish but next morning ministers were falling like ninepins, letters were going into the Tory 1922 committee and Theresa May was being reassured by everybody that her agreement had a snowball’s chance in hell of getting through parliament. Even by the rollercoaster standards of Britain’s progress toward Brexit, this was an extraordinary lurch, though things have calmed down a little now.

Is it all just a bad dream? How comforting it would be to turn the clock back to February 2016, and the fork in the road then. By the time of the EU summit in Brussels that month, it was already clear that David Cameron’s negotiation over the terms of Britain’s membership had fallen short. Newspapers had already run “is that it, prime minister?” front pages.

Cameron could and should have said that the deal he was offered was not good enough, that he would tell the rest of the EU so, and that it was back to the negotiating table. His deadline for holding a referendum by the end of 2017 might have slipped, or even fallen by the wayside when the government woke up to the reality of dealing with a Trump presidency. But it did not, and like the American president recently, Brexit supporters were able to take advantage of a caravan on asylum-seekers fleeing wars and poverty and making its way across Europe, though not to Britain.

The clock cannot, however, be turned back. We voted, as I said here on June 26 2016, for a poorer and more uncertain future. That there would be so much political chaos at this stage, cementing Britain’s position as, to put it politely, very eccentric, is a surprise even to me. We are where we are. So where are we heading?

I still think there will be a deal on withdrawal, rather than no deal, and that it will be quite close to the lengthy document (586 pages) agreed by the cabinet – before the resignations – and discussed with business leaders,

There will thus be a transition period in which very little changes, lasting an initial 21 months after March next year, but extendable by mutual agreement. Britain will pay up roughly £39bn as the divorce settlement, more if the transition period is extended. If that does not happen, and there has not been enough time to negotiate a trade deal, the customs union backstop, the “single customs secretary” would kick in to prevent a hard border between Ireland and Northern Ireland. A deeper customs union, together with following the single market rulebook, would be the additional, “belt and braces” backstop in Northern Ireland.

Why do I think that, in the end, there will be a parliamentary deal on withdrawal, rather than the descent into chaos of a no-deal Brexit? Though this may be a heroic assumption, I think in the end common sense will prevail, though perhaps not first time and maybe only after parliament has stared into the abyss, but there is much less support for a no-deal Brexit than for something similar to the prime minister’s draft treaty.

The markets are with me on this. Sterling slumped by two cents to a little below $1.28 on Dominic Raab’s resignation as Brexit secretary. It would have fallen a lot more, to below $1.20, probably well below it, if the markets began to price in no deal.

The risk for the next few weeks is that the economy starts to react as if Britain is heading for a no-deal Brexit. Prospects for the current quarter were already looking downbeat, and surveys and hard data suggest that it has got off to a subdued start. The danger is that adding a new layer of uncertainty at this stage, if only temporarily, will compound that weakness. The economy may find itself limping, at best, towards the March 29, 2019 finishing line.

Does the draft treaty, or something like it, constitute a good deal? When it comes to Brexit, there are many who live in a fantasy world of the never-possible, and those who take a pragmatic approach. The prime minister’s aim has always been to hug the EU as close as possible economically, while delivering on leaving the union, ending free movement of people and exiting the EU’s common agricultural and fisheries policies.

Getting there has been as complicated as a game of three-dimensional chess and some said it could never be done. But it has been. The prime minister and her chief negotiator, Olly Robbins, have tried to make the best of the bad job of leaving the EU.Whether it is that deal, or a different deal under a different prime minister or a different government, it is unlikely to differ greatly from the draft published in the past few days.

EU officials say they have taken things pretty much as far as they can go. If there were to be another referendum, it would have to be under a different prime minister, as May has made clear, and while I understand the clamour for and appeal of a People’s Vote, the outcome would, perhaps surprisingly, be unpredictable. Remainers, to paraphrase Lady Bracknell, have to be wary: to lose one referendum is a misfortune, to lose both looks like carelessness. They should be happier with this deal than many of them appear to be.

What I would be more concerned about in the documents we have seen in recent days, as a business contemplating investing in Britain, either from inside or outside, was what the much shorter seven-page political declaration which accompanied the massive draft withdrawal agreement.

There is work to be done on this, which is just as well. As things stand, the outline political declaration talks of “creating a free trade area combining deep regulatory and customs cooperation, underpinned by provisions ensuring a level playing field”, which sounds fine. But it also says that the “extent of the United Kingdom’s commitments on customs and regulatory cooperation, including with regard to alignment of rules, to be taken into account in the application of checks and controls at the border”.

There is nothing yet in that which guarantees the frictionless trade that businesses with integrated EU supply chains regard as essential to ensure that their operations in Britain remain viable. They will be looking for much more detail, and reassurance, before pressing the button on new investment. The risk for the government is that such detail will open up a new can of worms for the Brexit hardliners. Expect many more lurches on the road to Brexit.

Sunday, November 11, 2018
How we won the Great War but lost the economy
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

This is a moment of history. The Great War itself went slowly, painfully so, but the period since we were marking 100 years from its start, four years ago, to today’s centenary of the Armistice seems to have flashed by. Those four years, of course, have included events that will also change the course of history.

You might think there is not much new left to say about the 1914-18 war. We rightly commemorate the sacrifices made in the world’s first industrial war, as we have done for many years. That is what todays’s 100th anniversary is all about.

But historians, including economic historians, are always delving, and discovering. A new Centre for Economic Policy Research (CEPR) collection, The Great War: A Centennial Perspective, edited by Stephen Broadberry and Mark Harrison, available as a free eBook on the vox-eu.org website, taught me things I did not know.

Calling it the Great War, for example, was commonplace until the 1940s, until the bigger 1939-45 saw it downgraded to merely the first of two 20th century world wars. By the 1960s the Great War description was much more rarely used but I will stick with it today.

Harrison, professor of economics at Warwick University, points out that the war was no accidental conflict brought on by a chance assassination in Sarajevo; it was fully intended. It was not undertaken for commercial advantage, being opposed by business interests in all countries. It was less “needless slaughter”, though French and British losses occurred at a faster rate than those for German troops and there was a terrible waste of life, than a calculated war of attrition.

He also challenges the view that Germany was starved into submission by the cutting off of food imports, a myth later fostered by Hitler. German war mobilisation did more to damage food production and create hunger on the home front, which in the end undermined its war effort.

Economic firepower was key to the victory of the allies. They began the war with bigger economies, measured by real gross domestic product, than Germany and the other central powers, and used it to their advantage. During the Great War the allies produced four times as many tanks, three times as many aircraft and twice the number of machine guns as the German side. As Harrison notes: “The Allies produced far more munitions, including the offensive weaponry that finally broke the stalemate on the Western front.”

There was another paper in the collection that also sparked my interest, from Nick Crafts, also of Warwick University, where he is professor of economic and economic history. That Britain lost her position as the world’s leading economy in the first half of the 20th century is well known. Fighting two world wars was central to that. In the aftermath of the Great War, and for years afterwards, the British economy could be described as “walking wounded”, he writes.

Crafts sets out clearly the extent of the loss of economic advantage incurred by Britain as a result of the Great War. It is customary to focus on the costs of the war itself, which as he notes, were considerable: “Britain incurred 715,000 military deaths (with more than twice that number wounded) and the destruction of 3.6% of its human capital, 10% of its domestic and 24% of its overseas assets, and spent well over 25% of its GDP on the war effort between 1915 and 1918.”

But, as he points out, this was only part of the effect, as “economic damage continued to accrue throughout the 1920s and beyond”. The Great War ushered in a period of high unemployment and high government debt, with the last of the latter not paid off until three years ago under George Osborne’s chancellorship. Government debt rose above 100% of GDP in 1916 and did not come back down below that level (having hit 259% of GDP in the immediate aftermath of WW2) until 1963.

This sharp deterioration in the public finances required Britain to run what Crafts describes as “eye-watering primary surpluses [budget surpluses] to preserve fiscal sustainability”.

As much as this, the Great War destroyed Britain’s highly successful economic model. At the outbreak of war Britain was the poster-boy of the first period of globalisation, the liberal world economic order established in the second half of the 19th century. Britain accounted for 27% of global manufacturing exports and was the world’s leading capital exporter, with net property income from abroad 9% of GDP. Trade accounted for 54% of UK GDP, much more than Germany, 40%, and America, just 10%.

This model was destroyed, not just because of the protectionism that took hold during the interwar years – a lesson for today – but also because other countries, notably America and Japan, stepped in to claim Britain’s international markets when this country’s attentions were devoted to the war effort. By the mid-1920s, Britain’s exports were only 75% of their 1913 level and the damage done to staple industries such as textiles and shipbuilding was never recovered.

By the time international markets were opened up again, which took many decades, it was too late.

Prolonged high unemployment, particularly affecting what Crafts describes as “outer Britain” including a jobless rate of 30.5% in shipbuilding and 25.5% in iron and steel was the result in the second half of the 1920s. Policy, notably the return to the gold standard announced by Winston Churchill in April 1925, not his finest hour, made a bad situation worse.

In recent years we have been used to talking about the hangover from the financial crisis. It is clear that, for Britain, the economic hangover from the Great War was proportionately much bigger.

Crafts suggests that the losses to Britain during the 1920s, broken down into a higher “natural” rate of unemployment, a loss of trade and the consequences of dealing with much higher levels of government debt mean an annual loss of roughly 11% of GDP each year through the 1920s, adding up to “a total not very different from the amount spent on fighting the war”, much more than previously thought.

Time has passed but one thing is clear. “To the victor belong the spoils” could hardly be less appropriate. Victory in the Great War was achieved at enormous human cost. It also resulted in considerable damage to the British economy, from which, in certain respects, we have never recovered.

Sunday, November 04, 2018
Recession is a risk to these best-laid plans
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

You might think after the week we have just had that my cup runneth over. You wait a long time for a budget, and then we have one that was bolder and more interesting than expected. Then, a few days later there is another big event for economy-watchers – we lead quite sheltered lives – the Bank of England’s quarterly inflation report.

Actually, without sounding too curmudgeonly, this has not been the finest hour for economic policymaking. Some of the budget measures came too late for the Office for Budget Responsibility (OBR) to fully assess and properly incorporate in its economic forecasts.

And all of the budget came too late for the Bank to include in its assessment. The forecasting exercise that forms the backdrop to its inflation report is not just a back of the envelope calculation. A couple of days was too short a time to do it. In that respect, the inflation report was unfinished business.

It was not, however, message-free. The big picture of the budget was that Philip Hammond was presented with a windfall for the public finances and spent it, or rather used it to pay for Theresa May’s 70th generous birthday present for the NHS and a tax cut next year in the form of more generous income tax allowances.

That should not have been too much of a surprise, despite the chancellor’s reputation as the most conservative fiscal conservative you will come across. The OBR had signalled on October 19, 10 days before the budget, that stronger tax receipts would mean borrowing at least £11bn lower this year than it had expected. These things have a habit of carrying over to future years.

The big picture from the Bank was that it would like to get on with the job of raising interest rates, but Brexit uncertainty is holding it back for the moment. Had it had a chance to incorporate Hammond’s fiscal expansionism, which will boost the economy by 0.3% next year according to the OBR, that hawkish message would have been reinforced even more in its numbers.

On this view, and assuming a smooth Brexit, the Bank remains unlikely to raise rates until after Britain leaves the EU at the end of March next year but could do so two or three times before Mark Carney quits as governor in January 2020. That would take interest rates close to the 1.5% level at which the Bank would start unwinding its quantitative easing.

Will things turn out this way, or could a growth stumble upset the best-laid plans of both Hammond on the public finances and the Bank on interest rates?

You can put a cigarette paper between the Bank and the OBR’s growth forecasts, but not much of one. Both agree that the economy will grow by just 1.3% this year, its weakest since the crisis, despite a good third quarter. The OBR then thinks growth will average 1.5% a year, the Bank 1.7%, even without including the fiscal boost. Its optimism may surprise people but Professor Costas Milas of Liverpool University points out that there has been an optimistic bias to the Bank’s recent growth forecasts, even since the referendum.

Importantly, however, it is foolhardy to get to excited about small differences in five-year official forecasts. They tell us what the two bodies, the OBR and the Bank, think the economy is capable of, its new “steady state”. The fact that one is 1.5% a year, the other 1.7%, does not disguise the disappointing reality of that. This is disturbingly slow growth by historical standards, more akin to an economy growing old gracefully than taking on the world. Only a significant revival of productivity – both predict a gradual pick-up to only half its long-run average – would do that.

These five-year projections also do not allow for the possibility of recession. What are the chances of that? About one in two over the next five years according to the OBR, even on the assumption of a smooth Brexit.

As it put it: “In the 63 years for which the ONS has published consistent quarterly real GDP data, there have been seven recessions – suggesting that the chance of a recession in any five-year period is around one in two. So the probability of a cyclical downturn occurring sometime over our forecast horizon is fairly high.” One fear it has is that in the event of a recession, and with interest rates still low, the Bank would not have the monetary ammunition to fight it.

If a recession is a serious possibility even with a smooth Brexit, it must be a nailed-on certainty in the event of a disruptive, no-deal departure from the EU. The Bank is comfortable that it got it largely right on the economic consequences of the leave vote in June 2016.

In the latest inflation report, it says: “A disruptive withdrawal from the EU would probably result in a further decline in the exchange rate and a large, immediate reduction in supply. Tariffs might also be extended. Each of these developments would tend to increase inflation. Set against that, it is likely that demand too would weaken, reflecting lost trade access, heightened uncertainty and tighter financial conditions.” People should not necessarily expect it to respond in the same way as after the referendum because, as it puts it, “there is little that monetary policy can do to offset supply shocks”.

I don’t think it would raise interest rates in those circumstances but cutting them might be the equivalent of trying to put up an umbrella in a hurricane. S & P, the ratings agency, was brave enough to put some numbers on a no-deal Brexit a few days ago, and they included a 5.5% hit to gross domestic product, a near-doubling of unemployment, a 10% drop in house prices and a £2,700 average financial hit per household.

None of this, of course, has to happen, and the mood music on Britain and the EU achieving a withdrawal agreement has improved a little in recent days, even though this appears to be mainly driven from the British side.

But it is a reminder that the budget, the accompanying OBR forecast and the Bank’s inflation report had one thing in common; they were all overshadowed by Brexit. Normal service will not be resumed for some time.

Sunday, October 14, 2018
A new dawn for pay - or another false one?
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

It has been a very long time in coming. So long indeed, that looking forward to a meaningful revival in pay and productivity has become the economic equivalent of Waiting for Godot. I won’t spoil the plot of the play but when I saw it, it went on a bit.

But has the moment finally arrived? The latest figures on productivity – the amount we produce for every hour we work – showed an uptick. As the Office for National Statistics reported, there was a 1.4% rise in the year to the second quarter, and this was the seventh successive quarter in which productivity had grown on this basis.

A sustained revival in productivity, as noted here, is the perhaps the most important positive development that could happen to the economy. I don’t have to quote Paul Krugman’s deadpan observation that “productivity isn’t everything but in the long run it is nearly everything”, but I will.

Productivity is the ultimate driver of economic growth and any improvement helps competitiveness, the public finances and is intimately connected to pay. And on this, it was a neat coincidence that Andy Haldane, the Bank of England’s chief economist, appointed a few days ago to also chair the government’s new industrial strategy council – with part of its aim to raise productivity – is also more upbeat on pay.

In a speech to the Acas Future of Work conference, he discussed the “puzzling pattern of rich jobs but poor pay growth”, the biggest reason for which has been weak productivity. As he put it: “Productivity growth pays for pay rises, at individual firms and for the economy as a whole. Over the past ten years, productivity has barely grown in the UK.” A lost decade for productivity largely (but not entirely) explains the lost decade for real wages.

But now, he suggested, a new dawn is breaking for pay. Average earnings growth has picked up to 2.9% and the Bank’s own evidence on private sector wage settlements suggest they are running at 2.8% so far this year, and above 3% in IT and construction. The 1% public sector pay cap, he noted, “has now been lifted and decisively so.” And, perhaps most tellingly: “Measures of labour market tightness have increased to their highest levels since before the crisis and, in some cases, ever.”

When a member of the Bank’s monetary policy committee speaks of stronger pay growth, there is always a swings and roundabouts aspect of it for households, certainly those with mortgages. The stronger that pay is, the more emboldened the Bank will feel in raising interest rates.

But the central question is a different one. Is this really a new dawn for productivity and pay? Just when we were ready to go home, has Godot lumbered into view?

Let me take productivity first. The ONS, when reporting the upturn, also noted that at 1.4%,”this remains noticeably below the long-term trend observed before 2008 when productivity growth averaged nearly 2% per year”. There are also a couple of clear caveats about the figures.

The more traditional way of measuring productivity, output per worker, is not doing anything special. It showed an annual rise of just 0.2% in the latest quarter, so is flatlining. The disconnect between the two is because while the number of workers employed rose by 0.9% over the latest 12 months, the total number of hours worked dropped by 0.2%. I would be a lot more comfortable if both measures of productivity were breaking out of their long period of stagnation. It is possible that the apparent improvement is a statistical quirk.

The other reason for scepticism is that none of the things that we think about as the drivers of productivity – investment, skills, better infrastructure, less intrusive regulation – have changed, and if anything they have got worse.
On pay, pretty well every economist would share Haldane’s view that a tighter labour market should be leading to stronger pay growth. The Phillips curve, the inverse relationship between wage growth and unemployment, still means something.

Without a sustained increase in productivity, however, pay could easily disappoint and, as noted, there are reasons for scepticism about that. And, as with productivity, none of the other “structural” factors the Bank’s chief economist also identified as holding down pay have changed, as he acknowledged. What he described as “tectonic” shifts in the labour market, including a decline in unionisation and collective bargaining, the power of employers and their unwillingness to pay up to stop staff leaving, the rise of the gig economy and self-employment, and so on, all remain in place.

Having said all that, in normal circumstances Britain would be due a sustained recovery in pay and productivity. The economy cannot go on indefinitely with stagnant real wages and productivity. Three years ago, when productivity growth pickled up to within a whisker of 2%, we seemed to be on the brink of something. But then it fell back. And, if you wanted to take an optimistic view of pay and productivity, you would not want to start when Brexit is looming

The Office for Budget Responsibility (OBR), the government’s fiscal watchdog, issued a Brexit discussion paper last week, warning that the fog will not lift in time for any withdrawal agreement to be embodied in its forecasts to appear alongside the October 29 budget. Whether it lifts in time for its spring update must be a serious doubt.

The OBR, citing the experience of the 1974 three-day week ( a quarterly fall in gross domestic product of nearly 3%) as an example of the kind of damage a no-deal Brexit could do, thinks there would be a drop in asset prices, including the pound, pushing up inflation and thus squeezing real wages again. In that environment, companies and households would rein back investment and the banks would reduce the supply of credit. Any gradual upturn in pay and productivity would be stopped in its tracks. And, while the economy would eventually recover from the shock, but “the effects on output could be very long-lasting”.

Even in the event of a deal in coming weeks, the OBR notes “that this will be just one additional milestone in the Brexit process”. A trade deal will take years while the new migration framework – reducing migration will more likely harm rather than help productivity – will also take time. “Much of importance for the economy and the public finances will remain to be determined,” it says.

That has to be right. And it is why we should be sceptical about a breakthrough for pay and productivity. As long as uncertainty persists, firms will be keeping a lid on pay rises and productivity-enhancing investment. There will be a new dawn. But there is the rest of a dark night to get through first.

Sunday, October 07, 2018
A Brexit deal by Christmas? Even that's too late as uncertainty bites
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

And so it goes on. Businesses hoping for clarity on Brexit from the party conference season were hoping in vain. With less than six months to go, there are at least six different possibilities.

They include a failure to negotiate a withdrawal agreement with the European Union; a failure to get a deal through parliament; a second referendum – now more or less backed by Labour; a general election; and an extension of the Article 50 Brexit process. Labour has helpfully said it will oppose any deal negotiated by Theresa May, while the Tory “chuck Chequers” crew seems happy to join Jeremy Corbyn in the division lobby when the time comes.

The possibilities also include, of course, an outbreak of sweetness, light and common sense on both sides and an agreement to leave the status quo in place during what is likely to be a long transition during which Theresa May’s “deep and special partnership” with the EU is negotiated.

There are signs of optimism this weekend from EU officials, including the Commission president Jean-Claude Juncker, that an agreement on withdrawal is close, and this has boosted the pound. However, it is not yet clear what the solution will be to the Irish border issue, though it could involve Britain effectively staying in the customs union for a very long time, and Brussels is a very long way from accepting Mrs May's Chequers' proposals as the basis for future negotiations.

Were there to be an agreement in the next few weeks there would be a huge sigh of relief from business. I am sceptical of whether it will bring a significant “deal dividend” for the economy, as promised by Philip Hammond at the Tory conference, but it has to be infinitely better than a disruptive and highly damaging no-deal Brexit. As a way of killing of Britain’s car industry, and others, no-deal would be hard to beat.

The chancellor, who was deprived by the prime minister of the chance to announce the ninth successive fuel duty freeze in his speech – a tax that is withering on the vine so badly that it cannot be too long for this world – has to manage the “sunlit uplands” that will follow a deal; the promised end of austerity next year. This for a chancellor who reportedly told cabinet colleagues that there was no money left after the National Health Service’s 70th birthday settlement.

All that will come later. For now, the uncertainty persists. What impact is it having? That the economy has slowed is not in doubt. Latest official figures show that gross domestic product (GDP) growth has slowed to 1.2%, just over a third of its rate in late 2014 and early 2015, when the economy was getting into its post-crisis stride. Growth in the first half of the year was its slowest for six years, when the eurozone crisis was bearing down on Britain’s economy.

The interesting thing about the growth slowdown is that it is more or less in line with the view of the majority of economists, and me, about the likely short-term consequences of Brexit, which is that Britain’s GDP would be around 3%, or roughly £60bn, lower by 2020 as a result.

A new assessment by George Buckley, a veteran London-based economist with Nomura, the Japanese investment bank, suggests that is very much the case and, indeed, may be a best-case scenario. The calculation, which is derived by looking at the slowdown so far and comparing it with both Britain’s average growth over the past two decades and the performance of “peer” economies in the G7, looks entirely plausible.

As Buckley points out: “This methodology suggests the UK will have lost 3% of GDP in relative terms which we believe is largely down to the Brexit process. The loss could have been even greater had it not been for stimulus in the form of weaker sterling and monetary and fiscal support packages. And, of course, it could be substantially greater still in the event of a disorderly no-deal Brexit.”

In practical terms, Brexit and the renewed squeeze on real wages as a result of sterling’s Brexit fall, have been a factor in the outbreak of extreme retailing woes we have seen this year. Ross McEwan, the RBS chief executive, as well as warning in a BBC interview that a no-deal Brexit could tip the economy into recession, said the bank was becoming more cautious about lending to the retail sector.

Brexit uncertainties have held back business investment, as official figures now clearly show. Instead of rising by 6%, 8% or 10% annually, as was expected at this stage of the cycle, business investment has fallen over the past year. This is the reality behind the Brexit warnings from business.

The economy has not collapsed, which is the good news, though even the Treasury’s much-maligned short-term forecast did not predict that. The latest purchasing managers’ surveys, which measure business-to-business activity, suggest growth of between 0.3% and 0.4% in the third quarter, compared with a “norm” of 0.5% and 0.6%. The service sector is holding up, though growth slowed slightly last month, but construction, after a bounce from the “Beast from the East” disruption earlier in the year, is struggling.

Manufacturing did a little better last month but its performance is described by HIS Markit, which compiles the purchasing managers’ surveys, as “lacklustre”. Growth has slowed markedly from last year’s short-lived boost to exports from the weak pound.

The detail in these and other surveys chimes with the conversations I have with many business people. They do not record the exasperation and anger with politicians I get from many of them. The economy has slowed but business life has to go on. That also explains why, for example, the job market has held up even as growth has faded.

So respondents to the service sector purchasing managers’ survey reported that “Brexit concerns among clients and heightened economic uncertainty remained the main constraints on growth” but that also many firms continue to be beset by staff shortages and are thus still recruiting.

There was a similar story in the construction industry, but, again, recruitment remained healthy in a sector where the fears about the future supply of workers are intense.

Manufacturers appear most uncertain, as last week’s Paris Motor Show warnings from BMW and Jaguar Land Rover underlined. Large manufacturers are shedding jobs, while smaller ones are recruiting. Some firms are stocking up to cover themselves in the event of a disorderly departure from the EU, while others are running them down in the expectation that demand will be even weaker after March 2019. Confused and uncertain? They are.

When will the uncertainty lift? We have now moved into “it should all be over by Christmas” territory in terms of the negotiation with the EU, which means that the parliamentary process will drag on into next year. Many firms cannot leave it until the last minute to take contingency action.

I still think it is probable that there will be compromises in coming weeks, particularly on the Irish border, and that a withdrawal agreement followed by a long transition is still more likely than no deal. But this has been a damaging and dispiriting exercise for the economy and business. And it is not over yet.

Sunday, September 30, 2018
No need to get queasy about the unwinding of QE
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

When America’s Federal Reserve raised interest rates on Wednesday, nobody was much surprised. The increase, the eighth since the US central bank began to move away from its crisis level of near zero interest rates, takes the official rate to a new target range of 2% to 2.25%.

That is still very low by past standards and, with luck there may not be many more rate rises to come. There will be another this year, in December, and maybe two or three next, but the Fed no longer regards monetary policy as “accommodative”, central banker language for stimulating the economy.

Alongside the Fed’s announcement was conformation that it will continue unwinding its quantitative easing (QE), by $50bn (£38bn) a month from October. It brought barely a murmur.

QE remains one of the most controversial policies embarked on by central banks to pull their economies back from the brink and avoid a re-run of the Great Depression of the 1930s. The Fed is close to the 10th anniversary of its launch of QE, while for the Bank of England it began a decade ago next March, alongside a reduction in official interest rates to what was then an all-time low.

Since then, the Fed, European Central Bank, Bank of England, Bank of Japan and others have done around $14 trillion (£10.7 trillion) of QE, of which £435bn has come in Britain from the Bank. $14 trillion is a big number; if you want to put it in perspective it is nearly a fifth of the combined gross domestic product of every country in the world.

From its launch, QE has been widely misunderstood. Many thought it was all about bailing out the banks, which it was not. Other predicted a great inflation, even a hyper-inflation, as central banks turned on the monetary taps, and were embarrassingly wrong.

Once people saw how easy it was for central banks to electronically create money and purchase assets – the Bank’s QE vehicle is known as the asset purchase facility – eyes began to light up. Why not electronically create money to build roads, bridges, houses, hospitals or schools, or give every household a big cash bonus?

Those arguments, misguided as they were, have not gone away. Some are still determined to see QE as a magic money tree. There are other arguments about QE, which is the policy has benefited the holders of assets, and thus increased inequality. But an asset purchase programme was always going to benefit the holders of assets, mainly pension funds and insurance companies, and any marginal increase in wealth inequality looks like a small price to pay for avoiding more serious economic damage and deflation.

What we are now seeing in America, and will see at some stage in Britain, is one of the essential components of QE, its reversibility. The assets, mainly government bonds, that were purchased, can be sold back. That is what kept the policy honest, and anchored, as distinct from a Weimar Republic, or Zimbabwe-style exercise in money-printing.

At first, as in America, the process of running off QE assets is being achieved by not reinvesting the proceeds of maturing bonds. Later, if all goes well, central banks will step it up by actively selling bonds back into the markets.

The interesting thing, so far at least, is the dog that has not barked. Markets were supposed to fear the indigestion, and the loss of a comforting balm, that the reversal of QE was supposed to bring. Five years ago even the prospect that the Fed was about to wind down the amount of QE it was still doing produced the so-called “taper tantrum” and markets, like spoilt children, took a long time to get over their sulk. Now they are very relaxed.

It this the shape of things to come? Gertjan Vlieghe, a member of the Bank’s monetary policy committee since 2015, has worked in both the Bank, as economic assistant to Mervyn King, and in the markets, for J P Morgan, Deutsche Bank and Brevan Howard. He is thus well placed to assess the impact of the unwinding of QE on the markets and the economy.

In a speech at Imperial College in London Vlieghe addressed the issue. His starting point was something else QE often gets blamed for, flattening the yield curve. Normally, in the 20th century, holders of long-term bonds required significantly higher returns than holders of short-term bonds. The yield curve was upward sloping and higher yields on long bonds supported, among other things, more generous annuity rates on pensions.

Vlieghe point out, however, that a flatter yield curve was typical in the era of the gold standard in the 19th century, that its upward slop largely reflected the return of inflation in the second half of the 20th century, and that the period of Bank independence since 1997 has been associated with more stable inflation – and a lower risk of high inflation – than before. The conditions were in place for a flatter yield curve long before QE came along. There is more in the speech that elaborates on this point, and on his view about how QE works, but I don’t want to get too bogged down.

This then leads on to his second conclusion, that the fear in markets that a reversal of QE is bound to put up long-term interest rates and steepen the yield curve, is misplaced.

That does not mean unwinding QE will have no effect. When any stimulus is withdrawn, the effects of that stimulus in boosting the economy will fade. Central banks, by raising interest rates alongside the gradual unwinding of QE will be taking their foot off the monetary accelerator and, in time, pressing down gently on the brake.

There is no need, however, for that process to be disruptive. As Vlieghe puts it: “Unwinding QE need not have a material impact on the shape of the yield curve, or indeed on the economy, if properly communicated and done gradually.”

We are still, of course, some way away from the unwinding of the Bank’s £435bn of QE. It will not happen until interest rates reach 1.5%, and they are currently only half that level. It remains possible that, in the event of a rocky, no-deal Brexit, the Bank will think it is obliged to launch a further tranche of QE.

But it will eventually be reversed. And there is no reason why we should be unduly worried about that.

Sunday, September 16, 2018
Pay's up - but don't put out the bunting just yet
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

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

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

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

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

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

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

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

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

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

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

This ‘better the devil you know’ sentiment may have been good for job security but not for pay. The best way of getting a pay rise tends to be to change jobs.
On this, however, the Bank noted that things are changing. “Job-to-job flows,” it said, rose in the second quarter and were “close to their pre-crisis average and well above levels seen in recent years”. People have been more willing to take a risk on a job change and their pay may be benefiting as a result.

All good stuff, but what about the case for the defence, and the argument that we should not get too excited about pay yet? The most enduring argument of the past decade has been that the job market is not as tight as it looks, even with apparently very low unemployment.

Slack in the post-crisis period might be better measured by the nearly 1m part-time workers who would like a full-time job, together with the 425,000 temporary workers who cannot find a permanent job, or the indeterminate proportion of the 4.8m self-employed people, “gig” economy or not, who would prefer to be in employment.

The latest figures, indeed, did not give the impression of a red-hot labour market. Employment growth slowed to a crawl, rising by just 3,000 over three months, some of which may be explained by a reduction in labour supply from the rest of the European Union. Unemployment fell but there was a rise of 108,000 in the so-called economically inactive.

The pay numbers themselves also offer reasons for caution. While the latest monthly figures were strong, they benefited from the comparison with a particularly weak July last year and thus showed what looks like a quirky jump. Using the three-monthly comparison favoured by the statisticians, total pay growth of 2.6% on a year earlier only took us back to the growth rate of a couple of months ago and was lower that at the start of the year. For regular pay the three-monthly figure of 2.9% was last seen in the early spring. I am not saying “nothing to see here” but there is less in the acceleration than meets the eye.

There is, moreover, no strong sign that much is changing on the ground. NHS staff are enjoying their share of the 70th birthday present with a pay rise, and some of that is reflected in the figures for stronger public sector pay. There is not sign, however, of much of a general relaxation. Only a few days ago Cressida Dick, the Metropolitan police commissioner described as a “punch on the nose” the fact that police had been awarded a 2% pay rise rather than the recommended 3%.

The latest data on pay awards across the economy, from XpertHR, showed that they dropped back to 2.3% over the summer, from 2.5% earlier in the year. Pay awards fit the story of what we used to call a pay norm of 2% or so, which most people are happy with, rather than anything much higher.

Then of course there is the uncertainty of the next few months. The majority of formal pay settlements are agreed in the early months of the year, as are most pay reviews. It could be that by early next year the fog will have lifted and a clear Brexit path established. At the moment, however, you would say that that is less likely than the alternative of continued uncertainty. In this environment, caution over pay rises will persist.

News of higher pay is the kind of thing to lift the spirits of put-upon households and troubled retailers. But it is far too early for them, or anybody else, to put out the bunting.

Sunday, September 09, 2018
Austerity had to be done - but did it lead to Brexit?
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

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

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

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

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

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

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

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

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

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

Under austerity the economy continued to grow and, after a short-lived rise, unemployment fell. The private sector created seven times as many jobs as those cut by the public sector and today we have the lowest unemployment rate since the mid-1970s. There were scares about double-dip and triple-dip recessions, particularly around the time of the eurozone crisis in 2011-13 but the economy trundled along and avoided such traps, gaining strength from 2013 onwards.

It could have been done better. Voters were prepared for austerity in 2010, and a short, sharp shock. Dragging it out, and handing some of the money back with tax cuts such as raising the personal allowance, cutting corporation tax and freezing fuel duty meant that austerity fatigue was bound to set in. Achieving spending cuts by slashing capital spending – infrastructure – was short-sighted.

The long view on austerity also has to take in its impact on the referendum. There is credible evidence, notably in a recent Warwick University paper by Thiemo Fetzer, ‘Did Austerity Cause Brexit?’, that cuts in welfare spending in particular influenced the referendum outcome. Fetzer’s research suggests that without these cuts, support for leaving the EU could have been as much as 10 percentage points lower. And in the context of austerity it was harder to argue that EU migrants, despite being net contributors to the public finances, were not putting pressure on public finances.

The context set by austerity – and weak productivity and wages – also lay behind the Commission on Economic Justice report, published under the auspices of the left-leaning Institute for Public Policy Research (IPPR). It would be easy to rubbish this report – archbishops and economic policy are not usually a happy combination – and I was invited on to a couple of radio programmes to do so.

But it is true that there is an air of dissatisfaction about the economy, even nine years after the last recession and with low unemployment, and some of its diagnoses are spot on. Britain has invested too little; at the bottom of the 30-plus members of the Organisation for Economic Co-operation and Development for investment, public and private, as a percentage of GDP from 1997-2017. Within that, too much bank lending goes into housing rather than productive investment.

We also have too big a “long tail” of low-productivity businesses, and too little competition in many markets. A proper industrial strategy, rather than the damp squib the government has come up with, is indeed needed. So is action to transform skills. Increasing housing supply, particularly that of social housing, is vital.

Many of the Commission’s ideas, however, should remain firmly on the drawing board. It may be true that businesses have not responded to corporation tax cuts by increasing investment but increasing the corporation tax rate to 24% (from 19%) is not something you would want to do when Britain needs to maintain its attractiveness to inward investors.

Nor would you want to increase Britain’s overall tax burden, currently the highest for 30 years, to the levels of Germany or Denmark in order to increase public spending. Government receipts look to be close to a natural limit of 37% of GDP.

It is good that a debate is taking place on improving Britain’s economic performance, and the IPPR report is part of that debate. But it is also important that ideas are rooted in reality. There is more to reform, too, than turning the clock back to an era when unions were more powerful and a national economic (development) council helped steer the economy.

As for austerity, the worst is probably over and there has been a welcome increase in public investment. But the Treasury, starting to make preparations for next year’s spending review, is in no mind to turn on the taps.

Sunday, September 02, 2018
The Amazon effect has kept a lid on prices - but not for much longer
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

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

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

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

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

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

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

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

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

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

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

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

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

Most researchers have found it hard to pin down the size of the effect; though a paper presented to an IMF conference suggested a short-term disinflationary impact, though was sceptical about the long-term impact. The European Central Bank has examined the impact on prices in Europe.

Part of the problem in measuring that impact, which looks to be real, is the absence of a counterfactual. We live in a world of an increasing online impact and knowing what would have happened in the absence of it.

Another difficulty is the way that inflation data is collected, which tends to be from collecting prices at traditional retailers. It was reported earlier in the summer that the Office for National Statistics is to do more to incorporate online prices, through “webscraping”, into its figures. It is quite possible that official figures have understated the internet impact, and overstated inflation, in recent years.

Now the question is whether the Amazon effect on inflation is set to fade, like the China and discount-retailer effects before it. A paper presented at the Jackson Hole symposium, a key event for central bankers hosted by the Federal Reserve Bank of Kansas City, offered a new perspective.

The paper, presented by Harvard Business School economist Alberto Cavallo, who has done extensive research in this area, had two key conclusions. One is that a consequence of online retailing is more frequent price changes. Online retailers can change prices more easily and cheaply than traditional retailers and do so, forcing traditional retailers also to change.

The other conclusion, perhaps because it is easier to change prices for online retailers, was that the the larger the internet presence, the quicker the “pass-through” to higher prices from nationwide events such as increases in energy prices or a fall in the exchange rate. The internet could lead price increases rather than act as a drag on them.

Traditional retailers have had much to complain about with the rise of Amazon and other online retailers but consumers have benefited from greater pricing transparency and lower prices. Those lower prices, and lower inflation, could never however be permanent. There is a limit to how far margins can be squeezed, as we may now discover. We are not heading into a period of seriously higher inflation but another downward influence may be diminishing in its impact.

Sunday, August 26, 2018
As the budget defciit falls, Hammond's task is clear
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

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

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

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

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

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

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

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

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

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

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

I also detect in the Treasury’s approach no desire whatsoever to go down the Trump route. His tax cuts were launched at a time when the US budget deficit was around 3.5% of GDP. They will push it up to some 4% of GDP in the current tax year and to 4.6% in the following two years. Cutting taxes may have given the US economy a sugar rush but at the cost of increased borrowing and debt. As I say, there is little appetite in the Treasury to follow that route.

As for taking out some Brexit insurance by cutting corporation tax, making businesses reluctant to leave Britain and persuading others that they should come, this is not gaining much traction either. Faced with the bigger risks of Brexit and of a Jeremy Corbyn government – cutting business taxes probably does not bring in many votes - a big cut in corporation tax would have a substantial deadweight cost in lost revenue without much impact on investment.

When it comes to loosening the purse strings on spending, the chancellor gave cabinet colleagues an iconic “there’s no money left” warning after the NHS announcement. They will hope to do better than that in next year’s comprehensive spending review but can expect a tough negotiation. And after a week dominated by the risk of a Brexit no-deal, the chancellor knows that he may have to dig deep to deal with the consequences.

Indeed, Hammond will be diverted from his budget preparations in coming weeks by his efforts to prevent the lemmings in his party diving over the no-deal cliff-edge, and educating his cabinet colleagues, including the new Brexit secretary, of the economic effects. That was the context of his letter to the Treasury committee on Thursday and his efforts will not stop there. The battle is joined.

So has the improvement in the public finances had any impact? Yes. It has headed off, for Hammond, the need to come up with unpopular tax rises to pay for the NHS settlement. None of the suggestions doing the rounds for those tax rises made much political or economic sense, so this has been a welcome escape.

Is that it? There is a phrase etched in my memory, used by Gordon Brown when chancellor, which is “prudence for a purpose”. In his case the purpose was a little too much imprudence. There is also the strategy in part employed by Osborne, also when chancellor, which was to not want to have the public finances in too healthy a state in 2015 for fear of diminishing voters’ fears about a Labour victory. Whether that was deliberate or an ex-post rationalisation can be debated.

There are examples of chancellors who have been too prudent for their party’s and the economy’s own good. Roy Jenkins spent years telling people that his prudence after the 1967 devaluation did not cost Labour the 1970 election.
Hammond is probably right to be cautious now, given the uncertainties. But at some stage, long after most voters have forgotten about the financial crisis but before the next election, he will have to demonstrate that the sacrifices were worth it.

Assuming the next few difficult months can be negotiated, that will include some tax cuts, and the experience with corporation tax is that you can reduce rates and increase revenues at the same time, and it will include an eventual easing of the squeeze on spending. Hammond’s prudence has to be for a purpose or voters will conclude it was all for nothing.

Sunday, August 12, 2018
A no-deal Brexit - the silliest of silly season ideas
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

This is a time of year when it is customary to talk about the silly season for news, and one prominent example of it has been running for the past few days, Boris Johnson. When it comes to Brexit, meanwhile, it has not so much been the silly season this summer as the stupid one.

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

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

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

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

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

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

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

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

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

What about the argument, which has recently re-emerged, that WTO rules prevent the EU discriminating against British exports. If a product is good enough for the EU on March 29 2019, why should it not be good enough on April 1? Two WTO agreements, that on sanitary and phytosanitary measures, the SPS agreement, and the TBT (technical barriers to trade) agreement, have been cited by some Brexit supporters as reasons why the EU will have to stay open to British exports even in the event of a no-deal.

In fact, as many real-world trade negotiators have pointed out, these agreements do nothing of the sort. And, as Emily Lydgate, Peter Holmes and Michael Gasoriek of the respected UK Trade Policy Observatory pointed out in a recent blog, such claims are mistaken and “shows a lack of understanding of the WTO rules”.

“These rules impose an obligation to talk – but ultimately it is down to the importing country to determine whether the regulation meets its standards,” they wrote. “For the UK the issue is not whether or not the goods are produced to the same standard on Monday or Friday. On Monday the UK does not need to prove this, on Friday it may have to. And this would be WTO compatible.” Even if the UK challenged the EU in the WTO, a challenge that would be unlikely to succeed, the process would take years.

It goes further. For the EU to accept UK goods under EU rules in the event of no-deal, it would be required to extend the same privilege to all other third countries. As Malcom Barr of J.P. Morgan, a close Brexit-watcher puts it: “A basic principle of the WTO’s operation is equality of treatment where a preferential trade deal is not in place (the Most Favoured Nation Principle). That principle would compel the EU to extend the same regime to the UK as extended to others without a trade deal in a no-deal scenario. If the EU were not to do so, other WTO members would be able to sue the EU and UK on the basis that preferential treatment was injurious to them.”

There is another thing often claimed, which is that plenty of countries trade happily with the EU on the basis of WTO rules. No advanced country, however, trades with the EU on the basis of WTO rules alone. Britain would go from having a very close relationship with the EU to the most distant among advanced economies. More on that, if necessary, on another day.

Finally, could not Britain avoid disruption at the ports by simply announcing the abolition of all tariffs on imports from the EU on no-deal day? No. There are several problems with this idea. One is that non-tariff barriers are more important than tariffs. Another is that, as noted, WTO rules require equality of treatment. Abolishing tariffs on EU imports would require the abolition of tariffs on all imports, including cheap manufactured goods from China. The effect on British manufacturing would be devastating, even existential. Add that to the disruption and you are definitely making a drama out of a crisis.

And, while abolishing tariffs might – only might – ease the disruption in northern France, it would do nothing for the queues on this side of the Channel. Trade is a two-way street, and any unilateral gesture by Britain would not be reciprocated. Those who want to turn Kent into a giant lorry park would have their wish granted.

We must hope that this very silly phase of the silly season is short-lived, and that there are enough wise heads in parliament to keep us from the cliff-edge. The fact that we are still having this debate at this stage is both worrying and depressing.

J.P Morgan’s Barr puts it well: “By now it might have been thought that an informed consensus would have developed such that ‘no deal is better than a bad deal’ was recognized as political bluster. As tribal as Brexit has become, the implications of ‘no deal’ are not simply an issue of ‘remain’ versus ‘leave’. One can be pro-Brexit while regarding ‘no deal’ as potentially disastrous.” But not, it seems, if you are a certain kind of Brexiteer.

Sunday, August 05, 2018
A curiously downbeat rate rise. Is it going to hurt?
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

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

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

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

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

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

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

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

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

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

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

On the face of it, the Bank had a clear enough case for raising rates, even though business conditions are at best mixed. As Carney put it: “Employment is at a record high, there is very limited spare capacity, real wages are picking up and external price pressures are declining. With domestically generated inflation building and the prospect of excess demand emerging, a modest tightening of monetary policy is now appropriate.”

It was, however, a marginal call. At one time the Bank was looking for stronger growth in wages than current sub-3% rates before raising rates. Now it can call on the combination of a slight acceleration in wages and continued weak productivity to point to the danger of rising unit labour costs. These are now expected to grow by more than 2% annually in coming years, from only 0.5% a year in 2010-15, the Bank’s inflation report notes.

Another Bank key judgment, that “demand growth outstrips potential supply growth, and a margin of excess demand emerges, pushing up domestic cost growth”, is also very much at the margins. The Bank thinks the economy will average 1.75% growth in 2019 and 2020, after 1.4% this year, so pulling just ahead of the economy’s 1.5% a year speed limit. But growth has only to slip a little below the Bank’s predictions and the danger passes.

The case for raising rates was certainly technocratic. The best policy moves are those that are easiest to explain, and the Bank would struggle to explain this one, in layman’s language to the regulars at the Dog and Duck. In comparison with their colleagues at America’s Federal Reserve, MPC members have a tougher task.

That may be the nature of the game now, one which operates on small margins. As foreshadowed last week, the Bank also produced something new in the form of R* (r-star), its estimate of the equilibrium interest rate. I have to say that, as a tool or signal, it has some way to go before it is very useful.

It could be that, under certain conditions, R* is between 0 and 1%, compared with between 2.25% and 3.25% before the crisis. That would convert, using the 2% inflation target, into an actual or nominal interest rate of 2% to 3%, compared with its old level of 5%. But to get even to 2% to 3%, the economy has to shrug off some of the current weakness in productivity and growth and the markets think that will take until well into the 2020s.

For that and other reasons, it seems sensible not to expect the Bank’s promise of “limited and gradual” rate rises to turn into a rush. One of the big dangers of ending a long period of ultra-low rates was that people, businesses and the markets would interpret any move as the first of many and that the Bank would get “behind the curve” and be forced to tighten in a rush.

The Bank has avoided that. Sterling fell on the hike, because of the expectation that it will be a long wait until the next one. With Brexit looming, assuming it is not messy enough to require rate cuts, it is touch and go whether the next hike will come before Carney’s departure as governor in mid-2019. By that time, another visit to the dentist will not be anything to get too concerned about. It could even be overdue.

Sunday, July 29, 2018
Will they or won't they? A big moment for the Bank
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

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

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

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

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

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

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

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

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

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

Normalising rates is justified by the distortions created by years of ultra low rates, including what official figures suggest is a collapse of Britain’s savings culture. It also mean central banks need not go naked into the next downturn, with barely a rate cut at their disposal.

It will be a close-run thing and I would be very surprised if we see a unanimous vote from the MPC this week. There was no unanimity, remember, when the MPC voted for its first increase for more than 10 years last November, reversing the post-referendum rate cut. It will be no surprise if the Bank hikes this week but equally nobody should be too shocked if the Bank decides to put it off.

The normalisation argument for raising rates brings up the question of what is normal now for official interest rates. That is the second significant thing the Bank will do this week. It will provide an estimated for what is known as r* (r-star). R* sounds more complicated than it is. It simply provides an estimate of the neutral or equilibrium real interest rate. It is the interest rate which, as the Federal Reserve Bank of San Francisco defines it “is consistent with full use of economic resources and steady inflation near the target level”.

R* provides guidance on where the MPC thinks it might end up after a sequence of interest rate rises. The Fed has been providing such guidance for some time.
What will the Bank’s be? Allan Monks, an economist with J P Morgan, an investment bank, suggests the Bank may opt for an r* of between -0.5% and zero, in other words, a marginally negative real rate. To put that in numbers people will find more familiar, that translates into an actual interest rate of between 1.5% and 2%.

As an idea of the kind of destination the Bank has in mind it makes a lot of sense. It is, of course, a far cry from the 5% Bank rate typical before the crisis or the 12% average of the 1980s, though the Fed’s experience has been that the neutral rate is not set in stone and varies with circumstance. Those accustomed to previous Bank guidance will recognise that as par for the course.

Many things will affect the direction and ultimate destination for interest rates in coming years. Brexit is one big factor but so, as Ben Broadbent, another deputy governor, said last week, is the pace at which the Bank unwinds it quantitative easing (QE). The more QE the Bank reverses by reducing the assets it bought under the policy, the less will be the need for rate hikes.

We are not there yet. The Bank’s guidance on QE is that it will not begin to be reversed until interest rates have reached about 1.5%. After that, any further tightening will take the form of both raising rates and unwinding QE. Any need to relax policy would at first be through rate cuts.

There is a lot happening there and, whatever happens on Thursday, we are moving into a new phase for monetary policy.

Sunday, July 22, 2018
Why Britain's debt is on a dangerous trajectory
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

The most important, and very worrying, economic report in recent weeks came a few days ago from the Office for Budget Responsibility. For what it said about the outlook for the public finances and in particular the explosion of government debt in coming decades it did not get the attention it deserved.

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

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

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

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

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

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

There are several reasons. What happens now matters a lot for the trajectory of government debt and Theresa May’s abandonment of Osborne’s targeted budget surplus by the end of the decade, or at least its postponement to the mid-2020s (well beyond current political horizons) matters a lot.

Last month’s 70th birthday present for the National Health Service, as yet unfunded, has a big long-term impact. The OBR assumes that NHS spending will continue to rise from the new higher base to accommodate demographic and other cost pressures. The effect builds over the long-term and is huge. In the absence of the boost to health spending government debt to GDP would be 57.9 percentage points lower than is now projected.

There is, as the OBR confirmed, no Brexit dividend to pay for this NHS largesse. In fact, the public finances will be worse, and could be considerably worse as a result of leaving the EU. Britain’s demographics, meanwhile, look less favourable, putting additional upward pressure on spending. By 2067, 7% of the population will be 85-plus, compared with 2% now. And 27% will be 65-plus, against 18% now.

The debt cannot be allowed to rise as far and as fast as the OBR’s baseline suggests. How can it be stopped from doing so? The government is not about to reverse Brexit, or tax people and businesses to the hilt, though if it did so the negative effect on growth would make the public finances worse rather than better.

Cutting immigration to the tens of thousands is government policy, even though it appears to more of an aspiration than a firm aim. Contrary to popular opinion, allowing higher immigration would be far better for the public finances. The OBR assumes net migration of 165,000 a year. A “high migration” alternative, 245,000 a year, would reduce the debt to GDP ratio by around 30 percentage points, while low migration, 85,000 a year, would increase it by 40 points, to over 300% of GDP.

There is also, given the importance of the new NHS settlement in the projections, scope for higher NHS productivity and healthier lifestyles to alter the trajectory for debt very significantly. It could happen but whether it will is another matter.

Rising government debt has been the story of the past 20 years. In cash terms the debt has risen from £359bn in 1997-98 to £557bn in 2007-8 and almost £1,800bn in 2017-18. The deficit has come down but the debt has increased exponentially.

Even at low interest rates, debt interest now costs more than the government spends on the police and the armed services. If the debt interest bill was a government department it would have the third largest spending in Whitehall, after health, welfare and education.

In the end, the only way to secure the public finances in the long run, and prevent debt rising to unsustainable levels and provoking a fiscal crisis, is to lock in the reduction in the budget deficit achieved since 2010. That was the argument for aiming for a small but permanent budget surplus which the Treasury would still like to achieve. It may already be too late.

Sunday, July 15, 2018
Give young people the skills - or they won't do the job
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

For British business, the question of skill shortages, never very far away, is now a pressing one. Though the government’s EU white paper failed to spell it out – detailed proposals on immigration are expected later in the year – Britain’s labour market after Brexit is likely to be less open to EU migrants than in the past.

That has yet to be negotiated, and it may be that the government will have to offer concessions. But the situation is already changing. The ready supply of EU workers, needed to fill key gaps, including gaps in skills, is already tailing off. Over the latest 12 months there has been a 28,000 drop to 2.29m in the number of EU workers in Britain.

Such workers account for 6% of employment across all sectors and regions, and are particularly important in some. Official estimates show that 13% of workers in London are EU nationals, a proportion rising to 28% in the construction industry.

Many people say to me that, if indeed we are heading for a future in which the supply of skilled EU migrants will be restricted, as well as those who perform less skilled tasks such as fruit picking, the solution is to better train and equip our own people, particularly young people.

While the unemployment rate is at its lowest since the mid-1970s, it still equates to a jobless level of 1.42m. There are 808,000 young people (16-24) who are Neets – not in education, employment or training – and that number has started rising again.

On the face of it, however, at a time when we should be boosting the skills of young people – and the rest of the workforce – we appear to be heading in the opposite direction. The introduction of the apprenticeship levy in April last year, a measure heavily criticised by business, has been associated with a sharp drop in new apprenticeships, not an increase.

Data for the first three-quarters of the 2017-18 academic year show 290,500 apprenticeship starts, a drop of 34% compared with the figures reported at this stage for 2016-17. The Institute of Directors says that without reform it will be impossible to meet the government’s target of 3m apprenticeship starts by 2020. Apprenticeships suffered with the sharp decline in manufacturing in the 1980s and it is not clear whether the current model is the answer.

When it comes to technical education, and equipping young people with the skills they need in a modern economy. Britain has arguably had a problem for even longer. As early as the time of the Great Exhibition of 1851, shortcomings in Britain’s technical education in comparison with Germany were being noted. A century later, the 1944 Education Act, brought in by R.A. Butler, envisaged a tripartite system of secondary education, with grammar schools, secondary moderns and technical schools. But technical schools were always the poor relation, and many local authorities chose not to open any.

Lord Baker, who as Kenneth Baker was education secretary under Margaret Thatcher in the 1980s – giving his name to the “Baker days” of in-service training for teachers which were not always welcomed by parents – has been a tireless campaigner for technical education in Britain. There have been many times when that campaigning has run up against the preferences of those in power for academic education, including the period when Michael Gove was education secretary in the coalition government.

Baker has not stood still. His Baker Dearing Educational Trust, set up with the former senior civil servant and Post Office hear Lord Dearing, has pioneered the introduction of university technical colleges (UTCs), whose mission is to help grow the “talent pipeline” by providing “the next generation of engineers, technicians and scientists”. There are now 49 UTCs, with approval just granted for a 50th, in Doncaster, the result of a collaboration between the local chamber of commerce and the two universities in Sheffield.

I accompanied Lord Baker to the South Bank Engineering UTC in Brixton. Like the other UTCs, its provides technical education for students from 14 to 19. And, though many students were occupied with exams on my visit, it is unlike other schools. The students all wear business dress, were engaged in a range of collaborative projects and on the premises had access to and were using sophisticated design and engineering equipment, including 3D printers. They work with and are in demand from local employers.

Though the record of UTCs has been far from perfect, in part because they do not fit the traditional Ofsted blueprint, Baker points to the record of those students leaving them. In 2017, 97% of 18 year-olds leaving UTCs went on to additional education, work or apprenticeships; 2% took gap years or left the country and only 1% became Neets. That compares with an overall Neet rate of more than 11%. The average graduate earns less five years after graduation than a Level 5 apprentice two after completion, he notes, and the graduate has the millstone of student debt hanging around his or her neck.

It is a start, and the UTCs are a good thing, but much more needs to be done. Many fewer subjects that will be essential to Britain’s future in creative and digital industries are being studied in schools. Figures from Ofqual show that since 2014 the number of GCSE entries in design and technology have fallen by 42%. Entries in computing and ICT (information and communications technology) are also falling. The number of entries for A-level engineering have collapsed, to just 10 across the whole country.

The government wil argue that it is responding with the introduction of new T-levels, technical qualifications with parity of esteem with A-levels. Last week the first 54 colleges to offer them werer announced. The first course will not begin, however, until September 2020, and then only in a limited range of subjects. It is not clear whether what the government describes as “the most significant reform to advanced technical education in 70 years” will meet the needs of students and employers.

For business, Adam Marshall, director-general of the British Chambers of Commerce, says that what is needed is a change of attitude in the department of education, and among teachers, most of whom go straight from university and into teaching, to vocational education. Teachers should, he says, spend time becoming familiar with business, and its needs. He is right, and parents should also be taught that the academic route is not always to right one for their children.

It may be that in the future Britain can continue to rely on importing people from countries where technical and vocation education is better. But it would be unwise to gamble on it. And it would imply a continued waste of talent and potential.

Sunday, June 24, 2018
We don't need a new Bank target - but we do need to raise our game
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

Just when you think there is nothing new to say about one of the defining problems of our age – stagnant productivity growth – somebody comes up with something new. A report commissioned by John McDonnell, Labour’s shadow chancellor, has called for the Bank of England to be set an additional target, that of achieving productivity growth of 3% a year.

Productivity, output per worker or, as it is more commonly measured, output per hour, has been the missing link in the economy in the period since the financial crisis. Had it made up the ground lost then, something that usually happens after recessions, we could be looking at gross domestic product (GDP) per worker 20% higher than it is. That was where the pre-crisis trend, if maintained, would have left us.

Most of that would have translated into a level of GDP a fifth larger than it is, alongside much better public finances; the budget deficit, 1.9% of GDP in 2017-18, would have long been eliminated and there would be no worries about how to fund the £20bn-plus boost to National Health Service spending.

Sustained growth in productivity of 3% a year would be transformative, converting Britain from the seven-stone weakling of the international productivity comparison tables to a country capable of kicking sand in anybody’s face. We could laugh in the face of Brexit and the uncertainties and prolonged drag on economic growth it brings.

To put it in perspective, the Office for National Statistics has data on GDP per hour worked going back to 1972. In that time, productivity growth has averaged 1.8% a year, so 3% would be an improvement of 1.2 percentage points, or more than 60%, on that long-term average.

By decade, productivity growth averaged 2.2% in the 1970s, 2.4% in the 1980s, 2.3% in the 1990s, 1.4% in the 2000s and just 0.5% since 2010. McDonnell’s Labour is sometimes accused of wanting to go back to the 1970s but in terms of its productivity ambitions it wants to go further.

It is not impossible; there have been 11 years in the past 45 when productivity has grown by 3% or more, years of strong economic growth or falling employment. But it is a long way from where we are now. The last 3%-plus productivity year was in 2000.

Much of the response to the report commissioned by the shadow chancellor, written by the consultancy GFC Economics and Clearpoint Advisors, has been that it reflects muddled thinking. Monetary policy and financial stability, the Bank’s responsibilities, have no direct links to productivity and adding to its targets merely makes it more likely that it will miss its central one, that of controlling inflation.

Where central banks have adopted so-called dual mandates, targeting employment as well as price stability, as in America, Australia and, currently, in New Zealand, there is a logic. Low inflation is a necessary condition of rising employment. But when it comes to productivity, some of the best years for its growth in Britain have been alongside high inflation, including the infamous Barber boom of the early 1970s.

Not only that but the idea of giving the Bank a target, and responsibility for raising productivity is the exact opposite of one of the motivations Gordon Brown had in giving the Bank independence 21 years ago. The Treasury, he said, had been too preoccupied with the short-term, and in particular the short-term question of when to raise or lower interest rates. Younger readers may need reminding that this used to be the preserve of chancellors of the exchequer.

Freed from that, he wanted to turn the Treasury into a fully-fledged economics ministry, with a focus on, among other things, raising productivity. A productivity agenda was an important part of new Labour’s economic programme, which included commissioning reports on Britain’s shortcoming from experts. Abolishing the dividend tax credit, the famous raid on pensions, was done with the aim of getting companies to invest more, rather than distributing all their profits to investors.

That Treasury tradition continues. Philip Hammond has his £31bn National Productivity Investment Fund, split between investment in the infrastructure and research and development. A separate £1bn artificial intelligence (AI) fund was anno0unced two months ago.

Tackling poor productivity is about addressing the three i’s – investment, infrastructure and innovation – as well as one ‘s’, skills, a subject I shall return to shortly. Investment, the lowest of any advanced economy from 1997 to 2017, tells quite a lot of the story.

What is lacking in the Treasury’s efforts is a sense of urgency. Brexit has weakened productivity directly, by choking off the expected strong recovery in business investment. It has also sucked the life out of everything else in policy terms. The urgent national task of raising productivity has been left to simmer gently on the back-burner.

That is why, while Labour is wrong to think the Bank needs another target, and that directing bank lending to “productive” investment is the right way to raise productivity, the party is right to focus on the issue. This is notwithstanding the fact that many of its policies in other areas, notably tax, are likely to reduce rather than raise productivity.

What should be done? A new study from the St Louis Fed, one of America’s regional federal reserve banks, suggests that innovation is one of the keys to productivity differences between countries. Given the productivity gap, Britain needs to do a lot more of it.

Recent work by the National Institute of Economic and Social Research, funded by the Joseph Rowntree Foundation, has also found that in low-wage, high-employment sectors of the economy, covering a range of mainly service sectors, Britain’s productivity is 20% to 30% below Germany, France, the Netherlands and America.

In retailing, Britain compares well with other European countries but is 40% behind America. In hospitality, productivity is 45% higher in France. There are traditional explanations for these differences, in lower levels of investment and labour quality, which brings us back to skills. They also feature in another part of the story, poor management quality and practices in Britain.

The good news about all these factors is that they lend themselves to solutions. Britain would be a lot more productive if we invested and innovated more, had better infrastructure and workforce skills, and improved management quality. All can be fixed though it will take time, even with greater urgency than now.

Improving Britain’s productivity is one for the long haul, not a short-term Bank target. But we should be doing more than we are.

Sunday, June 17, 2018
Why jobs are booming when growth stays weak
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

Today, away from the parliamentary kerfuffle over Brexit, Donald Trump’s dangerous protectionist rhetoric, higher interest rates in America, the prospective end in December of quantitative easing in Europe and other momentous issues, my attempt to answer something that has been puzzling me for a while. Why is Britain’s labour market so strong when growth is quite weak?

The latest official statistics brought news of what appears to be a continuation of Britain’s jobs’ miracle. The number of people in work in the February-April period, 32.39m, was 146,000 up on the previous three months and 440,000 higher than a year earlier.

The employment rate, the proportion of 16-64 year-olds in work, remained at a record high of 75.6%, while unemployment was down 115,000 on the year and, at 4.2%, the unemployment rate is at its joint lowest since 1975.

These are remarkable figures in any context, but particularly so in the light of other economic data. A few days ago the Office for National Statistics (ONS) gave us a Black Monday of official figures, with construction output in the latest three months dropping at its fastest rate for six years, and new orders also slumping; manufacturing output also dropping at its fastest rate since 2012 and the trade deficit widening because of a drop in exports of both goods and services.

All this translated, according to the National Institute of Economic and Social Research, into likely growth of gross domestic product of a mere 0.2% in the March-May period, only a touch above the “barely there” growth of 0.1% in the first quarter. A stronger bounce was expected, including by the Bank of England, from the effects of the “Beast from the East” weather disruption of March. The ONS, it should be said, played down the effects of the weather on the weak first quarter growth.

What the weather takes away, it can also give. The influence of the second-warmest May in 108 years, as well as the royal wedding, can be seen in the May retail sales figures, which showed a jump of 1.3% on the month. That may help the second quarter growth figures but it has not lifted the cloud over retailing, and will not. N.Brown, the Manchester-based company which has been operating since the 1850s, said it has begun a consultation process to close its remaining 20 high street stores. Its brands include High & Mighty, a store I fear I may now never visit.

Retail employment, in fact, is behaving as you would expect. The number of people employed in retailing, wholesaling and related activities has dropped over the past year and, given the recent spate of store closure announcements, is set to drop further.

The big picture, however, remains a puzzling one. Growth in the economy has slowed from around 3% in late 2014 and early 2015 to a fraction over 1% now. The Institute of Chartered Accountants in England and Wales (ICAEW) has just revised down its growth forecast for this year to 1.3%, citing weak business investment.

Growth has slowed to rates that would not normally be associated with any growth in employment and with rising rather than falling unemployment. Part of the explanation for that lies with weak productivity; when output per person is not growing by very much – not at all over the past year – you need more people even to produce a modest increase in GDP.

There are, however, other aspects of the figures which help resolve the puzzle. Public sector employment is not directly related to the state of the economy, though it has been boosted by the Brexit process. After adjusting for reclassifications, the number of people employed in the public sector is up by 42,000 over the past 12 months, following years of decline. Two of the biggest increases in workforce jobs in the past year were in the categories of health and social work and public administration and defence.

I would not overstate this; 42,000 is only a tenth of the rise in employment over the past 12 months, though it is a factor. For most of the time in recent years, rising overall employment has been against a backdrop of falling public sector employment.

A better explanation lies with another labour market measure provided by the ONS, which is for the total number of hours worked in the economy. While employment rose by 146,000 in the latest three months, the total number of hours worked dropped by 4.1m to 1.03bn, an odd combination. And, while employment has grown by hundreds of thousands in the 18 months since late 2016 and early 2017, hours worked have not grown at all. We require more workers, not just to produce a given level of output, but also to put in a certain level of hours.

Regular readers will recall that I have written recently about the potential positive effect of reducing working hours on productivity. Something else, however, appears to have been happening. More than 70% of the jobs created in the latest three months were part-time. The more part-time jobs that are created, the lower the average work-week.

Even for full-timers, however, the work week is falling, from 37.5 hours a year ago to 36.9 now. Why this is not clear. Some of it may be in response to slower growth and weak demand; some because of automation. Zero-hours contracts, by their nature more responsive to demand, are part of the explanation. In addition, older full-time workers may be negotiating shorter working weeks.

Clearly this does not just apply to women but one reason for the record female employment rate, identified by the ONS, is that changes in the state pension age have resulted in more women staying in employment in the 60-65 age group. This is the plight of the so-called WASPI (women against state pension inequality) cohort.

If we measure the strength of the labour market by hours worked rather than numbers of people in work, the scales lift from your eyes. A flat picture for hours worked is consistent with an economy that has slowed significantly over the past 2-3 years.

The idea that the job market is not as strong as appears at first glance may help explain another ongoing puzzle, that of weak growth in wages. Strong employment growth and falling unemployment should be giving us bigger rises in average earnings than the current 2.5% annual rate. Stagnant hours worked, alongside low productivity, suggests that people are not necessarily feeling as secure in their jobs as the headline figures would suggest.

So a couple of puzzles solved. Thankfully that leaves plenty more.

Sunday, June 10, 2018
The NHS: 70 years old and counting ... the cash
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

When Philip Hammond announced that he was scrapping the spring budget and the autumn statement in favour of an annual autumn budget, many people applauded. A single “fiscal event” each year had the merit of preventing chancellors from engaging in too much tinkering, and this self-imposed restraint was why he did it.

The chancellor, however, had reckoned without birthdays which, as everybody knows, can be very expensive. The National Health Service’s 70th birthday is on July 5th and, unlike many 70 year-olds who would be happy with a new pair of slippers and a bumper bag of Werther’s Originals, it wants a big present.

The NHS, which accounts for the vast bulk of UK public spending on health, has shown a formidable appetite for consuming taxpayers’ money over its lifetime. Efforts to put it on a diet have generally been time-limited or followed by a binge.

Since the NHS was established in 1948, health spending has risen from £12.9bn to £149.2bn a year, in today’s prices; in other words it is nearly 12 times what it was. This has been achieved by an average annual rise in real terms – on top of inflation - of 3.7% a year. Taxpayer-funded health spending has risen from 3.5% of gross domestic product (GDP) to its current 7.3%.

It has also been the cuckoo in the Whitehall nest, squeezing other spending, as it is now. In the NHS’s history, health spending has risen from a low of 10% of all outlays on public services in the early 1950s to 30% now. Yes, a third of all spending on public services is on health.

In arriving at this point, successive politicians have gone with the flow. The NHS is not seen by the public as the greedy child in the corner but, according to a survey last week, is the most-loved British institution. Nigel Lawson, who as chancellor had his own battles over NHS funding memorably described it as the closest thing the English have to a religion.

At this point I would normally say that even religions encourage fasting, and that the fast the NHS has been on since 2010, during which spending has risen by between 1% and 1.5% in real terms, a third of its long-run average, has led to greater efficiency. Productivity in the NHS has grown by 1.4% a year since 2010, outstripping the rest of the economy, which is unusual.

I have written many times about the need for greater efficiency in the way the NHS is run, of reforms that spread best practice, of forcing users of the NHS to behave better – charging for appointments mixed for example – and of reforming an organisation that is vast in size, roughly 1.5m employees. Each time I do so I am assured that no effort is being spared to raise efficiency and that the NHS is not as top-heavy as it is usually painted, managers only accounting for 3% of staff.

In any case, with the 70th birthday looming, time is of the essence. The government is in the happy position of knowing what the NHS wants. Three health think tanks, the King’s Fund, the Health Foundation and the Nuffield Trust, have written to the prime minister calling for a long-term settlement for the NHS which would provide a 4% a year increase in real terms. This, they say, “is the minimum required to keep pace with rising demand for services, provide some investment in key priorities such as mental health, cancer and general practice and continue the transformation of services set out in the NHS five-year forward view”.

“Anything less than this,” they add, “risks further deterioration in standards of patient care and would delay tackling the growing backlog of buildings maintenance, including safety critical repairs. If sufficient funding is not provided, patients and families will pay the price as the service declines.” A 4% a year real increase is also backed by Jeremy Hunt, the health secretary.

On the face of it, then, if the government stumps up a 4% a year real increase for the NHS, slightly above its long-run average, nobody will ever be able to accuse it of underfunding health.

The trouble is, as the Treasury knows only too well, it would also be very expensive. The Institute for Fiscal Studies, which has done some excellent work ahead of the birthday announcement, points out how much of a bind this would put the Treasury in.

A 4% real increase from 2019-20 to 2022-23 would mean £21bn of extra spending. The government is already committed to £5bn of non-health spending cuts, 1.6% in real terms, by then, to stay on target for achieving a budget surplus by the mid-2020s. Embracing the extra NHS spending would increase the requirement for other spending cuts to £26bn, or 12.7%, which does not look, as it notes, “either feasible politically or consistent with maintaining quality”. Raising taxes, the alternative, is no more palatable or politically feasible, even if some surveys suggest people would be willing to pay more.

Funding the extra NHS spending via tax would require either a 5p increase in all rates of income tax, a £3,900 reduction in the income tax personal allowance and higher-rate threshold, a 4.5p increase in either employee or employer National Insurance contributions, an increase in VAT from 20% to 24%, or a combination of these things. It is not going to happen.

So the Treasury continues to push for a more modest settlement for the NHS, of less than 3% a year, knowing that even that will mean more borrowing and thus slippage on the ambition of ever achieving a budget surplus. Officials are sceptical about whether the recent improvement in the public finances will last. The response from the health think tanks and the unions, if the Treasury gets its way, will be that the government has been parsimonious, and that the NHS will continue to struggle.

That, sadly, may be how it has to be. Anybody thinking that a 4% settlement would convince everybody that the NHS was again properly resourced is being naïve. In the 2000s, when NHS spending was rising at double that rate, public satisfaction with it was often lower than it is now. One thing that we have learned over 70 years is that there is no amount of money that will provide sufficient resources for a service with growing, and in the end unlimited, demands. At this birthday celebration, the Treasury will have to be prepared to be a bit of a party pooper.

Sunday, June 03, 2018
A nation that no longer values its shopkeepers
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

Whatever else 2018 brings it is already on course to be a year to forget for Britain’s retailers, closely followed by casual-dining restaurant chains. It may not yet be retail Armageddon but a year that has already seen the disappearance of Toys R Us and Maplins and a string of profit warnings and store closures – including the announcement of a programme of more than 100 closures from Marks & Spencer – is gaining notoriety for all the wrong reasons.

As someone who has patronised Marks & Spencer since the days of St Michael – the label not the saint himself – it grieves me to see this British icon retrenching. A town centre is never quite the same again after it loses its M & S, as the people of Stockton and Darlington, those famous railway towns, as well as Northampton, Newmarket and Walsall, will soon discover.

The Centre for Retail Research lists 16 medium to large retail business failures in April this year alone, with more jobs potentially affected, over 13,000, than in the whole of last year, and twice the number of stores and employees affected as in the whole of 2015. In recent months the curtain has come down on established furniture retailers such as Multiyork and Warren Evans. Carpetright is struggling, as are Mothercare and House of Fraser.

Behind the big name difficulties, of course, lie very many thousands of smaller failures of family-owned retailers, restaurants, wine bars and the rest, each one a story of broken dreams. Every empty high street property is somebody’s minor tragedy.

The CBI, in a survey, described “a tale of two service sectors”, with business and professional services doing fine but consumer-facing firms struggling against a backdrop of falling sales volumes over the latest three months.

In that respect, the current struggles are not hard to explain. Growth in retail sales, unexpectedly strong even 18 months ago, has petered out. Latest figures show no growth in retail sales over the latest three months. The annual rate of growth of retail sales volumes has come down from a high of 6%-7%, and a typical rate of 3%-4%, to less than 1.5%.

Consumer confidence perked up slightly last month but is lower than it was in 2015, which was the best year since GfK-NOP began surveying it in the 1970s, and reflects deep pessimism among households over the outlook for the economy.

Anybody in the furniture or carpets business, meanwhile, is suffering from what appears to be a permanently lower level of housing transactions. The Bank of England reported that mortgage approvals in April were at their lowest level this year and their second lowest since August 2016, though unsecured borrowing picked up, while the Nationwide building society said house prices fell again last month for the third time in four months.

What the numbers do not full explain, however, is why now? Why is it that we are now seeing what the independent retail analyst Nick Bubb describes as a “perfect storm” affecting Britain’s high streets and shopping malls.

After all, while retail sales are weak, they have been weak before; very obviously in the recession of 2008-9 but also again from 2010 to the early part of 2013, under the impact of falling real wages and George Osborne’s 2011 hike in VAT to 20%. Consumer confidence is weaker than it was a couple of years ago but higher than in that earlier period. The housing market has never got back to pre-crisis levels of activity.

There are many issues affecting retailers and other consumer-facing businesses. They bear much of the £30bn annual brunt of business rates which, despite Treasury attempts to soften their blow, are a fixed cost that can mean the difference between survival and failure for many high street firms.

They, as many warned at the time of its introduction, have seen an increase in labour costs as a result of the government’s switch from the national minimum wage to a higher national living wage, now £7.83 an hour for those aged 25 and over.

Sterling’s Brexit slump has also squeezed margins, in some cases taking them below viable levels. The pass-through from the pound’s fall to inflation has been lower than feared, because firms lack pricing power and have had to try to absorb higher import costs. The latest shop price index from the British Retail Consortium shows that overall shop prices last month were 1.1% lower than a year earlier. Food prices were up by 1.2%, non-food prices down by 2.5%.
Faced with higher costs such price falls are difficult for many retailers to bear.

The strongest answers to the “why now?” question, however, comes from two factors. One is that the renewed slowdown in consumer spending is, for many consumer businesses, the straw that breaks the camel’s back. They had thought the toughest times were behind them and that their best days lay ahead. Now a grimmer reality is taking hold.

The Bank of England, in its May forecasts, predicted that consumer spending growth in coming years will be half the rate prevailing before the EU referendum and a third of that achieved in the 2000s. Business had geared up for something like a return to normal in terms of spending growth but the outlook has deteriorated. Weak income growth in prospect and households have run out of room to draw on their savings.

The result is overcapacity, particularly in the casual dining sector, hence all the talk of a “crunch” and the plethora of restaurant closures. The latest is Carluccio’s, on track to close up to 30 restaurants. It is also, as the larger firms are discovering, overcapacity in their retail estates. An industry geared up for strong growth is having to adjust.

The other key factor, of course, is the rise of online retailing, where sales value in growing at an annual rate of 11.7%, according to official figures, and which now account for more than 17% of all retail sales.

Online businesses escape the severity of the business rates’ burden faced by high street store and, in a nasty pincer movement, also constrain their ability to raise prices. If online retailers do not get conventional stores one way, they will get them the other.

Bricks and mortar retailers who have embraced online, some successfully, have to abide by the norms of the internet, which often means free delivery. And, by building their online presence, they often cannibalise their traditional, physical businesses. In a dog eat dog world, some of the dogs are from the same litter.

The government could level the playing field, mainly via tax, but chooses not to, because ministers have decided that anything that deprives consumers of low internet prices would be unpopular. So they preside over the hollowing out of our high streets. Bubb, a veteran analyst who has followed the retail sector for many years, thinks we are nearer to the start of this adjustment than the end of it.

Adam Smith, in The Wealth of Nations nearly 250 years ago, had some acerbic words, to the effects that: “To found a great empire for the sole purpose of raising up a people of customers pay at first sight appear a project fit only for a nation of shopkeepers. It is, however, a project altogether unfit for a nation of shopkeepers but extremely fit for a nation whose government is influenced by shopkeepers.”

These days, Britain’s shopkeepers would love to have rather more of that influence. In its absence, many only see a struggle ahead.

Sunday, May 27, 2018
Italy will work hard to avoid crashing out of the euro
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

It is comforting when normal service is resumed, by which I mean that Italy has taken its rightful place as the number one worry for the eurozone. The formation of a wacky coalition of the anti-establishment Five Star Movement and the right-wing, anti-immigration League, under an unknown and untested prime minister, Giuseppe Conte, is a little extreme even by Italian standards. But the fact of a populist Italian challenge to living under the eurozone yoke should not be a surprise.

Indeed, when I used to write and talk about the eurozone in the distant days before the financial crisis, I used to say that while the euro would survive it was unlikely to do with all its constituent parts intact and the country I picked as the most likely drop-out was Italy. Traditionally inflationary and fiscally-undisciplined Italy made a strange bedfellow for Germany, which was the opposite of those things.

Then, however, the global financial crisis led on to the eurozone crisis and, rather than Italy, other countries hovered near the euro exit door. Ireland was substituted for Italy in the original “pigs”, Portugal and Spain had their very nervous moments. Greece came within a whisker of crashing out in 2915. Italy was not immune from the crisis’s effects, far from it, but had a background role.

Now Italy is once again firmly in the foreground. Its new government wants to increase public spending and cut taxes, cocking a snook at the eurozone’s deficit rules. Even an Italian president of the European Central Bank, Mario Draghi, is outraged by suggestions that the Italian debt bought by the ECB under quantitative easing be written off. Italy, “too big to fail but too big to bail”, is in the spotlight.

Italy’s economic woes are not new; the peak of Italian post-war economic optimism was probably half a century ago in the 1960s. Its performance since the lira was shoehorned into the euro at its birth in 1999 has, however, been strikingly poor.

Based on full-year figures, in 2017 Italy’s gross domestic product (GDP), in real terms, was just 6.3% above its 1999 level, which averages out at growth of 0.3% a year, equivalent to prolonged stagnation; almost two “lost” decades.

By comparison, German GDP over the same period has risen by 27.4%, more than four times as much, underlining the difference between the eurozone’s haves and have-nots. Britain, which sensibly decided to stay out of the euro, puts both of them to shame, having recorded a 38.9% rise in GDP over the same period.

If Italy’s GDP performance looks terrible, bear in mind that it is smaller than the rise in population – 6.5% between 1999 and 2017 – over the same period. GDP per capita has therefore done even worse.

The unemployment rate, which averaged 10.9% in 1999, at the dawn of the euro, was 11.2% last year and 11% in March this year. The unemployment rate among under-25s is a staggering 31.7%, which is only exceeded by Greece and Spain. Italy’s legendary black economy may mop up some of the people officially measured as unemployed but not enough to seriously diminish what is a huge problem.

So why does not Italy just leave the euro, which has clearly been bad for growth, living standards and has done nothing to alleviate a chronic unemployment problem? Why does it not go the whole hog and follow Britain out of the EU, an Italexit? Italy has a justifiable gripe with the EU because it has had to carry the burden of refugees from North Africa and the Middle East, very large-scale immigration, without much help or even sympathy from the rest of the EU.

EU exit remains a very long shot, but what about an exit from the euro? After all, if I thought Italy was the most likely single currency faller a few years ago, before others intervened, it must surely be a very strong candidate to leave now.

Actually, I now think it much more likely than not that Italy will stay in the euro, for three reasons. The eurozone crisis displayed a considerable determination on the part of the authorities to hold it together and, while Italy is a bigger proposition than Greece, with an economy ten times the size – the third largest in the eurozone and the 9th biggest in the world – we will see the same determination, if it comes to it, again. The domino effect, if one member goes others will follow, is still feared by the EU. The euro may be a flawed project but a considerable effort will go into saving it.

As well as this, and despite the woes inflicted on them by euro membership, public opinion in Italy still favours continued membership. The latest Eurobarometer poll showed that while Italians have a low opinion of EU institutions, supported by just a third of people (one of the lowest proportions in the EU), there was 45% to 40% backing for continued euro membership. It is like a Roman version of the Stockholm syndrome; Italians have grown close to their captors. If nothing else, Italians see that as a founder member of the EU and one of its biggest economies, being in the euro is their right.

Most of all, Italian citizens and businesses know that, however tough life in the single currency is, by leaving the euro they would be shooting themselves in the foot. A new Italian lira would become a currency to dump by the foreign exchange markets, rather as the Turkish lira has recently.

As big a reason as that would be the effect on Italy’s borrowing costs. In joining the euro in 1999, despite government debt being almost double the supposed Maastricht ceiling of 60% of GDP, Italy’s enjoyed an instant benefit. Its borrowing costs, government bond yields, converged on Germany’s removing its budget deficit problem at a stroke. Its budget deficit, 7% of GDP in the mid-1990s, came down to 2% or below and has remained generally well behaved since.

But the debt has nevertheless increased as a result of the years of weak growth, and is 130% of GDP. The fear of political instability pushed Italian 10-year bond yields close to 2.5% last week, which is still low by historical standards. A sharp rise in Italy’s borrowing costs would follow exit from the euro, plunging the country’s public finances into deep crisis. It was a different era but in pre-euro days in the 1990s Italian government bond yields were are high as 14%. Italy’s troubled banks are struggling while inside the euro; departure would expose them to the serious risk of collapse.

None of this means that keeping Italy in the euro with a populist government offering a new kind of politics will be painless. None of it should mean, either, that there are not issues around the way the eurozone operates that need to be addressed. Germany, with its large trade surplus and tight fiscal policies, imposes a huge burden of adjustment on other countries, including Italy. That needs to change if that euro exit door is not to swing open.

Sunday, May 20, 2018
Long hours are part of the productivity problem
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

After Ben Broadbent got into hot water a few days ago for his clumsy metaphor, I am determined today not to follow the Bank of England deputy governor and use language that anybody of any sex or age will be offended by. Having said that, I must also comment on what I can only describe as a worrying droop in productivity. Whatever the opposite of a virility symbol is, we appear to have it.

Those who have been following the productivity story will know that it is not been a happy one. I was sceptical about whether an apparent rebound in the second half of last year was another false dawn and rightly so, it turns out. The latest “flash” estimate from the Office the National Statistics showed a drop of 0.5% in productivity, gross domestic product per hour worked, in the first quarter, leaving it just 1.5% higher than ten years ago in the spring of 2008. In 10 years Britain has achieved less growth in productivity than would have been expected in a normal year in the past.

When I talk to business people about productivity, there is often puzzlement. Most are committed to raising productivity in their organisations, and can point to successes in doing so.

Rarely a day goes by when I do not receive a report pointing to ways of raising productivity. The Federation of Small Businesses says small firms could boost productivity significantly if given help by larger businesses further up the supply chain. A study by Oxford Economics, commissioned by Ricoh, says that £37bn of productivity gains could be unlocked, if we invested in what they describe as “the optimal office”; a better workplace resulting in greater efficiency.

When it comes to the macro figures for productivity, as opposed to micro solutions, the calculation is a very simple one. You have GDP which, despite its faults, is still the best overall measure of economic activity. And you have the labour input, measured in hours worked, of which more in a moment.

There are many reasons for Britain’s poor productivity performance. Investment as a share of GDP over the period 1997-2017 was the lowest of 34 advanced economies, including Greece and Italy. Low business investment and inadequate infrastructure are bad for productivity. Levels of skills also compare badly with other countries.

Since the crisis, the normal forces of “creative destruction”, in which inefficient, low-productivity firms fail and new growth leaders emerge has been thwarted. Too many zombies still roam Britain’s economy. A service-sector dominated economy is likely to be less productive than one with a larger manufacturing base.

There is, though, another factor and it goes back to the way that productivity is calculated. We can debate whether the numerator, GDP, is under-recorded, particularly in an increasingly digital age. It may be, but probably not by enough to make a serious difference.

The denominator, however, is also of interest. Throughout modern economic history, it appeared to be a certainty that the working week would decline. So, in Britain, the average working week, 60 hours or more in the 1850s, 55 by 1900, less than 50 in the inter-war years and close to 40 in the post-war period, would fall much further. Computers and automation would reduce the need for people to be in the workplace for so long.

This was the context in which Keynes, in his Economic Possibilities for Our Grandchildren in 1930, speaking out against “a bad attack of economic pessimism”, wrote of the prospect of 15 hour working weeks becoming the norm.

It has not happened. The average working week for full-time workers in Britain in the first three months of this year was 37.1 hours. Not only is that a lot more than 15 but it has barely declined – by just over an hour – in a quarter of a century. The downward progress of the working week has been halted.

It is easy to observe examples of why this is the case. Longer opening hours in retailing – which may merely have spread the available spend over an extended time period – mean longer working weeks for employees, together with more hours of dead time, long periods when there is nobody in the store and very little productivity is being generated.

Other “always on” consumer and business-facing sectors, which are expected to provide a round the clock service, are in a similar situation. While some countries have begun to move towards four-day working weeks as the norm, Britain has not. Being present is either required or expected. It is more than 60 years since C. Northcote Parkinson came up with what became known as Parkinson’s law, that “work expands so as to fill the time available for its completion” but it is arguably more accurate now than then.

How unusual is Britain? According to OECD data, hours worked by Britons in 2016, an average of 1,676 hours per person, was barely lower than the 1,700 of the year 2000. Not only did other countries have much larger falls, in the case of Germany by nearly 100 hours, but European countries that outshine Britain on productivity tend to have much shorter working hours.

On the basis of GDP per hour worked, Germany, where workers put in 300 hours less a year than their British counterparts, achieves 34.5% higher productivity. France, where average annual hours worked are 200 less than in Britain, has 28.7% higher GDP per hour worked.

You can also see this very clearly in an alternative measure of productivity, GDP per worker, where the gap closes dramatically. On this basis German productivity is a mere 9.3% higher than in Britain, while France is 13% higher.

The argument is not as perfect as it might be. America works longer hours than Britain, more than 100 extra a year on average, but also has significantly higher productivity, as much as 36% higher, however it is measured. The post-crisis productivity record for Britain on a GDP per worker basis has also been feeble.

But there is something in it. Studies suggest for every extra hour put in after a certain point there is a decline in productivity; diminishing returns. The Parkinson’s law point stands. It is quite likely that in many organisations where staff attendance is not essential that working hours could be reduced without any meaningful impact on output. It is not the solution to the productivity crisis but it could be part of the solution.

Sunday, May 06, 2018
Manufacturing's new dawn is starting to look like a falso one
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

When it comes to bright spots for Britain’s economy over the past couple of years, probably the best place to look has been in Britain’s factories. While the pound’s Brexit tumble pushed up inflation and squeezed household incomes, it provided a shot in the arm for manufacturing exporters.

Manufacturing has, additionally, looked like the one part of the economy taking advantage of the strengthening world economy. The upturn in global growth to something close to pre-crisis norms (the pre-crisis norm being 4%), has been good for industry globally, and in Britain. Until very recently, based on official figures, ministers could boast of the longest run of monthly growth in manufacturing since the late 1960s.

This bright spot was to be welcomed, and we should never fall into the trap of thinking that, because of the rise of services, we are now a post-industrial economy and manufacturing does not really matter.

Though manufacturing has a weight of only 10.1% in the official gross domestic product (GDP) calculation, new research suggests it is much more important and influential than that. The research, by the consultancy Oxford Economics for the Manufacturing Technologies Association, suggests the true impact of manufacturing, taking into account its direct impact, its effect on supply chains and the spending power of people employed directly and indirectly in the sector, is equivalent to 23% of GDP. And, rather than the conventional figure of 2.6m people employed in manufacturing, the “true” figure for jobs dependent on the sector is 7.4m, according to the research.

As the report puts it: “Those numbers give a truer picture of the importance of manufacturing to the UK economy. The reasons are clear: over the last 40 years, manufacturing has increasingly outsourced activities which used to be done in-house—in areas as diverse as logistics and catering. There are also companies, from design houses to accountancy practices, whose activity, or at least a large part of it, is predicated on serving manufacturing businesses.”

It is not just nostalgia that has led some people to yearn for a future in which Britain’s factories play an even more important role in the economy, though it is hard to fund any examples of economies in which the share of manufacturing in GDP has risen after a long decline.

Though some visions of Britain’s post-Brexit future, including those set out by certain Brexit supporters, see only further decline, for others hope springs eternal, and for good reason. Compared with the economy as a whole, manufacturing jobs are characterised by higher skill levels, higher productivity, and better pay and job security.

There is also the not-so-small matter of Britain’s trade deficit in manufactured goods. It appeared for the first time since the industrial revolution in 1982 and has not gone away since. Last year it was an eyewatering £97.6bn.

So everybody loves a sustained manufacturing revival, and the economy would be better off for it. The question is whether this has been another false dawn for factories. There have been plenty of these before. George Osborne’s “march of the makers” of a few years ago never got much beyond a gentle stroll. A strong upturn in the sector in 2014 was dealt a blow by the collapse in the oil price, which reduced investment in energy products. One result of this is that manufacturing output has yet to get back to where it was before the financial crisis took its toll; output is currently 1.5% below its January 2008 level.

All good things come to an end and the latest official figures showed that the continuous run of manufacturing growth came to an end earlier this year. Though the context was a very weak GDP figure, manufacturing’s contribution to growth in the first quarter was feeble; it grew by a mere 0.2%..

Perhaps most disturbing was the April purchasing managers’ index (PMI) for manufacturing, released a few days ago. It was expected to show a strong revival, following the weather disruption of March, which affected output at some factories. Instead it slumped to a 17-month low as a result of slower growth in output, new orders and employment. New export business was at a 10-month low.

“While adverse weather was partly to blame in February and March, there are no excuses for April’s disappointing performance,” said Rob Dobson, a director at IHS Markit, which compiles the survey. “Looking ahead, the trend in manufacturing production is likely to remain subdued. Weak demand meant firms are seeing backlogs of work fall and stocks of unsold goods rise, limiting the need for output to rise in May. Business optimism has also dipped to a five-month low as concerns about Brexit, trade barriers and the overall economic climate remained widespread.”

It is important to stress that the PMI, while pointing towards slower growth in manufacturing, is not suggesting no growth at all. Lee Hopley, chief economist at the EEF, which represents Britain’s manufacturers, says that while last year saw the maximum benefit of stronger global growth and sterling’s depreciation, and the sector grew by 2.5%, some of those effects have begun to fade.

Manufacturers are benefiting from strong demand overseas for capital goods, as a manufacturing investment upturn gains pace. Such an investment upturn is, however, mainly absent in Britain, and that keeps her awake at night.

As always , the range of experiences in manufacturing is a wide one. In the latest official figures the brightest spots were computers and basic metals, with output up by 7-8% on a year earlier. The weakest included electrical equipment, with production down by a similar amount.

The automotive sector, until a few months ago a definite bright spot, now looks troubled, with declining out put and job losses. Car production in the first quarter was down by 6.3% on a year earlier, while commercial vehicle production fell by a worrying 17.9%. Engine production has been strong but showed a 3.7% year-on-year fall in March.

This is an important moment for Britain’s manufacturers. They are holding off investment until the Brexit fog begins to lift and are anything but reassured by the signs coming out of government. Some complain that the government’s much-trumpeted industrial strategy has been shunted into a siding, like many other policy strands.

Manufacturers are weighing up their post-Brexit options amid the uncertainty. Airbus has said that while it will not move any of its existing activities out of Britain, future activities and investment are “open for discussion”.

The hope was that the stronger manufacturing growth of the past couple of years was a new dawn, The fear is that it was a false dawn; a last pre-Brexit hurrah for Britain’s factories. And that would be very bad news indeed.

Sunday, April 29, 2018
A record spending squeeze puts us back in the black
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

A milestone has been reached, somewhat earlier than officially expected, and I feel honour bound to take note of it. After the global financial crisis wreaked havoc on Britain’s public finances, part of the repair process has now been completed.

The current budget, the difference between day-to-day public spending and tax revenues moved back into surplus in the fiscal year just ended, 2017-18. This was the first time this has happened for 16 years. The deficit on this measure peaked at £100.4bn in 2009-10. Now it is surplus, admittedly by a tiny amount, £112m, but in surplus nonetheless.

In the context of the disappointing growth figures, a 0.1% increase in gross domestic product in the first quarter and just 1.2% over the past year, this is surprising.

In eight years, more than £100bn has been taken off the deficit. George Osborne’s original 2010 target, of eliminating the current budget deficit, has been achieved, admittedly a couple of years later than he hoped. He also hoped to still be around as chancellor to celebrate this moment but events intervened.

True, Britain still las an overall budget deficit, £42.6bn in 2017-18. But that was the lowest since 2006-7, has come down to just 2% of gross domestic product, and was £2.5bn lower than the Office for Budget Responsibility predicted only last month. It, by the way, was more than £110bn below its 2009-10 peak.

The OBR’s forecast miss, which may or may not be confirmed as more data become available for last year’s revenue and spending, provides a snapshot of what has been an extraordinary period of spending restraint. The OBR did not get its forecast wrong because tax revenues beat its forecast. They actually came in a little lower than it had expected.

The biggest mistake it made was in overestimating government spending. It came in some billions of pounds lower than it had expected. Spending undershot and local authorities borrowed less than expected.

And that, in a nutshell, is the story of Britain’s public finances and the fiscal repair of recent years. Look at government receipts, mainly tax revenues, relative to GDP and not much has happened. Their current level of between 36% and 37% of GDP is no different to what it was in 2010-11 and 2011-12.

This measure of the tax burden, which has not been above 37% of GDP in the past 30 years, has not broken new ground, despite some well-publicised tax hikes (alongside some notable reductions).

Public spending, however, has undergone a big adjustment, falling from 45.1% of GDP in 2009-10 to less than 39% last year. It done the overwhelming majority of the heavy lifting in reducing the budget deficit.

Surprisingly, indeed astonishingly, I still come across people who say there has been no austerity in Britain. Some of this is the choice of language; some older people still think of austerity as 1940s and early 1950s rationing, the grim winter of 1947 and, to quote Monty Python’s four Yorkshiremen, the days when if you lived in a cardboard box or a hole in the road you were lucky. Nobody is suggesting that the past few years have been as grim, even up north, as earlier episodes.

On the narrow description of austerity, however, public spending control, iut has been very real. Paul Johnson of the Institute for Fiscal Studies calls it “completely unprecedented in the scale of the cuts imposed”.

The normal tendency is for public spending to rise year after year, in cash or real – inflation-adjusted terms. There are good reasons for that. The population is growing and the demand for public services rises over time, as we expect more and better provision. That is particularly true of the National Health Service, where real spending has to rise by at least 2% a year just to stand still, but it is also true of other public services.

At the same time, and even with the helpful effects of low interest rates and quantitative easing, the government has been faced with a higher debt interest bill. There have been other unavoidable spending increases.

Yet government spending in real terms in 2016-17 was lower than in 2009-10, and in 2010-11, and in fact in pretty well every year in between. When adjusted figures are available for 2017-18, a similar picture will emerge.

There has never been anything like it. The OBR has records going back to the mid-1950s and there has never been a period as long as this in which the trend for real public spending has been down. There have been short, sharp cuts, as in the late 1960s and 1976 when Britain turned to the International Monetary Fund. There was a a four-year period of constraint in the late 1980s, and a shorter run in the mid-1990s.

This period, however, has been different. The public spending feast of the 2000s, under Labour, gave way to the famine of the 2010s. You can debate whether it should have happened, though the state of the public finances cried out for this kind of surgery. You can debate whether it should have been more evenly split between spending cuts and tax hikes, though as noted there appears to be a limit on how much beyond 37% of GDP can be raised in tax.

You can debate whether the cuts that have been achieved were done sensibly and fairly, or whether some branches of government, such as local authorities, the police and the prison service, shouldered too much of the burden. What cannot be debated is that it happened.

The question is where we go from here. Current budget surpluses were commonplace in the 1950s, 1960s and early 1970s, then disappeared until the late 1980s. Since then they have been rare, a brief appearance in the late 1980s, and then again in the last 1990s and early 2000s. And again now.

They are rare for a reason. Governments with budget surpluses of any kind still want to be re-elected. The hair shirt can be politically very uncomfortable if voters contrast it with the promises of largesse made by your opponents.

The government is already planning a modest relaxation, which the OBR says will be consistent with continued current budget surpluses. That relaxation will see public spending in 2022-23 some 4% higher in real terms than now.

It may not be enough. There were plenty of times in the 2000s when public spending rose by more than 4% in a single year. Though Philip Hammond is determined to hold the line, the pressures will build as we approach the spending review planned for next year. Looking forward, a report from the Institute for Public Policy Research (IPPR) suggests the NHS will need an additional £50bn a year by 2030.

Budget surpluses, however defined, are rare. We should make the most of this one while we can.

Sunday, April 22, 2018
Reasons to be cheerful as the rest of the world blooms
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

I return at a time of good news about the world economy. Despite worries about rising trade tensions, and a slight softening of economic activity surveys since the start of the year, optimism persists.

The International Monetary Fund, holding its spring meetings in Washington, has stuck to its January forecasts for global growth of 3.9% this year and next, in line with the average for the 2000s and thus similar to pre-crisis norms. The world economy, which grew by 3.8% last year, appears to have settled into a run of stronger growth.

Oxford Economics concurs, noting that despite weaker numbers in some countries, world growth is “still running at a solid pace” and set to continue.

The IMF is concerned about trade tensions, though its chief economist Maurice Obstfeld described what we were seeing so far as mainly a “phoney war”, with only warning shots fired. It is also concerned that, because of rising debt since the crisis, countries will not have the ammunition to fight the next downturn.

That is for later. For now, however, things look set fair, particularly in the so-called advanced economies. Not so long ago they were struggling, dragged down by the eurozone recession and sluggish growth in America. In 2012 and 2103, advanced-economy growth was just over 1% a year. Now it is 2.5%, boosted by an expected recovery in eurozone growth to 2.4% this year, and in US growth to an impressive 2.9%. Donald Trump will not achieve his promise of doubling US growth from its post-crisis average of 2% but he has helped shift it significantly in the right direction.

It is at a price – America is the only advanced economy projected by the IMF to see a rise in its debt to gross domestic product (GDP) ratio over the next five years – but he would no doubt say that is a price worth paying.

This matters a lot for Britain. When the world economy is strong, it is hard for anything really bad to happen to an open economy like ours. Growth has weakened – the latest four-quarter growth rate of 1.4% for gross domestic product (GDP) was less than half of its rate three years’ earlier even as the world economy has strengthened – but it would have weakened a lot more if not for the upside surprise on global growth.

That upside surprise is reflected, though sadly not yet by enough, in a stronger performance for exports of goods. On the most flattering measure, excluding oil and erratic items, export volumes in the latest three months were up by 4.2% on a year earlier.

Exports of services are also doing well. They are rising at a 7% annual rate in value terms, and were boosted by a very strong rise in exports to the rest of the EU last year.

Britain is missing out on the global boom because of what Christine Lagarde, the IMF managing director, described as the “cloud of uncertainty” hanging over the economy. It predicts growth of 1.6% this year and 1.5% next. The EY Item Club’s new forecasts to be published this week are a touch stronger – 1.6% and 1.7% respectively – but not by much.

Most people do not, however, obsess about the GDP numbers; many do not know what they are. They do care about unemployment and about whether their incomes are outpacing inflation.

The level of unemployment, at just over 1.4m, is similar to what it was last summer but thanks to a rising working-age population, the rate has dipped to 4.2%, a new low since 1975. That is good news, and better than anybody expected. Though there is a lot of talk of job insecurity, the job market overall looks secure for the moment.

And, while nobody will be putting any bunting up, the fact that wage growth, 2.8%, has moved fractionally above inflation, 2.7% in the relevant month for the comparison and 2.5% now, is also good news, and better than the alternative of falling real wages.

It will take time before this reduces the difficulties affecting retailers, though over time it will. The downturn that has brought a string of high street casualties was reflected in the official figures, which showed a 0.5% drop in retail sales volumes in the first quarter. The figures were dragged down by weak, snow-affected petrol sales last month, though the snow also boosted online spending, but sales were subdued even before the bad weather hit.

The other reason for optimism, as we embark on the next stage of Brexit negotiations, is that despite her difficulties on other fronts, the prime minister is pursuing a skilful course in steering us away from the most dangerous and destructive EU exit.

At every stage, through concessions, compromise and blurred red lines, Theresa May has been moving towards what Philip Hammond has described as “the closest possible arrangement” with the EU, with only “modest” divergence from the current situation. The absence of a credible alternative from around the cabinet table, still less from those Tories who would flounce away without a deal, has made that task easier.

This too limits the damage to the economy. Last month’s agreement on a 21-month transition period, while still dependent on other aspects of the negotiation, has made businesses notably less nervous about Brexit. The latest Deloitte survey of finance directors, conducted since last month’s EU summit, showed that Brexit was no longer their chief concern, though weak growth was.

Meanwhile, following last week’s House of Lords vote in favour of Britain staying in a customs union with the EU, and this week’s expected knife-edge Commons vote on the same issue, the government’s position may also be evolving.

Though staying in a customs union (it would have to be a new one) would ruffle some Tory feathers, few voters would go to the stake on the issue. Polling suggests that voters are broadly in favour and unmoved by the constraints this would impose on Britain’s ability to negotiate bespoke trade deals. It would also have the useful effect of resolving the thorny issue of the Irish border.

Whether it happens remains to be seen, but staying in a customs union is no longer off limits. Some in Brussels think Britain may also eventually decide to stay in the single market though that looks like a much longer shot.

The strength of the global economy and an easing of some of the immediate Brexit uncertainties, because time has been bought, are both good news for Britain’s economy. We can but hope for more of it.

Sunday, March 25, 2018
A green light for the Bank to keep on raising rates
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

It is reassuring, for those of us who write about economics, when things happen the way that economic theory says they should. When unemployment is low, pay pressure should increase, and it is finally happening.

Though the latest official figures were not as clean as might have been hoped – the number of people unemployed rose by a tiny 24,000 in the latest three months though the unemployment rate fell from 4.4% to 4.3% - they were accompanied by an acceleration in earnings growth.

The Phillips curve, the inverse relationship between unemployment and wage growth, is one of the first thing students of economics learn. Earnings growth excluding bonuses picked up to 2.6% and to 2.8% including them. Inflation, though for a little later than the November-January period to which those figures apply, is now 2.7%.

Behind these bald comparisons, and the welcome news that the Phillips curve is alive and well, though not necessarily for employers facing higher wage bills, there are quite a few implications. Let me take just two of them.

The first is whether the end of the wage squeeze, and the return of modest pay growth, will do anything for attitudes towards a job market which has been extraordinarily successful in generating unemployment but is still widely regarded as insecure and exploitative. The second is whether anything will stop the Bank of England raising interest rates in May, and again later in the year.

Britain’s flexible labour market continues to generate jobs at a significant rate, as it has done for several years. In the latest three months employment increased by 168,000, while over 12 months there has been an increase of 402,000.

There is a downside to this in the sense that rising employment alongside weaker economic growth means stagnant productivity, and the latest figures for hours worked suggest that that the pick-up in output per hour in the second half of last year was indeed a blip.

Overall, however, this is a picture of success. Some of the rise in employment has been achieved by bringing people out of economic inactivity, when they are not working or seeking work. The rate of inactivity among working-age people, 21.2%, is at its joint lowest since records began in 1971.

Digging into the employment numbers, one of the things often associated with insecurity is the rise in self-employment, which includes gig economy workers. Self-employment is, however, now falling, both in absolute terms, to below 4.8m, and as a proportion of overall employment. In contrast, the number of traditional full-time employee jobs is rising strongly; up 377,000 over the latest 12 months.

The labour market, then, is continuing on the path it has been on since the crisis. Though public sector employment, when adjusted for reclassifications, is rising again, it remains the case that the private sector has created roughly seven times the jobs lost as a result of austerity in the public sector.

Perhaps attitudes will change when real wages pick up a bit, though one likely effect of lower inflation is that employers will seek to scale back pay awards. Maybe people are programmed to be curmudgeonly about the job market, something that was noticeable when employment was booming, and real wages rising strongly, in the 2000s. The symptoms are an over-emphasis on zero-hours contracts, covering fewer than 3% of people in work, and nostalgia for a past that never really existed. Will this change? Maybe not, but we shall see.

On my second question, on interest rates, a rise in May looks pretty much baked in, following the stronger wage figures and the agreement on transition between Britain and the EU. Two members of the Bank’s monetary policy committee (MPC), voted for a hike in last week. On Friday another member, Gertjan Vlieghe, said people should expect one or two rate rises a year for the next trhee years. All members endorsed “an ongoing tightening of monetary policy”. The Bank is prepared for the first quarter gross domestic product figures to be adversely affected by the Beast from the East and its successor, but intimated that this will not deter it.

A rate rise in May, to 0.75%, would in many respects be more significant than the hike to 0.5% in November. That one was merely reversing the emergency cut after the Brexit referendum. This one would take us into new territory.

Assuming it happens, what about beyond May? The case for raising rates even against a weak growth backdrop is, for the Bank, quite straightforward. The economy’s “speed limit”, its underlying or trend growth rate, is now estimated to be a weak 1.5% a year. The Bank’s forecasts are for growth to be a little stronger than that, averaging 1.75% a year, increasing domestic inflationary pressures, which higher rates will help subdue.

What could get in the way of higher rates? One argument is that inflation, which is already below the Bank’s expectations, could fall further and faster from here than it is predicting. The Bank expects it to stay above the 2% target until 2021 on the basis of market interest rate assumptions.

A second argument is about growth. What if it is weaker than the Bank is predicting/ The Office for Budget Responsibility (OBR), for example, does not expect growth to exceed 1.5% between now and 2022, a strikingly weak prospect. Its forecasts for the next three years, 1.5%, 1.3% and 1.3%, would leave growth tucked in just below it and the Bank’s 1.5% speed limit.

There are risks to growth, in both directions, which do not have to be spelled out here. Simon Ward, chief economist at the fund managers Janus Henderson, a dedicated followed of money supply data, notes that the growth rates of narrow and broad money are at their weakest since 2012 and appear to be weakening further since the November rate hike. If the money supply slowdown signals slower growth ahead, then the Bank risks a policy mistake by raising rates, he argues.

It will be a surprise if the Bank does not raise interest rates in May; America’s Federal Reserve did so again, and without fuss, last Wednesday. But the path towards a new normal for Bank rate of 2% or so, on which it has embarked, is unlikely to be a smooth one.

Sunday, March 11, 2018
The deficit's down - but Hammond can't risk a spending spree
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

If I were to allow a robot to take over the writing of this column, something I am gradually working towards, it would take previous known patterns and run with them. So a piece starting with the words ‘the chancellor will this week make a statement on the economy’, would automatically be followed by ‘and we can expect more bad news on growth and borrowing’.

The robot would be blameless. I have written something like that so often that, even under human control, I am struggling to prevent the keyboard from doing so again.

But not this week. On Tuesday, Phillip Hammond will deliver his spring statement. Advance briefing suggests it will be short, no more than 15 minutes or so. Though it is roughly on what would be budget day in normal years, it will lack most of the usual paraphernalia. It will not, the Treasury says, be a “fiscal event”, in other words there will be no important tax and spending decisions (though the option to include some exists). That is why my inbox, usually creaking with budget submissions and predictions, has been empty of such things.

The spring statement will nevertheless contain good news. Growth this year and next will be forecast to be a little higher than the Office for Budget Responsibility (OBR) predicted in November. Instead of the 1.4% growth for this year and 1.3% for 2019 predicted then, consensus forecasts point to figures of 1.6% and 1.5% respectively, perhaps even a little higher. Growth over the next few years is still likely to be a little weaker than the OBR predicted in March last year but it is heading in the right direction.

Even more dramatic will be the figures on government borrowing, the budget deficit. Instead of the £49.9bn the OBR expected for this year, 2017-18, in November, and the £58.3bn it predicted a year ago, the deficit is likely to come in at around £40bn.

The greater significance of this is that it will show that the deficit is 2% of gross domestic product or below, a level not seen since 2001-2. The current budget deficit, borrowing excluding public investment – spending on the infrastructure and so on – has been eliminated.

Achieving that, which again has not happened since the early 2000s, was George Osborne’s original aim in 2010. It has come about three years too late, and it was superseded by a tougher target of getting to an overall budget surplus. But it is a milestone nonetheless.

It raises a couple of questions. Was the austerity needed to get the deficit down worthwhile? And, with the deficit down to a level which bothers nobody very much, is it time for the government to start spending a lot more?

First, for those who are unaware of the history and wondering why it is necessary for the chancellor to be on his feet at all this week, a brief recap. For the past 40 years or so, since the 1975 Industry Act became law, the government has been required to publish two economic forecasts a year.

One of those occasions has been provided by the budget, though its timing during the year has varied. The other has come under various guises. In the second half of the 1970s and the early 1980s it came in what was called an economic progress report. That gave way to the autumn statement, which was abolished in favour of a single autumn budget, with effect from 1994, so the then Tory government published a separate summer economic forecast.

Under Gordon Brown in 1997, the budget shifted back to the spring, but the pre-budget report in the autumn provided an opportunity to publish the forecast. George Osborne renamed that the autumn statement before Hammond went back to the Kenneth Clarke model of a single autumn budget. This week’s is the first ever spring statement but, given the penchant chancellors have for rearranging the fiscal furniture, there can be no guarantee that the musical chairs will stop here.

That the deficit is down to levels considered appropriate by Osborne in 2010, after a lot of pain, has sparked a renewed debate about whether it was worthwhile. Some argued that austerity should have been delayed until the economy was on the sunlit uplands of significantly stronger growth, while some said there should have been no austerity at all.

Both arguments, it seems to me, are flawed. Delaying would have taken us, not into the sunlit uplands, but the uncertainties of Brexit. Doing nothing against the backdrop of a budget deficit of £153bn, 9.9% of gross domestic product, was never an option. The growth numbers for 2010-15, averaging just over 2% a year, were perfectly respectable and compared well with other countries. Employment grew well and unemployment fell.

During the Osborne years it was common, particularly among some US economists, to see austerity as a kind of mad British exceptionalism. There may be a mad British exceptionalism but it was not that; America’s growth over the same period was barely any different to that in Britain. Both did a lot better than Europe, weighed down by the eurozone crisis and recession.

Is now the time to abandon austerity? Local authorities are creaking under the strain and the cash freeze on most benefits and tax credits, set to last until 2020, is biting hard. The National Health Service, missing its target, is experiencing the slowest spending growth in its history.

Sometimes, the Treasury’s determination to avoid extra spending leads to convoluted policy, such as the latest damp squib on housing a few days ago. I have long argued that if the government is serious about addressing housing shortages, and wants to get anywhere near its target of 300,000 new homes a year, it will have to take a leaf out of Harold Macmillan’s book and fund the building of a lot more council houses.

The Treasury, however, appears determined to hold the line, and has good reasons for doing so. Though this year’s borrowing undershoot will carry through to future years, we are a long way from a balanced budget on a sustained basis, or a reduction in government debt, currently £1.74 trillion, or 84% of GDP. Even if you say it quickly, that is a lot of debt.

The Treasury also fears, quite rightly, what lies ahead for the public finances. The OBR has long highlighted the upward pressures on borrowing from the early 2020s, largely due to the impact of an ageing population on health, pensions and other spending.

The government’s Brexit impact assessments, now published, show that annual borrowing will be between £20bn and £80bn higher than under the status quo by the early 2030s, reinforcing the Treasury argument for caution. That red Brexit bus could hardly have been more misleading.

Sunday, March 04, 2018
Don't worry, be happy - even when confidence is weak
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

If we’re happy and we know it we should probably clap our hands, as I think I remember singing many years ago. And, however you may feel today, the official verdict is that we are indeed getting happier.

Thanks to an initiative a few years ago by David Cameron, the former prime minister, the Office for National Statistics now measures happiness, alongside whether life is worthwhile, life satisfaction and anxiety.

The latest results, just released, show that in the year ending last September there were what the ONS described as slight improvements in all these wellbeing measures.

Anxiety has risen over the past two years, is higher among women than men, and is only up compared with when it was first measured in 2011-12 among the young, those aged 16 to 24, and the old, those of 90-plus. High anxiety, as in the Mel Brooks film, has been broadly stable.

Though the measures only go back a few years, you could say that we have never felt happier since records began. Many would choose to go back a bit further, perhaps to the 1950s, for a time when they were really happy and you could leave your back door unlocked at night. Even then, however, Harold Macmillan had to reassure voters that they had never had it so good.

Only after a longer run of data will a fuller picture emerge. It is worth saying that the survey was launched when things were pretty grim, a combination of high inflation and a lot of worries about unemployment and austerity.

The official happiness measures raise some questions. How do the statisticians know? And how do we square rising happiness with other measures, like consumer confidence, which suggest people are feeling squeezed and rather miserable?

The answer to the first is that the ONS carries out a survey of a sample of people aged 16 and over. They are asked to respond to four questions: how satisfied are they with life, whether the things they do are worthwhile, how happy were they yesterday and how anxious did they feel.

They respond on a scale of 0 to 10, 0 being not at all happy and 10 being delirious, or at least completely happy. The latest average scores are 7.52 for happiness, 7.69 for life satisfaction, 7.87 for life being worthwhile and 2.92 for anxiety. It is not rocket science, but it is an approach that gives you usable measures.

How do we square it with weak consumer confidence? Consumer confidence, measured since the 1970s by GfK, dropped by a point last month to an index reading of -10. It has been depressed since the EU referendum, as retailers know to their cost. Can people be simultaneously be happy and lacking the confidence to spend?

Yes they probably can. For one thing consumer confidence is an economic measure while life satisfaction and happiness are far wider. For another, confidence has fallen but from a high base. 2015 was the best year for confidence in the 40-plus years the survey has been conducted.

It is also the case that weak confidence reflects, not people’s own financial wellbeing, but their perception and concerns about the wider economy. This disconnect, not uncommon in surveys, shows that a net 5% of people are confident about their own financial situation over the next 12 months, while a net 26% think the economy will do worse. They are taking the view that, if their fears about the wider economy are justified, they will not be the ones to suffer.

When, all those years ago, Cameron announced funding for the ONS to develop happiness measures, he was accused of trying to divert attention away from the economic data. He insisted that it was not but that it could “lead to government policy that is more focused not just on the bottom line, but on all those things that make life worthwhile".

That is the focus of a book I attended the launch of a few weeks ago at the London School of Economics and have been meaning to write about since. The Origins of Happiness, by Lord (Richard) Layard, Andrew Clark and colleagues, looks at happiness and well-being and addresses the question of whether policy should be directed more towards it.

It begins from a characteristic common to many happiness studies that, notwithstanding recent improvements, huge increases in living standards in recent decades have not produced much of an increase – and in some studies have resulted in a decrease – in happiness. You can explain this by reference to the hedonic treadmill, the tendency for happiness to revert to its previous level even after big positive or negative events. Or it can be explained by the “money does not buy happiness” Easterlin paradox, under which, after a certain point, increases in income do not make people happier.

The authors of the Origins of Happiness say public policy should shift its focus from wealth creation to wellbeing creation. I don’t think that is going to happen, particularly with the current crop of politicians. But there are useful and relatively inexpensive things that governments can do. Depression and anxiety are major causes of unhappiness. Modest additional investment in what used to be called the talking cure could help.

The break-up of relationships is a major cause of unhappiness, for couples and for children and, on the face of it, there is not much that government policy can do about it. But the authors argue that more investment in relationship and social skills, at an early age, can make a significant difference. Maybe cramming young people with too many exams is counterproductive.

They also have the striking finding that emotional health at the age of 16 is a far more important than academic qualifications up to the age of 25 in determining whether people will live satisfying adult lives. Investing in the emotional health of young people will pay dividends in the long run.

There is another striking finding, enough to make any politicians sit up and take notice, which is that in elections in Europe since 1970, life satisfaction is the best indicator of whether a government gets re-elected. In that respect, rising happiness is good news for Theresa May. But then it was rising last June, and we saw what happened then.

Sunday, February 25, 2018
Productivity's up - but keep the champagne on ice
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

Amid the flurry of economic news in recent days, one number stood out. This was that, after a strong rise in productivity in the third quarter of last year, there was another strong rise in the fourth. Taking the two together, productivity was rising at an annualised rate of about 3.5% in the second half of last year.

I am sure I do not need to tell you how much it would mean if it marks the start of a sustained revival in productivity. Productivity, the amount of value-added we produce for what we put in, is the ultimate driver of living standards. Without rising productivity there can be no increase in real wages.

It matters for competitiveness, and the huge productivity gap between Britain and our main competitors, in their favour. Closing that gap is important, and not just for national pride.

It is also important for the public finances. The Office for Budget Responsibility (OBR), which looks to have been too gloomy about the budget deficit again – it is likely to undershoot its November forecast by a significant margin – took a red pen to its productivity assumptions then, with important negative implications for the public finances over the medium-term. That productivity downgrade came amid the recent productivity revival. If it was premature in doing so, that would suggest Philip Hammond will have more room for manoeuvre in coming years than he feared.

It is worth putting the recent rise in productivity in perspective. Though it has been customary to talk of productivity stagnation, this is not quite accurate. What is true is that in the middle of last year, output per hour was no higher than at the end of 2007. Having fallen in the crisis, recovered, then falling again from 2011, productivity has been creeping higher in recent years, though creeping is the operative word. Its performance in the second half of last year represented a step change.

It is worth digging into that step change. The productivity numbers were based on a rise in gross domestic product rose of 0.4% in the third quarter and 0.5% in the fourth quarter of last year. The fourth quarter number was revised down to 0.4% after the release of the productivity figures. Revisions to earlier quarters cancelled each other out.

So how do you get to increases in output per hour of 0.9% and 0.8% respectively?

The answer is that in both quarters hours worked fell, by 0.6% and 0.3% respectively. This is, it should be said, a little odd. The job market is tight and full-time jobs have dominated the recent rise in employment, so why are people working fewer hours?

That is why, taking another measure of productivity, output per worker, there is little in the figures to get excited about. It rose by a reasonable 0.5% in the third quarter of last year, but by only 0.2% in the fourth, and at the end of 2017 was a mere 0.5% up on a year earlier (compared with 1.1% for the output per hour) measure. Adjust those figures for the downward revision to GDP and output per worker rose by only 0.1% in the fourth quarter and was just 0.4% higher than a year earlier.

So how do you get to increases in output per hour of 0.9% and 0.8% respectively?

The answer is that in both quarters hours worked fell, by 0.6% and 0.3% respectively. This is, it should be said, a little odd. The job market is tight and full-time jobs have dominated the recent rise in employment, so why are people working fewer hours?

That is why, taking another measure of productivity, output per worker, there is little in the figures to get excited about. It rose by a reasonable 0.5% in the third quarter of last year, but by only 0.2% in the fourth, and at the end of 2017 was a mere 0.5% up on a year earlier (compared with 1.1% for the output per hour) measure. Adjust those figures for the downward revision to GDP and output per worker rose by only 0.1% in the fourth quarter and was just 0.4% higher than a year earlier.

The big question is whether we are at a labour market turning point, and on the road to a future in which employment and hours worked do not rise very much but productivity does.

There were, on the face of it, turning point aspects in the latest numbers. Before the labour market figures were released last week, many analysts though the unemployment rate might drop to a new four-decade low of 4.2%. Instead unemployment rose by 46,000 in in the latest three months and the rate went up to 4.4%.

There was also a little bit of evidence of a firming of pay. Total pay rose by 2.5%, as in the previous month, but regular pay edged up to 2.5%. Pay and productivity are intimately linked, and an acceleration in pay is less concerning if accompanied by rising productivity. Surveys, including those by the Bank, point to stronger pay growth this year.

It is, however, too soon to call a turn in unemployment, despite the surprise rise in the latest figures. This is because there was a rise in employment, of 88,000, in the latest three months. That was smaller than expected but was nevertheless positive. It was possible for rising employment and unemployment to go hand in hand because of a drop in the economically inactive proportion of the population. Only when employment is falling and unemployment rising would you be confident that the job market has turned.

As for pay, there have been many occasions in recent years when it appeared to be on the brink of an acceleration, only to slip back. Regular pay growth picked up to 2.9% in the autumn of 2014, and was 2.7% in the autumn of 2016, both higher than now. The CIPD, the trade body for human resources professionals, says its survey shows a median expectation of pay rises of only 2% over the next 12 months. There are good reasons to expect stronger pay growth than that but the jury is still out.

It is also out on whether the tide has turned on productivity. The oddity in the latest numbers, a drop in hours worked, may resolve itself in coming months. Some of the things needed to drive sustained productivity improvements; significantly higher levels of business investment, improved skills and better infrastructure, are no different now than they were six months ago. We have yet to see how the reduced supply of generally high-productivity EU workers affects the numbers.

So, while we would all love to see the latest figures as the start of a sustained productivity revival, which would have a profound impact on Britain’s economic prospects, it is a little too soon to celebrate.

Sunday, February 18, 2018
Blooming Europe needs to grasp the nettle of reform
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

As impressive recoveries go, it is up there with Jesus raising Lazarus from the dead, four days after he had apparently shuffled off this mortal coil. The corpse that some said Britain was shackled to now looks very sprightly.

For those who have long memories of relations between Britain and Europe, this is a kind of reverse “Up Yours, Delors!”. Instead of moping around in disappointment at Britain’s decision to leave the EU, the European economy has been on a victory roll.

It reminds me of nothing more than the French taunters in Monty Python and the Holy Grail, who told the English knights of King Arthur that they could go and boil their bottoms and promised to spit, or something like that, in their general direction.

France is on a political roll. It has Emmanuel Macron, and his world view, who always rises to the occasion in speeches and interviews. We have Boris Johnson.

The figures tell the story. Last year, according to new figures from Eurostat, the eurozone and wider EU economies grew by 2.5%, the best for 10 years. In the final quarter, eurozone gross domestic product (GDP) was up by 2.7% on a year earlier, almost double Britain’s 1.5%.

Not so many years ago, the eurozone ‘s difficulties seemed likely to condemn the region to permanent stagnation, a drunken lurch from crisis to crisis. Now growth has returned, even to the worst of the crisis-==hit countries, including Greece. The days when Britain;s growth rate comfortably exceeded that in the eurozone are fading in the memory.

Mario Draghi, criticised for his quantitative easing (QE) programme, particularly in Germany, has one from zero to hero. That QE programme should come to an end soon.

In that final quarter of last year there were strong growth performances from Spain and the Netherlands, both 3.1%, but also from Germany, 2.9%, and even Italy, 1.6%.

Britain is not shackled to an EU corpse but it is still part of the EU, and benefiting from its recovery. Without it, indeed, growth in Britain over the past year or so would have been significantly weaker. Some of the numbers for British exports to EU member states in the year to the fourth quarter are striking: France up 24.6%, the Netherlands 15.2%, Ireland 8.5%, Germany 7.7% and Sweden 7.6%. Outside the EU, exports to China grew by an excellent 24.1% from a low base (and remain below British exports to Ireland), but exports to America fell by nearly 5%.

There is no sign yet that the return of EU and eurozone growth is a flash in the pan. The latest purchasing managers’ index for the eurozone, produced by IHS Markit, showed growth at a near 12-year high, and well spread across countries and sectors.

Noting that the latest reading was the strongest since June 2006, Chris Williamson, chief economist at IHS Markit, said: “The strong upturn is also broad-based, which adds to the potential for the growth to become more self sustaining as demand rises across the single currency area, feeding through to higher job creation as spare capacity is increasingly eroded. The survey data are therefore indicating that the eurozone has started 2018 with very good growth momentum.”

There is much that is good about the European economy. Last year the eurozone ran an €238bn (£210bn) trade surplus with the rest of the world. Much, though not all, was due to Germany, and a considerable chunk of that surplus was with Britain.

Eurozone economies have higher productivity than Britain, in some cases embarrassingly higher. Germany sets the standard. It has much higher productivity as well as a lower unemployment rate; 3.6% against Britain’s 4.3%.

Mostly, however, higher productivity in Europe is against a backdrop of higher unemployment. Average eurozone unemployment is 8.7%, and France has a 9.2% rate. Average eurozone youth unemployment is 18.2%, compared with around 12% in Britain.

Europe is not, either, yet out of the political woods. The consensus is that the upcoming Italian elections will not upset the applecart, but they could. The consensus too is that the membership of the SPD will not scupper Angela Merkel’s long and painful quest for a coalition government but it could.

The bigger question for the EU is whether it can seize the opportunity provided by the revival in growth and falling unemployment to put in place meaningful reforms.

Those reforms fall into two categories. The first are to correct the structural weaknesses in the eurozone itself. The second are to make EU economies, and in particular EU labour markets, more flexible.

On the first, I have written on many occasions during the near two decades of the euro’s existence of its basic design flaws. The single currency is lopsided. There is no fiscal counterpart, a central Treasury, to the European Central Bank. There is insufficient wage flexibility and, while you would not believe it from the debate in Britain, not enough labour mobility. The eurozone is a long way from what economists would call an optimal currency area.

Macron has pushed for a separate eurozone budget and finance minister to address one of the euro’s structural shortcomings. He has received some support from Merkel, but strong opposition from elsewhere in Germany to what would be seen as a permanent transfer union for transferring German taxpayers’ money to other countries. The rest of the EU, it should be said, has been pretty lukewarm.

As for labour market reforms, Draghi summed up he dilemma in a speech a few weeks ago. While there was a window of opportunity, the risk was that without a big investment in education and training, reforms would be “seen as a catalyst for a low-wage precarious economy.”

Macron, again, has gone further than most, pushing through the first phase of his labour market reforms last autumn. But while these provoked a backlash, including one description of them as a “neoliberal Blitzkrieg”, French employers are finding that they are not providing the free-for-all feared by the unions. The EU’s core economies, its original members, France, Germany, Italy, the Netherlands, Belgium and Luxembourg, have the tightest labour market regulations in Europe.

Is the eurozone seizing the opportunity provided by the return to growth? Not yet, or not enough. The first post-crisis opportunity to push through reforms was in 2010 and 2011 and was wasted. The second one is now. The eurozone has enough momentum to keep growth going for some time yet. But it needs to grasp the nettle of reform to secure permanently stronger growth.

Sunday, February 11, 2018
Be braced for a bumpy ride back to normal
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

The economic story of the week was the Bank of England’s “hawkish” signal that interest rates could rise “somewhat earlier and to a somewhat greater extent” than it expected three months ago. The financial story of the week was the record 1,175 point fall in the Dow Jones on Monday. It wasn’t a Black Monday, but it was pretty grey.

It was followed by wobbly Thursday, another 1,000 point fall, before a small recovery on Friday.

My task today is to draw these two things together, and it is not as hard as it sounds.

In normal times the Bank’s more hawkish stance on interest rates would be looked at through the spectrum of what Mark Carney, the governor, described as “the shallowest investment recovery in more than half a century”.

Housing market activity remains very soggy, as described here last week. And, while the Bank offered hope that the squeeze on real incomes will ease this year, thanks to bigger pay rises and falling inflation, we are not there yet. Normally these would not be the conditions in which the Bank would contemplate rate hikes, with the smart money on May.

These are, of course, not normal times. A stronger world economy has provided for a modest upgrade of the Bank’s growth forecasts, although they remain notably weaker than it was expecting two years ago. But the economy’s capacity to grow has also suffered, thanks to low investment and weak productivity. Growth of 1.75% a year compared with a speed limit of 1.5%, means more “limited and gradual” rate rises. We wait to see whether the Bank delivers on its hints.

Part of what the Bank is embarked upon is what is known in the jargon as normalisation. Monetary policy has been abnormally loose, and the aim is to return policy to something a little more normal. That may only mean 2% or 2.5% official interest rates in Britain, in time, but it is higher than the near –zero rates that have prevailed for the past decade.

There is, however, a bigger story here, and it takes us back to that plunge on Wall Street. Part of the normalisation will be achieved through higher interest rates, but part of it comes through reversing quantitative easing (QE), the assets purchased with electronically created money that central banks employed to prop up crisis-hit economies.

The great QE experiment is coming to an end. In America, the Federal Reserve is running down its QE holdings by the simple expedient of not reinvesting the proceeds of the maturing bonds it has on its books. Barring a disastrous cliff-edge Brexit, we are unlikely to see any more QE from the Bank. The European Central Bank will wind down its monthly QE purchases to zero this year.

Something else is happening. In the period since the financial crisis, bond markets have not only benefited from central bank purchases under QE, which has soaked up the supply of government bonds, but they have also gained as a result of tight fiscal policy. Governments have, in the main, acted to reduce the big budget deficits established during the crisis.

Mostly, though it continues for a while in Britain, that process has also come to an end. It has come to an end spectacularly in America, where official projections are for a $955bn (£680bn) budget deficit this fiscal year, up from $519bn in 2017. $1 trillion-plus budget deficits will soon become the norm in America. The Trump tax cuts may have helped invigorate the economy but they are expensive.

Austerity has come to an end too, on an aggregate basis, in the eurozone, where it was arguably most painful. It is one reason for the eurozone’s strong economic bounce.

The consequences of this, on a simple supply and demand basis, look to be quite straightforward. There will be a bigger supply of government bonds and, without central banks to soak them up, the price of those bonds will fall and the yields on them rise. This is not the bursting of a bond bubble but simple arithmetic.

In the case of America, the extra supply that the markets will have to absorb is the near $1 trillion budget deficit plus roughly $450bn of bonds that the Fed would have soaked up by reinvesting but will no longer do so. It is one reason why the 10-year US government bond yield has been nudging up towards 3% and it is reflected in similar if smaller moves elsewhere.

Why does this matter, and what does it have to do with the Dow’s plunge? Low bond yields have supported high stock market valuations. But when the spread between government bond yields and riskier equity market yields narrows too much, there is only one way for the stock market to go, and it is not up.

This, as I say, is entirely logical, if painful for some. The real problem would come if markets also start to seriously think that a significant rise in inflation is on the way. That fear, sparked by a stronger than expected reading for pay rises in America, would translate into an expectation of even faster rises in interest rates.

The International Monetary Fund warned of something like this in its updated world economic outlook last month. “Rich asset valuations and very compressed term premiums raise the possibility of a financial market correction, which could dampen growth and confidence,” it warned.” A possible trigger is a faster-than-expected increase in advanced economy core inflation and interest rates as demand accelerates.”

This is not the situation we are in yet. Give the strength of the world economy, inflationary pressures remain subdued. But even in the context of that strength, stock markets got ahead of themselves. For some, the return of volatility is no bad thing, reminding everybody that there are risks as well as opportunities.

But the return of volatility is also a useful reminder that the return to normality, when it comes to monetary policy, could be quite a bumpy ride for investors. Whether it gets too bumpy for central banks will be one of the interesting things to watch.

Sunday, February 04, 2018
Why a soggy housing market should concern us all
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

There are large parts of the economy in which it is relatively easy to work out what is going on. The housing market, it is fair to say, is not one of them. Contradictory information abounds, on prices, activity and just about everything else.

Nevertheless, it is also fair to say that, cutting through the undergrowth, we have a picture of a housing market that, if not “broken” – the government’s preferred phrase when talking about something that is on its watch – is certainly badly injured. It is a picture of weak, and probably weakening activity, slowing or stagnant house-price inflation and buyers and sellers who are so conditioned to expecting disappointment that they have given up on the market.

I base that on three pieces of evidence. The first comes with the Bank of England’s figures for mortgage approvals. They dropped by 6% in December to 61,039 and, before you ask, the figures are seasonally adjusted.

Mortgage approvals are a great barometer of housing market activity. In the 10 years leading up to the financial crisis, they averaged 104,000 a month, with monthly peaks of 134,312 in 2003 and 128,915 in 2006, both comfortably more than double the latest figure. They slumped to just 26,684 in the autumn of 2008, subsequently recovered to nearly 75,000 but are now at their lowest for three years.

The latest monthly fall has been attributed by some to the fact that the Bank raised interest rates to 0.5% in November, the first increase in official interest rates for more than 10 years. Did that have the immediate effect of cooling the housing market?

If it did, that would suggest a housing market, and indeed an economy, acutely sensitive to even very small changes in interest rates. I suspect that there was not that much of a direct effect – by the time people apply for a mortgage they have been in the process of house hunting for some time - though I would not rule out the possibility that some of the commentary around the November rate rise, that it was likely to be the first in a sequence, had a dampening effect.

The second bit of evidence is on house prices. You could go quietly mad trying to reconcile the various house price measures, some of which are measuring different things. There are asking price measures, which tend to be the most volatile, and measures of house prices at the mortgage approval stage. One of these, from the Nationwide Building Society, showed what it described as a “surprising” acceleration in house-price inflation from 2.6% to 3.2% last month.

It was indeed surprising. I tend to look at another measure, produced for LSL Property Services by the consultancy Acadata. It uses actual price data at which properties are bought and sold, including cash purchases.

It will provide a January update shortly but for December, and 2017 as a whole, it showed that house prices in England and Wales stagnated, rising by just 0.2% through the year. That, it should be said, reflected considerable price weakness in Greater London, where prices dropped by 4.1%, and a subdued picture for the rest of the south-east, with a rise of just 1%. Without the drag from them, house-price inflation was 3%, though that was still well down on the 7% reached in the first half of 2016.

The evidence on house prices suggests, with some certainty, a slowing of inflation, which few people will begrudge. The big question is whether falling prices in London ripple out to the rest of the country, as has happened in the past. Nationally, with continued very low interest rates (even with a rise or two this year) and limited supply, the scope for meaningful house price falls is limited. Stagnant prices are, however, very likely.

The third element in any assessment of the market is what is happening to activity. Official transaction numbers are flat at around 100,000 a month. But the message from surveyors is a very downbeat one. The Royal Institution of Chartered Surveyors (Rics) will also publish an update soon but its most recent residential market survey showed, along with expectations of modestly falling prices, a gloomy assessment of activity.

It showed the absence of any boost from the chancellor’s abolition of stamp duty for most first-time buyers in the November budget, a drop in agreed sales, and a continued stand-off between weak new buyer enquiries and sales instructions, with the latter negative for the 23rd month in a row. Weak demand and weak supply make for a very soggy market, which is what we have.

There is more to this, however, than a housing market in the doldrums. The recent English Housing Survey showed a housing market that is failing to deliver, for potential home buyers and the economy.

There was a time, not so long ago, when in a previous government ministers contemplated setting a target for home ownership of 80%. The survey showed that in 2003, when home ownership in England reached a peak of 71%, the country was within striking distance of such a target.

Now, however, home ownership in England is down to 63% of all tenures, and it is dominated by older people. Most home owners own their homes outright - 34% of the 63% – something that typically applies only to people who have paid off their mortgage.

Ten years before the period covered by the latest survey, so in 2006-7, 72% of those in the 35-44 age group were owner-occupiers. Now that has dropped to just 52%. The German model of later home ownership is becoming the norm in Britain. The drop in owner-occupation among the 25-34 age group, from 57% to 37%, alongside an increase from 27% to 46% in private renting, is just as stark.

This, as you may have seen from recent coverage, is causing deep concern within government, though it did not prevent Theresa May, in her recent less than successful reshuffle, maintain the revolving door tradition of appointing a new housing minister every time a prime minister reshuffles the ministerial dice. The latest is Dominic Raab, who on past form will be moved to another job by the time he has learned the housing brief.

The politics of this are straightforward; voters for whom the housing market fails to deliver are likely to take their revenge on the government. There were competing explanations for why there was net support for Jeremy Corbyn’s Labour up to and including the 40-49 age group but disappointed housing expectations were high on the list. The government has been keen to reap the benefits of taxing transactions – stamp duty receipts reached a record £9.5bn last year – without considering the consequences for those transactions.

For the economy, a housing market that turns over more slowly, and in which –even after recent small falls – London is far out of reach for people from most other parts of the country, contributing to low geographical mobility, is a serious constraint on efficiency.

This is the time when, after shrugging off the effects of the crisis, housing activity should be powering ahead and returning to some kind of normality. The fact that it is at best flatlining, at worst in a new decline, is worrying.

Sunday, January 28, 2018
A cash injection alone won't cure the NHS's ills
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

If it is winter, there must be a National Health Service crisis, and indeed there is. There was one last year, which was described by the Red Cross as a “humanitarian crisis”, and there is one this year. There was one in 2005, halfway through the biggest increase in NHS spending in its history, and there was one in 2008, even further into that splurge,

Look hard enough and there is a crisis every year, though they vary in severity. I do not diminish the distress for people caught up in this one, but it would almost have been bad manners not to have a crisis in this, the year the NHS celebrates its 70th birthday.

The question is what to do about it. This one has provoked much debate, and two things should be clarified at the outset. The first is the idea that there will be some kind of Brexit dividend available for the NHS, as claimed by both Boris Johnson, the foreign secretary, and Liam Fox, the trade secretary.

There will not be. Any saving on Britain’s next contributions to the EU budget, and we are yet to see whether there will be, will be swamped by other effects on the public finances. Britain will, be borrowing more, not less, in future years and, as the Institute for Fiscal Studies put it a few days ago: “Brexit has reduced rather than increased the funds available for the NHS (and other public services), both in the short and long term.”

The other thing this winter crisis has done is bring forward an old chestnut, the notion of a dedicated, or hypothecated, tax to pay for the NHS. There are many reasons why this is a bad idea but two will suffice. One is that tying something as important as NHS spending to the stream of revenue for one particular tax
would be hugely risky.

What happens when revenue falls short? You might respond by putting up the tax but there is no guarantee that a higher tax rate means an increase in revenues. Another objection is that hypothecation destroys the ability of governments to spread revenues across popular public services like the NHS, and unpopular ones, for which there is a fairly long list. If the NHS is to be financed out of taxation, it should be out of general taxation (which includes national insurance).

The financial backdrop to this crisis is that the NHS is four-fifths of the way through the tightest decade for spending in its history. NHS spending has risen by an average of 4% a year in real terms since 1948, an increase that accelerated to 5%-6% in the 2000s. In the current decade, real increases in NHS spending are averaging 1% to 1,5% a year, alongside a rising population. As long ago as the 1980s, it was discovered that NHS spending needed to rise by 2% a year in real terms just to keep up with higher medical inflation and technological advances. That figure may have increased.

When the population is adjusted for age (ageing populations put greater demands on the NHS) per capita spending is essentially flat. Money is tight.

So what should be done? It would be folly to pretend that next year’s winter crisis could be averted by action taken now but, over time, we should be able to do better than an NHS which lurches from crisis to crisis.

There are five things that can be done. The NHS can be helped over time by taxing more, borrowing more, rationing more, charging users more (which itself could ration use) or introducing genuine efficiency improvements.

Taxing more is always a possibility. This was the route used by Gordon Brown in the early 2000s when, much to the distress of business, employer and employee national insurance was raised to put more money into the NHS.

These days there is not much low hanging fruit for the Tories when it comes to tax increases for either business or individuals. A Labour government would be much less constrained.

The second route is to borrow more, which was what Philip Hammond did in November. Faced with an underlying deterioration in the public finances, he chose to spend more, notably on the NHS. Will it be enough, and the last time that happens? No. There will be more borrowing in future.

What about rationing? A problem for the NHS is that the range of services, and treatments, increases in line with medical advances and demographics. Nice, the National Institute of Health and Care Excellence, has the specific task of issuing guidelines, including guidelines on which new drugs and treatments should be used, based on a budget impact test. But some of the rising costs of healthcare arise naturally, for example because of the ageing population, and cannot easily be rationed.

Many people favour a different kind of rationing, by dropping the NHS “free at the point of delivery” maxim. Prescription charges were introduced early in the NHS’s history and people have for many years expected to pay when visiting an NHS dentist. Paying for a GP appointment, as is the practice in many other countries with state healthcare systems, or charging a penalty for patients who do not show for appointments, could be away to go. But the politics of that are very tricky and charging for GP appointments might have the unintended consequence of directing more people to already highly pressured casualty departments.

That leaves efficiency. Three years ago NHS England, having identified a £30bn funding gap by the early 2020s, committed to £22bn of efficiency savings in return for £8bn more of government money. It is fair to say that progress in achieving those efficiency savings has been disappointing.

As in the past, top-down pledges of this kind tend not to work. Tony Blair and Gordon Brown’s NHS spending splurge was supposed to be return for reform and greater efficiency. We had the splurge but not the efficiency.

Far better, as the think tank Reform argues, when ideas that reduce waste and improve efficiency develop on the ground and are spread around the NHS. Some of that happens now. Not enough of it does. An excessively bureaucratic organisation that employs at least 1.5m people across the UK is not an obvious candidate to be fast on its feet when it comes to efficiency savings. But there is good practice in the NHS, some of which has eased the pressure on A & E departments in some parts of the country even this winter, and it needs to be spread. Otherwise, each winter crisis will stretch, unbroken, until the next.

Sunday, January 21, 2018
Both sides need a good Brexit deal for the City
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

In the spirit of Anglo-French co-operation of recent days, which included a Sandhurst summit and the offer by President Macron of a loan to this country of the Bayeux tapestry, let me today say how much I agree with Christian Noyer, a former governor of the Bank of France, its central bank.

Noyer, who now has the role of luring financial services business and jobs to Paris, particularly from Britain, said in a BBC interview that the City of London would not be displaced by any other capital as Europe’s leading financial centre. He is right.

London is the world’s leading financial centre, according to the most recent Global Financial Centres Index produced by Z/Yen and the China Development Institute. It ranks ahead of New York, in second place, as well as Hong Kong, Singapore, Tokyo, Shanghai and Toronto. The next European challenger to London, in ninth place, is Zurich, which is not in the EU. No other EU financial centre in in the top 10, with Frankfurt in 11th place, Luxembourg 14th and Paris way down in 26th.

London’s financial infrastructure and expertise puts it way ahead of its EU rivals, with a market dominance that is almost embarrassing. In several key areas its EU market share ranges from 50% to more than 80%. There are few, if any, other parts of the British economy this can be said about.

In the light of this, it would be easy in the forthcoming phase two of Brexit negotiations for the government to take a relaxed attitude towards the City and concentrate on other things. There are, after all, few votes in standing up for the Square Mile. Some Brexit voters, perhaps a considerable number, see the vote to leave as an opportunity to bring the City to heel and tilt the economy away from reliance on it.

Add to that the stated position of Michael Barnier, the EU’s chief negotiator, that there will be no place for financial services in a post-Brexit EU-UK trade deal, and ministers might decide that there is no point banging their heads against a brick wall.

“There is not a single trade agreement that is open to financial services,” Barnier said last month. “It doesn’t exist.” This was a consequence of Britain’s so-called red lines: “In leaving the single market they lose the financial services passport.” That, notwithstanding my entente cordiale with Noyer, was also his view. Macron has this weekend confirmed that there will be no financial services’ deal for Britain equivalent to single market membership without a continuing contribution to the EU budget, and Britain accepting the four freedoms of the single market and the jurisdiction of the European Court of Justice.

Notwithstanding this it would, however, be a big mistake for the government not to place a high priority on the City and financial services in the forthcoming negotiations, both to ensure early agreement on a transition deal to stem any outflow of jobs, and to seek to break Barnier’s convention and ensure that the eventual deal between Britain and the EU does include financial services.

So, even if London does continue to be Europe’s biggest financial centre after Brexit, which I expect, it would do so even if it lost a significant part of its activity and jobs to other centres, such is the lead London has. But the loss of those jobs and activity, in the absence of a deal to preserve something like existing passporting arrangements, would be detrimental for the economy and Britain’s tax base.

It would also seriously undermine London’s standing in relation to other international financial centres. If enough activity peels away without a deal, which it could well do, it is unlikely that in five or 10 years’ time we would still be able to talk of the City as being the world’s leading financial centre. A slip down the global rankings would seem inevitable.

Targeting an EU-UK deal for financial services could not only underline the scale of the government’s ambitions but provide a template for other sectors. Britain starts from a position of regulatory alignment with the EU but also with a regulator, the Bank of England, which is trusted on both sides and which has been operating within the EU but outside the eurozone for years.

The result of this, according Sam Woods, a Bank deputy governor and head of the Prudential Regulation Authority (PRA), is that it should be “entirely doable” and “technically feasible” to conclude a financial services agreement within the next three years, in other words before the end of the transition period. Similar arrangements should also be “doable”, on the basis of continued regulatory alignment, for other sectors.

There is a final argument. There are very few areas associated with Brexit where the damage to the EU is greater than the damage to Britain; in most cases it is comfortably, or perhaps uncomfortably, the other way around. Logic, however

Financial services is, however, one of them, as Mark Carney, the Bank governor, has made clear. Woods described the “worst outcome of all” as one in which there is no transition, on co-operation and regulators on both sides would have to resort to a “deep fallback” position.

Cutting the EU’s businesses and banks from the City’s markets would be the equivalent, for EU countries. Of cutting off their noses to spite their face. The City, he has said, is “Europe’s investment banker” and accounts for roughly half the debt and equity issued in the EU. “I don’t accept the argument that just because it has not been done in the past [a trade deal including financial services], it can’t be done in the future,” he said last month.

In the short-term, the EU would suffer financial dislocation, including the complication of the £20 trillion of derivatives’ contracts which are at risk, together with £60bn of insurance liabilities. In the medium-term, the loss of London to the EU would mean higher transaction costs, a rise in the cost of capital and the acceptance of less efficient markets and more thinly-spread expertise.

The logic for a deal which maintains something close to the status quo for the City in the EU therefore looks inescapable. Logic, however, has not always been uppermost in the Brexit process.

Sunday, January 07, 2018
The most important trade deal is on our doorstep
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

I always try to start a new year in a mood of good cheer, and it is only in the past few days that I have come to realise the comic possibilities of Brexit. While some would call it a black comedy, who could fail to have been amused by David Davis’s “dog ate my homework” embarrassment a few weeks ago when the 58 detailed sectoral Brexit studies he had boasted about turned out to be nothing of the sort.

Then there was Theresa May’s dawn dash to Brussels in December to secure an agreement, days after the Democratic Unionist Party had scuppered a deal to move on to the second phase of Brexit negotiations. There will no doubt be more such dashes; not so much shuttle as shuttlecock diplomacy.

Many people have also seen the comedy in the activities of Liam “Air Miles” Fox, the international trade secretary, who is reported to have travelled 219,000 miles in the 18 months since he took on the job. He provoked mirth by holding out the possibility of Britain joining the successor to the Trans-Pacific Partnership (TPP), the trade grouping apparently fatally wounded by Donald Trump’s withdrawal.

With America out, the grouping consists of Australia, Brunei, Canada, Chile, Japan, Malaysia, Mexico, New Zealand, Peru, Singapore and Vietnam. Though Britain is not committed to replacing America in a new pacific partnership, Fox has not ruled it out and his ministerial colleagues say geography is no barrier to Britain’s participation.

The cue for the mirth is that this is happening as Britain is leaving a perfectly good trade arrangement with the European Union, an export market more than five times the size of the 11 TPP signatories. It is also that, whatever ministers may say about geography, it matters hugely for trade and, Brexit or not, Britain is not about to be towed into the Pacific.

I am no cheerleader for Fox but the barbs seem a little harsh. Travelling around the world is exactly what a trade secretary should be doing. The international trade department, started from scratch in the wake of the Brexit referendum, and having to cope with a gap of more than 40 years since Whitehall last had expertise in trade negotiations, has gone about its task in a sensible way.

In contrast to Davis’s Brexit department, known as DEXEU, where staff turnover is running at 9% a quarter and where the top civil servant, Oliver Robbins, was moved to the cabinet office in September to co-ordinate negotiations for the prime minister, the trade department is quietly getting on with it.

Trade negotiators have been recruited, and more are being sought. And, while Britain lacks firepower and expertise compared with the EU, America, and many other countries, the lost ground is being gradually made up.

There is nothing wrong, either, in an ambitious approach to future trade deals. Most of the supposed freedoms gained from leaving the EU are illusory but the freedom to negotiate trade deals, assuming there is no U-turn on belonging to the customs union or its equivalent, is one of them. Britain belonging to a pacific partnership may seem ludicrous but there is no harm in trying, and there may be goodwill as well as trade to be gained.

Britain runs an overall trade surplus, in goods and services, with the non-EU world, in contrast to the deficit with the EU. The three big prizes for post-EU trade deals, which will be the world’s big three economies by the middle of the century, are China, America and India. All three will be problematical, with conditions we may well not like. But they will need to be done, even of they take a very long time.

That is why there are two important provisos. The first priority for Britain’s future trading arrangements, which has to come before any new deals, is to roll over or “grandfather” the existing trade agreements the EU has with more than 60 other countries.

This will not be easy, as a new paper from the UK Trade Policy Observatory points out, and it may be necessary to prioritise some of these agreements. Agreement has to be reached by March 2019 and will involve trilateral negotiations between the EU, Britain and the third countries concerned. One difficulty that may arise is over definitions of the domestic content in exports once Britain leaves the EU. Another will be over regulatory divergence. I shall return to this.

The second proviso is that far-flung trade deals will be of little use if not accompanied by a comprehensive trade agreement with the EU that is as close to single market membership as possible. The EU is Britain’s biggest trading partner and, for reasons of both geography and history, will be for the foreseeable future.

Though the EU’s share of Britain’s exports has declined in recent years, thanks to the financial and eurozone crises and the rise of emerging economies, the EU share of Britain’s imports has been broadly stable. The export share, moreover, is now showing signs of increasing, reflecting the strong recovery EU economies are now achieving. The share of Britain’s goods exports going to the rest of the EU rose from 48% in 2015 to 48.2% in 2016 and 48.6% in the first 10 months of 2017.

This will be the year when the government has to move from vague generalities about Britain’s future trading arrangements to the specifics of at least achieving an outline deal by the time of Brexit, with the details then to be negotiated. The prime minister will find that she can no longer keep winging it in the hope of keeping her cabinet together. We are approaching cards on the table time.

There is nothing wrong, meanwhile, with the trade secretary travelling the world and talking potential trade deals with other countries. But this can never be an either-or. The most important trade deal to be negotiated is on our doorstep.

Sunday, December 31, 2017
How jobs and interest rates surprised the forecasters
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

The table accompanying this piece, which is essential, can be accessed on the Sunday Times website,and in the newspaper.

So what kind of year was it? A good one for the global economy, with increasingly broad-based growth and a sense that the deadly grip of the financial crisis was starting to ease. For Britain, it was a year dominated by Brexit, as was always inevitable. We have not seen the last of these years.

A year ago my annual forecasting league table, a staple of the economic calendar, caused controversy because it showed that forecasters had a good year in terms of predicting the economic numbers, even though most of them did not anticipate the biggest development in 2016, the vote to leave the European Union.

This time there was no such problem. Forecasters knew what was coming in 2017 and in that context many of the forecasts were very good. The consensus at the start of year was a little low on both growth and inflation, though not decisively so.

I should say that we do not know precisely what growth in 2017 will have been, and even when we do the figures will be prone to revision. I have estimated 1.7%, following the release of the third quarter national accounts just before Christmas. But 2017’s growth could have been higher or lower than this.

The same applies to the balance of payments, where again we only have three quarters of current account data but my number, a rather eyewatering deficit of £90bn, will be close to the eventual outturn.

Inflation is easier. The figures do not get revised and we know that consumer price inflation was 3% in October and 3.1% in November.

That brings me on to the two biggest surprises, for forecasters looking ahead early this year, as far as the economy was concerned. The first was interest rates, for which I have sympathy with the forecasters.

At the start of the year the Bank of England had passed up on its earlier hints about a second post-referendum cut in interest rates in November 2016, but a further rate reduction still appeared to be on the cards. That and the fact that we were approaching the 10th anniversary of the last hike in rates meant that no change was the safest forecast at the start of the year. The tiny number of forecasters who did predict a rate rise are to be congratulated, though in most cases they expected growth in the economy to be significantly stronger than it was.

The surprise was that the Bank raised rates against a backdrop of weak growth. The justification was that weaker growth may be as good as it gets for some time. I shall take a look at prospects for interest rates in 2018 next week, along with other aspects of the outlook.

The other big surprise was unemployment and again this consisted of two parts. One was that the economy was not expected to be strong enough to generate much of an increase in employment, and thus a fall in unemployment. The other was the expectation, not for the first time, that stronger productivity would kick in, if only against the backdrop of weak growth. There was indeed a glimmer of light on productivity this year, but not much.

So unemployment fell to a 40-year low, and most forecasters did not see it coming. There was a time when the labour market was very easy to forecast. In recent years it has not been.

So who steered a successful forecasting course through this tricky year? The winner, and he is developing a reputation for this kind of thing, is Alan Clarke of Scotiabank. Scotiabank is a Canadian bank which, as its name suggests, hails originally from Nova Scotia, where it was founded nearly 200 years ago. As well as operating in London, it is active across the Americas and in Asia.

Though Clarke did not quite get the extent of the unemployment fall, or the rate rise, his other forecasts were very good. And when I say he is developing a reputation, last year he finished joint first with Daiwa Capital Markets. In the long history of the forecasting league table I cannot recall anybody winning twice in a row before. So many congratulations are in order.

His predictions will be worth watching in 2018. As things stand they are for 1.5% growth, and a low 1.8% inflation by the end of the year, in spite of which he expects a rise in Bank rate from its current 0.5% to 1%. Daiwa, by the way, had another creditable year, coming in sixth.

Most of the top forecasters this year are from the City, which is not unusual. They tend to update their forecasts more frequently than official forecasters, embracing new data. Some of the official and semi-official forecasters, like the IMF, OECD and European Commission put themselves at a disadvantage by not forecasting all the variables I use in the comparison.

The Office for Budget Responsibility, which does not offer an interest rate prediction (neither did the Treasury when it did the official forecast) had a middling year. Its forecasts – last updated the previous November - were too low for both growth and inflation. The Bank does not feature because its forecasts are not included in the Treasury’s monthly compilation of independent forecasts.

All in all, not a bad year for forecasters. In 2017 the economy was not as bad as the pessimists feared and not as good as the optimists hoped. Roll on 2018.

Sunday, December 24, 2017
Only an end to the uncertainty will lift all our spirits
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

It was John Maynard Keynes, the greatest economist of the 20th century, who taught us about the importance of confidence, or as he dubbed it “animal spirits”, in the economy. As he put it in his General Theory of Employment, Interest and Money in 1936, “most of our decisions to do something positive, the full consequences of which will be drawn out over many days to come, can only be taken as the result of animal spirits — a spontaneous urge to action rather than inaction”.

As we approach the end of an interesting year, there is no doubt that animal spirits are lacking in Britain. The world economy is enjoying a revival but this country is in the slough of despond. Friday’s modest gross domestic product revision reflected growth that occurred more than a year ago. The question is whether anything can be done to lift the spirits.

Consumer confidence has been negative (more people expect things to get worse than better) all year, according to the closely watched GfK survey. The December reading, of -13, is lower than the levels the index tumbled to in the immediate aftermath of the EU referendum in June last year.

In 2015, consumer confidence enjoyed its best year in the survey’s history, with zero inflation and strong employment growth leaving households very chipper. Now, Joe Staton of GfK foresees further declines in confidence in 2018 after what he describes as a “slipping and sliding year”.

The animal spirits of consumers are important, and will help determine how the economy does in 2018. Animal spirits are, however, usually associated with business, and here they are notably absent. The latest results of the Bank of England’s decision maker panel, established to probe the implications of Britain’s withdrawal from the EU, were released a few days ago.

The panel, of about 2,500 executives from small, medium and large businesses across all sectors, is run by the Bank with Professor Paul Mizen of Nottingham University and Professor Nicholas Bloom of Stanford University.

Members have been disappointed by sales growth over the past year and expect a slowdown next year. Sales growth in cash terms, 4.9% in the year to the third quarter, is expected to slow to 3.7%. That slowdown is alongside continued high inflation, which they expect to slow only modestly from its current 3.1% to 2.6%. The panel is also gloomier about jobs, with recruitment growth expected to be lower in 2018.

The panel, interestingly, is more downbeat about wage prospects than are the Bank’s regional agents. While the agents see a modest upturn, the panellists think that wage growth will, if anything, dip from this year’s 2.6% to 2.5%. They also offer little succour to those who expect that falling migration from other EU states will boost wages, with an even split between those expecting to see stronger wages and those anticipating them to weaken.

As things stand, some businesses are squeezing wages to compensate for the impact of sterling’s fall on costs such as raw materials, while others are boosting wages to compensate for the rising cost of living.

The big picture, which explains the lack of animal spirits, is that businesses think they face a weaker sales environment because of Brexit. Asked about the impact on sales in 2020, by a margin of 45% to 18% they expect a fall. The most exposed sectors are those that export to the Continent, and include high-value professional services, manufacturing, transport and information and wholesaling and retailing. In each of these, the probability of a drop in sales in 2020 is put at between 25% and 35%.

Every survey tells a similar story. The Lloyds Bank Business Barometer has edged slightly higher but concludes that “firms remain concerned about the outlook”, with larger companies particularly worried about Brexit.

The Recruitment and Employment Confederation found a rare unanimity among 200 employers it surveyed, with not one expecting economic conditions next year to be less challenging than in 2017, and a decline in confidence about investment and hiring decisions.

What can be done to lift the mood? A stronger global economy is, as I said, not preventing slower growth in Britain. Neither are buoyant stock markets, a reflection of global rather than British strength. Christine Lagarde, managing director of the International Monetary Fund, was right to say the Brexit process is damaging the economy, as her organisation and others had predicted.

Theresa May is striking an upbeat tone after just making it to the finish line for the first phase of Brexit negotiations, but, like a Guide leader telling everyone to buck up, it doesn’t quite work.

The end of the first phase is supposed to be followed by early agreement on the length of the transition period after Britain formally leaves the EU at the end of March 2019. Even here, though, the two sides have managed to sow doubts. The prime minister’s request, in her Florence speech, for a transition period lasting roughly two years has been rather petulantly pegged back to 21 months (the end of 2020) by Michel Barnier, the EU’s chief negotiator.

They are, in truth, both wrong. Two years will not be enough for a transition during which a comprehensive trade agreement between Britain and the EU can be negotiated, with all the bells and whistles it will require. It will need to be much longer, as sensible people in business recognise. The first priority will be a transition deal, and agreement on rolling over the 750-plus deals the EU has with non-EU countries. Only then will the talks be able to proceed to an outline trade agreement. Months of uncertainty, or longer, loom.

Britain’s approach needs to be realistic. Any hope that the end of phase one would be followed by an outbreak of realism has proved unfounded. The prime minister’s goals are inconsistent, wanting comprehensive, frictionless trade, alongside the ability to set our own rules and regulations. Nothing has been learnt in the past 18 months, and I would not expect much greater clarity in May’s promised speech next month. As I wrote recently, it’s a case of still clueless on Brexit, and business knows it.

There are good ideas out there. The Institute for Government has some. It suggests a deal could involve an EU-UK economic area, “bespoke Norway”, or a comprehensive trade area on the Ukraine model, with participation in the single market for sectors that remain aligned in regulatory terms. Or there could be a Canada-plus style of free trade agreement, with a “plus” for some services. The institute also suggests a new regulatory partnership, to manage divergence between EU and UK rules.

The key thing is to have something workable to aim for. In the absence of any such certainty, those animal spirits will remain depressed. And the economy will suffer.

Sunday, December 17, 2017
Fall in jobs casts a new cloud over consumer spending
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

One fall in the number of people in work looks like a blip, two in succession and you might start to detect a trend. The fall in employment announced by the Office for National Statistics (ONS), 56,000 in the August-October period compared with the previous three months, is in the context of more than 32m people in work a drop in the ocean.

But it is worth watching, and it may signal the start of a significantly weaker trend after what has been an employment recovery in Britain since the financial crisis of 2007-9 verging on the miraculous. Even after this fall, it should be remembered that the number of people in work is 3m higher than it was in mid-2009, the crisis low point. In the context of that miracle, a fall in employment is unusual.

Part of that miracle is that private sector job creation has comfortably outstripped the loss of public sector jobs. The ratio of private sector jobs created to public sector jobs lost as a result of spending restraint has been roughly seven to one.

That has changed in recent months. ONS figures show that there was a rise of 19,000 in public sector employment between June and September, alongside a fall of 75,000 in private sector jobs. Public sector jobs are on the rise again, if modestly, while the private sector jobs’ machine has sputtered.

Why should that private sector miracle not continue? Growth and employment are intimately related. The puzzle has been that Britain’s growth slowdown was not reflected in the jobs’ figures. Now, with a lag that explains the puzzle, that slowdown effect is starting to come through. Slower growth in the economy means a fall in employment, or at least a levelling off, is to be expected.

Related to this, though it is not always foolproof, when any economic variable is at record levels, it is sensible not to expect it to keep breaking records indefinitely. We can debate the quality of employment in Britain but the numbers have been clear.

Whichever way you look at it, whether broken down by UK-born, UK nationals or the workforce as a whole, Britain’s employment rate has broken new ground. The 16-64 employment rate peaked at a record 75.3% in the spring and early summer, before slipping back to its current 75.1%.

You may ask why it is not possible to get the employment rate above 75% or so. There are 8.9m people of working age, defined as 16-64, who are officially recorded as economically inactive, and that number rose by 115,000 in the latest three months.

There are a number of reasons for inactivity: 2.4m of the economically inactive are students, 2.1m looking after family or home, 2.2m either temporarily or long-term sick and 1.2m retired. Of the 8.9m economically activity, most say they do not want a job, though 2m say they do. Matching that to the jobs available is the challenge, ands always has been. The number of economically inactive people who say they want a job has ranged between 2m and 2.5m for the past 25 years.

There is another component to the employment picture. Every survey suggests that many firms are experiencing recruitment difficulties. There are, in many cases, not the people to fill the jobs available. Though recruitment advertising is cheaper these days because of the rise of the internet, which may distort the figures higher, there are nearly 800,000 unfilled vacancies in the economy, spread across organisations of all sizes,

The supply of labour, meanwhile, is more constrained. Employment among non-UK nationals, up 88,000 over the past year, has slowed to a third of its rate in the previous 12 months. One of the reasons why employment growth is fading is demand, but another is the supply of suitable workers. For employment to continue to grow, you need the people, to do the jobs.

There is, it should be said, a more positive spin that can be put on all this, which is that, as the penny drops on slower growth, we are finally seeing the beginnings of the long-delayed rise in productivity. The latest three months saw, not just a drop in employment but a rather larger drop in hours worked, both because of fewer people in work and a decline in the average work-week, itself evidence of slower growth. So even a modest rise in output translates into a decent increase in productivity; output per hour. As it was, the ONS’s “flash” estimate of productivity showed a strong rise of 0.9% in the third quarter.

If that upturn in productivity can be sustained it is good news, which will eventually translate into rising real wages, and will help the public finances. The latest official figures showed a small strengthening of pay growth but a continued fall in real, after-inflation, wages.

The question for now is whether the pattern is changing. For several years we have seen strong employment growth against weak productivity. If that is now changing it has immediate implications for any consumer-facing businesses. While retail sales rose last month on the back of “Black Friday” deals, the trend towards slower growth in spending is unmistakeable, and stores are likely to discover that what kept the tills ringing in November will have stolen some business from this month and January. Meanwhile, underlying annual growth in retail sales volumes has slwo3ed from 6% a year ago to 1% now.

Strong employment growth kept the consumer pot bubbling during the earlier period of falling real wages. This time the prospect is for weak or falling employment, alongside falling real wages, at least until that improved productivity kicks in.

So times will be tougher for consumer businesses. More people in work has kept them going. Looking ahead for coming months, it is less likely that there will be many more people in work

Sunday, December 10, 2017
A hurdle overcome - now to decide where we're going
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

In the past few days my thoughts, like those of the prime minister, often turned to Northern Ireland and I offer the following facts without comment. Northern Ireland accounts for 2.1% of Britain’s gross domestic product, significantly smaller than any English region, less than two-thirds that of Wales and just over a quarter of the economic clout of Scotland.

Northern Ireland’s fiscal deficit with the rest of the UK – the gap between taxation and spending – is £5,438 a head, comfortably outstripping anywhere else, and roughly twice that of Scotland. The voters of Northern Ireland came out 56% to 44% for staying in the EU in last year’s referendum.

For several days last week, it looked as though, notwithstanding all this, the issue of the Ireland-Northern Ireland border had scuppered Theresa May’s “deal to move towards a trade deal”, because of objections by the (pro-Brexit) Democratic Unionist Party, on which the prime minister’s parliamentary majority depends.

Friday morning’s breakthrough many not have entirely satisfied the DUP and, as expected, the deal on the Irish border is something of a fudge. But it is only fair to say that the agreement May came to was in most respects a very acceptable one. The so-called divorce bill has been kept to under £40bn and will be spread out over such a long timescale that in most years it would be the public spending equivalent of small change. Any role for the European Court of Justice in the rights of EU citizens in Britain will be time-limited and very much a fallback one, which should concern nobody but the Brexit ultras.

What was also significant about Friday morning’s breakthrough is what it says about the direction of future trade talks. The harder the Brexit, the more difficult, if not impossible, it would have been to avoid a hard border between Ireland and Northern Ireland. It may have been the tail wagging the dog but the border issue has undoubtedly pushed us in the direction of a softer Brexit, which is why some on the Leave side hated the deal.

Much of the kerfuffle over the Irish border could have been avoided if, as I have argued here on a number of occasions, the prime minister had not been so hasty in ruling out continued membership of the single market, the internal market. Britain came to the EU via being a founder member of the European Free Trade association (EFTA). These days three EFTA members, Norway, Iceland and Liechenstein are part of the European Economic Area and thus the internal market.

It is a rapidly diminishing hope, but there is still a very slim chance that, as we do move beyond the preliminaries and into the real talks, EEA membership will come back on to the table. As it is, it may be possible to argue that regulatory alignment between Britain and the EU, the current buzz phrase, is a sort of de facto EEA membership.

It may or may not, and the fact that nothing can be definitively ruled in or out goes to the heart of the government’s problem, and the frustration of those on the EU side. Where there should be a blueprint for Britain’s future trading arrangements with the EU there is a vacuum that vague words in prime ministerial speeches do not fill.

Two things have stood out in recent days, apart from the deal early on Friday morning. One was Philip Hammond’s admission that the cabinet has not yet had a discussion on the government’s desired Brexit end-point. The other was David Davis’s admission that the 58 sectoral impact assessments, on how different parts of the economy would be affected by different scenarios, do not exist.

I do not entirely blame Davis for his embarrassing admission on the impact assessments, though he deserves all the ridicule he has suffered for his “the dog ate my homework” excuses, and for giving the impression that his Rolls-Royce department, and indeed the entire civil service, had been purring away producing the best impact assessments money could buy. That was bluster, and he has been found out.

Such assessments are not that difficult to do. I have been reading two good ones commissioned, interestingly enough, by the much-criticised European parliament. One looks at the impact of Brexit on the remaining 27 EU members. The other looks at financial services and, contrary to what you might expect, is constructive and helpful.

Hard Brexit would result in some relocation of financial services from the UK to the EU, it says, but would also result in increased costs and fragmentation for all. This is one of the ways Brexit reduces efficiency. A new regime of regulatory equivalence would help mitigate some of these effects, it says, while: “The least disruption to the financial system and markets occurs in the EEA membership scenario.”

KPMG published its impact assessments earlier in the year and most of the other big accountancy firms have conducted similar exercises. Last week the National Institute of Economic and Social Research held a conference in which it took its estimates of the sectoral impacts under “soft” and “hard” Brexit scenarios and applied them to localities. Soft Brexit is defined as zero tariffs but with increased non-tariff barriers with the EU. Hard Brexit has tariffs and higher non-tariff barriers.

Most sectors of the economy suffer under both soft and hard Brexit, though a minority gain. The biggest losers are the chemicals industry, financial services, electrical equipment, mineral extraction and others. But agriculture gains, which must explain all those Vote Leave signs in farmers’ fields.

All local authorities lose economically under soft or hard Brexit, with the biggest losses in the City of London. Aberdeen. Tower Hamlets, Watford and Mole Valley in Surrey, and the smallest in South Holland (Lincolnshire), Crawley, the Isles of Scilly, Melton (Leicestershire) and Hounslow.

Such results are one reason why the government has not come clean with its own, and indeed now says they do not exist. No government wants to tell voters that the course it has embarked upon, at their behest, will make them worse off.

Sometimes, even to the government, warnings can be useful. The verdict of the House of Lords EU committee on Thursday was that a “no deal” Brexit “would not just be economically disruptive, but would bring UK-EU co-operation on issues such as counter-terrorism, nuclear safeguards, data exchange and aviation to a sudden halt. It would necessitate the imposition of controls on the Irish land border, and would also leave open the critical question of citizens’ rights.”

The good news about Friday morning’s compromise is that it should have put an end to the damaging bluster about walking away without a deal. In normal circumstances it would. We are not, however, in normal circumstances. The no-dealers may yet make a return if and when the coming trade talks encounter difficulties.

The other reason why official impact assessments have proved hard to do is because of that vacuum. Comparing EU membership with the government’s desired end-point should have been straightforward. In the absence of that end-point it has proved all but impossible.

Business has breathed a sigh of relief at the latest turn of events. Sterling, highly sensitive to the state of Brexit, steadied. But the clock is still ticking and the Brexit preliminaries took at least three months longer than they should have done. The first and next priority is agreement on transitional arrangements that effectively keep us in the EU. They could last a long time.

Sunday, December 03, 2017
What the bitcoin bubble tells us about the economy
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

When the price of bitcoin makes it on to the BBC news bulletins, along with reassurances from a deputy governor of the Bank of England that when the bubble bursts it will not threaten the world economy, you know it is a breakthrough moment.

That moment was the rise last week in the price of Bitcoin above $10,000 (£7,400) for the first time, which was followed by a rise to $11,000, before a retreat back to around $10,000. The digital currency, or “peer to peer electronic cash system”, created almost a decade ago by the mysterious Satoshi Nakamoto, once worth a few cents, has never before scaled such heights.

Bitcoin and other so-called cryptocurrencies such as ether on the Ethereum platform, are in vogue. At $10,000, the digital currency is ten times its value at the start of the year and, whatever its devotees might tell you, that is unmistakably a bubble. It is a bigger and faster price surge than the Nasdaq before the dot.com bubble burst, the Nikkei before the collapse of Japan’s bubble economy or the gold price in the 2000s. It has something in common `with tulip mania in Holland between 1634 and 1637, but that too was a bubble waiting to burst.

Jamie Dimon, the J P Morgan chief executive, once described bitcoin as “worse than tulip bulbs”, while the economist Joseph Stiglitz has said it should be banned.

Could this time be different and this artificially-created currency be benefiting from a need for a safe haven from a troubled world? After all, the leader of the free world spends his time issuing deranged tweets, and his arch enemy, if that is not too Austin Powers, appears to have developed the capacity to fire missiles – though not yet with nuclear warheads – from North Korea to the whole of America.

The safe haven story does not really fit, however. Though there are risks, the world economy is enjoying its best sustained period of growth, spread across all regions, since the financial crisis. Other traditional safe havens such as gold, have not soared. The dollar is not strong. Stock markets, normally shunned in troubled times, are strong.

So the bitcoin surge appears to be specific to it and other cryptocurrencies, prompting warnings from the authorities to investors. Vitor Constancio, vice president of the European Central Bank, said it was “a speculative asset by definition” and that: “Investors are taking a risk by buying at such high prices.”

Jean Tirole, the Nobel prize-winning economist, wrote that “bitcoin is a pure bubble, an asset without intrinsic value”. And, while saying nobody could predict with certainty that it would crash, added: “I would not bet my savings on it, nor would I want regulated banks to gamble on its value.”

Bitcoin, however, is becoming more of a real currency by the day. A few days ago PricewaterhouseCoopers in Hong Kong said it has accepted payment in bitcoin for the first time for advisory services. Tens of thousands of other businesses accept it. The NME tells me that Bjork, the Icelandic star, encouraged fans to buy her latest album using bitcoin or other cryptocurrencies. A £17m property has gone on sale in London with the condition that the buyer must pay in bitcoin. The proportion of bitcoin transactions is tiny, but it is growing.

For central banks, this creates something of a dilemma. Sir Jon Cunliffe, the Bank deputy governor who offered reassurances on the impact of the bitcoin bubble bursting, said: “This is not a currency in the accepted sense. There’s no central bank that stands behind it. For me it’s much more like a commodity.”

The issue for central banks is whether they stand aside and allow privately-created cryptocurrencies to develop and claim a growing share of holdings and transactions, or whether they should issue digital currencies themselves. In other words, if they cannot beat the rise of bitcoin and its rivals, should the Bank of England and others join them?

Something is stirring on this front. A couple of days ago William Dudley, president and chief executive of the Federal Reserve Bank of New York, said: “I think at this point it’s really very premature to be talking about the Federal Reserve offering digital currencies, but it is something we are starting to think about.”

The Bank for International Settlements (BIS) in Basle, sometimes known as the central bankers’ bank, has also been thinking about it. In a report a few weeks ago it noted that several central banks are exploring cryptocurrencies and the distributed ledger technology that lies behind them. With cash use declining, and particularly sharply in countries such as Sweden, the idea of a central bank cryptocurrency would be as “an electronic version of central bank money that can be exchanged ina decentralised manner known as peer to peer …. without the need for a central intermediary”.

That will be an issue for central banks. One reason for the popularity of cryptocurrencies is their anonymity, which increases their appeal to criminals. But then cash is also anonymous, and central banks have issued that for centuries.

The BIS notes that the only way the public can hold central bank money at the moment is in cash. If they want to hold it in digital form they have to do so via a commercial bank. It sees the issue by central banks of digital currencies would also allow the public to have accounts at the central bank, something it suggests would be of benefit. But if it replaced commercial banks with a monolithic central banks it would not be.

Most central banks are not there yet. At the Bank, it is still a source of great interest and controversy when new physical banknotes are issued. The Bank is also investigating the possibility of issuing its own digital currencu and Victorias Cleland, its chief cashier, wrote an article on the subject in the summer. Cash is in long-term decline and digital currencies are on the rise.

As the BIS put it: “Whether or not a central bank should provide a digital alternative to cash is most pressing in countries, such as Sweden, where cash usage is rapidly declining. But all central banks may eventually have to decide whether issuing retail or wholesale central bank cryptocurrencies makes sense in their own context.”

Where technology is concerned, things move faster than we expect. Twenty years ago, as far as most of us were concerned, the interent and e-mail were curiosities. The first iPhone was only launched 10 years ago. Ten years from now, if not before, there is a very good chance that the Bank and other central banks will be issuing their own versions of bitcoin.

Sunday, November 26, 2017
Eeyore? We need reasons to be cheerful, amid the doom and gloom
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

It is five days since Philip Hammond’s budget and, though you should never disregard the dangers lurking beneath the surface, it remains intact. Sometimes budgets unravel quickly but sometimes it takes a little longer. This one looks as though it has some staying power.

Most of it has been well covered. There was a housing package of mixed merit, to which one can say without hesitation will not deliver 300,000 new homes a year. There was some essential sticking plaster, for the National Health Service – suggesting the government has given up on the hope of big productivity and efficiency gains – and for as yet unspecified Brexit preparations and for universal credit.

Hammond will go down as the chancellor who, against the traditions of the election cycle, loosened policy after a general election, even though there was no real room to do so, a reflection of the government’s very weak position.

Even so, his was a serious-minded budget from a grown-up politician, which should help the government. If it followed by an agreement at the EU summit on December 14-15 that “sufficient progress” has been made to move on to trade, Theresa May’s government will end the year on a stronger position than it dared hope a few weeks ago, when cabinet ministers were falling like ninepins. A government that is stable, if not strong, will help business and consumer confidence.

The chancellor borrowed more yet was able to point to a faster fall in public sector debt – relative to gross domestic product – than in March. That was partly because of the reclassification of housing associations to the private sector, which takes their debt off the government’s balance sheet, and partly the decision to raise £15bn by selling most of the government’s stake in Royal Bank of Scotland. Hammond is often regarded as a sober accountant-type but he and his officials are nothing if not creative.

What I wanted to focus on today, however, was the Office for Budget Responsibility (OBR) forecast underpinning the budget. In the old days chancellors would devise their policies and mould the forecast to fit with it. These days it is the other way around. Some would say it means the tail is wagging the dog, but it is the modern way.

In covering the economy over more years than I care to mention, even in the darkest days, I have always tried to look on the bright side. When, in the years after the crisis, many said all hope was lost if there was no change in policy, I held out the hope of recovery, which was eventually fulfilled.

Now, however, it is quite hard to do so. The strong growth the eventually started to emerge four years ago was depressingly short-lived. Just when it looked safe to go back into the water the sharks started circling again. This was meant to be a time of far stronger growth and healthy business investment, and a recovery in living standards.

Apart from the much-flagged productivity downgrade, but related to it, the OBR has come out with a disturbingly downbeat forecast. If it is right then, with the economy slowing to barely more than 1% a year from 2018 to 2020, the economy will barely be registering a pulse.

As Paul Johnson, director of the Institute for Fiscal Studies, out it: “The forecasts for productivity, earnings and economic growth make pretty grim reading. One should never forget of course that these are just forecasts. But they now suggest that GDP per capita will be 3.5% smaller in 2021 than forecast less than two years ago in March 2016. That’s a loss of £65 billion to the economy. Average earnings look like they will be nearly £1,400 a year lower than forecast back then, still below their 2008 level. We are in danger of losing not just one but getting on for two decades of earnings growth.”

Two questions arise from this. One is whether, as some suggest, the OBR has overdone the gloom. The other is whether, faced with such a gloomy outlook, the chancellor should have done more.

Forecasts are forecasts and nobody would be more surprised that Robert Chote, the OBR chairman, if these latest forecasts – the gloomiest in living memory – turn out to be right. But if the OBR has been at fault in recent years it has been to be too optimistic rather than too pessimistic about the economy. Its post-referendum forecast for growth this year, 1.4%, will turn out to be closer to the outcome than the upward revision to 2% it decided on in March. The latest forecast, for a year that is almost up, is 1.5%.

The ingredients for slower growth, feeble growth in real incomes constraining consumer spending and uncertainties holding back business investment, are in place. The OBR is rightly cautious about a sustained export boom.

There is also the fact that slap bang in the middle of the forecast period is an important fork in the road. In one direction there is a chaotic, no-deal Brexit, which the trade credit insurance provider Euler Hermes predicts would lead to outright recession in Britain. On the other is a smooth transition to a good Brexit deal, under which the damage to the economy would be minimised.

For forecasters, this is classic territory in which you hope for a good outcome but have to allow for the risks of a bad one, and in which the risks are skewed to the downside. This is not an environment in which any forecast would want to be stuck with a prediction of strong and untroubled growth.

Should Hammond, faced with such a subdued outlook, have done more to boost the economy? As with the Bank of England, the Treasury view appears to have been that, while the budget provided targeted help, and added up to a £25bn fiscal relaxation over five years, the government could never fully offset the negative impact on growth and living standards of the Brexit process.

Indeed, to have thrown much more money at it, at this stage, would both have smacked of panic and suggested a chancellor and a government prepared to drop its fiscal targets at the sound of gunfire. The balance was about right.

The fundamental challenge remains, which is that of reviving Britain’s supply-side. As the Treasury put it in the budget “red book” on raising productivity: “Evidence suggest the UK should prioritise upgrading infrastructure, improving skills, helping businesses to invest and improving the housing and planning systems.”

It claims that the budget measures were “a significant step” towards improving productivity, “in order to boost wages and enhance people’s living standards”. There were some moderately useful measures. Many more steps will, however, be needed. This is one for the long haul.

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


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

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

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

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

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

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

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

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

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

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

But there are two questions to address about the prospect of faster growth in pay. The first is: is it real, or another in the series of false dawns since 2010? The second, is it healthy?

On the first, a note of caution is justified. The Bank’s regional agents have been reporting a pay settlement norm of 2% to 3% for some time. The fact that this has been associated with average earnings increases of around 2% can be put down, as the Bank does, to compositional changes, in other words a rise in the proportion of lower paid jobs.

This, according to the Bank, reduces earnings growth by 0.75 percentage points. So, even if the agents’ intelligence is right, it may only convert to average earnings growth, as reported by the Office for National Statistics, of about 2.5%. Though inflation is expected to fall next year, it will not on this basis do so by enough to deliver any meaningful rise in real wages.

Another reason for caution is the outlook. The European Commission has just released a gloomy set of forecasts for growth in Britain, to which the response might be: they would say that wouldn’t they? But other forecasts also point to slower growth in Britain, despite a stronger global economy.

Britain’s labour market has been a great success, a minor if not a major miracle, as I wrote a few weeks ago. But slower growth will take its toll and the assumption that we are looking at a future of ever lower unemployment may be tested.

The increase in employment over the latest 12 months, to June-August, was about half that of the previous 12 months. And, while traditional full-time employment had been driving the growth in jobs, in the latest three months it was dominated by an increase in part-time self-employment. You write off Britain’s job market at your peril, but one or two signs of softening are emerging.

The second question is that, if it is happening, is an acceleration in pay a good thing? For those in receipt of it, and for the government, it would be. But, as far as productivity is concerned, higher pay looks to be putting the cart before the horse.

The same Bank agents’ survey that picked up rising pay pressures also found that businesses are quite downbeat on investment intentions, which point to “moderate” investment growth over the next 12 months and even weaker over the following two years. Investment is one of the keys to raising productivity.

There is an argument that only recruitment difficulties and pay pressures will force businesses to boost productivity but this is one of those chicken and egg questions. What comes first, higher pay or productivity? There is no doubt that, for business, higher pay funded out of productivity gains is infinitely preferable.

If higher pay is indeed starting to come through, it suggests that something rather old-fashioned is happening. A fall in the pound pushes up inflation and leads to pressure for higher pay, without a matching rise in productivity. The gains in competitiveness from the weaker pound are soon eroded. That has been the pattern in the past. If it is starting to happen again now, that definitely would not be good news.

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


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

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

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

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

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

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

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

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

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

I doubt if any budget could cure the Tory party’s ills, and the budget relaunch that was being talked about until recently would look risky for a government that is in danger of being holed below the waterline.

The difficulty for the chancellor is that the same bad news that drove the Bank’s decision to raise interest rates hangs over the budget, as Mark Carney, the Bank governor, came close to admitting. Economists at the Bank and at the Office for Budget Responsibility (OBR) share the same gloom about productivity. In the case of the budget, it means that the outlook for the public finances has worsened significantly.

The Institute for Fiscal Studies put flesh on this the other day. It looked at the chancellor’s options for easing the squeeze, for easing austerity, but it noted that Hammond is caught “between a rock and a hard place”.

It modelled scenarios for the budget deficit and government debt based on how big the downgrade is in the OBR’s productivity assumption. As the IFS put it: “Any substantial downgrade to productivity forecasts would easily dwarf the other factors affecting borrowing.” If the OBR assumes that productivity growth in future is in line with its average over the past seven years of just 0.4% a year for output per hour, what the IFS describes as a “very poor” outlook, the consequences for the public finances are pretty dreadful.

Instead of the budget deficit falling below £17bn by 2021-22, on its way to an eventual budget surplus by the mid-2020s, the budget deficit would rise to £70bn by the early part of the next decade, just as the demographic pressures for higher spending are kicking in.

Even on a slightly less scary “weak” productivity assumption, under which it grows by just over 1% a year, which is more likely, borrowing would be running at something like double the prediction the OBR made in March. This is the “bloodbath” for the public finances that has been doing the rounds in Whitehall. On the very poor scenario public sector debt stays above 90% of GDP. Under weak growth it falls, but only at a snail’s pace.

In a different era a chancellor under intense political pressure to deliver some popular measures in his budget would ignore the warnings from economists. Chancellors, famously, used to tear up forecasts and tell officials to come back with something better.

And the OBR, it should be said, has been too gloomy over public borrowing in the past couple of years; spectacularly so in its forecast a year ago for the budget deficit in 2016-17. Some Tories would like the forecasts to be ignored.

But Hammond cannot do that, without abandoning the framework established in 2010. The purpose of having a fiscal watchdog is that it barks occasionally. The government’s fiscal rules are looser than they used to be. They are to secure a return to budget balance as soon as possible in the next parliament and, in the meantime, reduce the structural or underlying deficit to less than 2% of GDP and have debt falling as a percentage of GDP by 2020-21.

Hammond has been telling his cabinet colleagues that he intends to stick to those rules, which when he set them did not look too onerous. He has rejected the idea, put forward by the communities secretary Sajid Javid, to borrow tens of billions more to fund a mass social housing programme.

He will no doubt avoid anything unpopular. Even the IFS has given up on the idea that the long and costly freeze on fuel duty will come to an end.

The question for Hammond is whether he uses some of the diminishing amount of elbow room he will be left after the OBR’s productivity downgrades to throw a few bones to his hungry colleagues. When the cost of Brexit is rising, measured in extra civil servants and lawyers, and when the outlook is deteriorating, the scope for anything but a few bits and pieces is limited. Don’t expect a bad news rate hike to be followed by a good news budget.

Weak productivity is doing what you would expect it do. adversely affecting monetary policy and blighting the public finances, while undermining living standards. Until the economy breaks out of it, there will be plenty more bad news to come.

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


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

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

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

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

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

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

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

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

That is not the case now. An unanswerable case for a rate rise would be a situation in which above-target inflation was expected to persist, alongside accelerating wage inflation and strong growth.

As things stand, only one of those three conditions is met. Inflation is 3% and set to move a little higher in the autumn. The Bank expects inflation to remain above the official 2% target until well into 2020, so that box can safely be ticked.

Admittedly it has “looked through” periods of above-target inflation before, and Mark Carney has laid the blame for this overshoot entirely on sterling’s Brexit slide. But this time the MPC majority appears unwilling to ignore a persistent target rmiss.

When it comes to wages, you have to look very hard to find any case for higher rates. Official figures show average earnings growth stuck at a little over 2%. A survey of employers a few days ago by the specialist consultancy XpertHR showed median pay awards of 2% are anticipated over the next 12 months.

This maintains a pay pattern that has been in place since January 2013. And, while formal pay awards are by no means the whole of the market these days, this suggests that very little is moving.

The quest for a wage case for higher rates takes us into the statistical detail. As I noted last week, the Bank thinks that the so-called compositional shift to lower paid jobs is depressing average earnings. It also thinks that with unemployment at a 42-year low of 4.3%, it can only be a matter of time before wage pressures build.

Not only that, but an error by the Office for National Statistics earlier this month highlighted the fact that unit labour costs in the second quarter were up by 2.4% on a year earlier. When productivity is so weak, even going backwards, it does not take much of a pay rise to produce a significant increase in unit labour costs. These are all good arguments about pay, though they are far from representing a slam dunk for higher rates.

Neither, it should be said, do the growth numbers. Until the Bank’s language changed in the summer, the assumption was that quarterly growth rates of 0.3% or 0.4%, well below normal, were just too weak to contemplate higher rates.

The construction industry has shrunk for the second quarter in a row, meeting the technical definition of recession. Consumers are being squeezed by falling real wages, the CBI saying on Thursday that retailers were suffering the biggest drop in sales since March 2009, and businesses are holding back on investment. Not only have the numbers this year been weak but the growth outlook is poor. Britain has entered the slow lane and appears to be stuck there.

Making the case for a rate rise on the back of this is not easy and, again, the MPC’s hawks have to dig a little deeper. This is the argument that, such has been the damage to the supply-side of the economy, and so weak had been the productivity performance, that the economy’s speed limit has been reduced.

The economy is growing at an annual rate of 1.5% and that, according to the Bank, is pretty much all it is capable of. Even at this year’s very modest growth rates it is bumping up against capacity, potentially keeping inflation high.

We are left with a reasonably clear argument for raising rates on inflation grounds, but much more tentative and harder to explain arguments on pay and growth. Communicating the rate rise, assuming it happens on Thursday, will be a challenge.

There are other arguments. A decade on from the start of the financial crisis, we are still at emergency levels of interest rates. The desire to begin the process of normalising policy, also seen with the Federal Reserve in America and the European Central Bank starting the tapering of is quantitative easing last Thursday, is a strong one among central banks. Prolonged near-zero interest rates have consequences, and many of those consequences, including an excessive build-up in debt, are adverse.

Communication will also be important on the future direction of rates. The Bank’s watchword will be limited and gradual, a slow pace of rate rises to a new norm of around 2%.

The case for starting that process this week is weaker than it might be. The ducks are far from all in a row and there have been better occasions to raise rates in recent years. But the Bank has to start somewhere. And I don’t think anybody could bear it if, having teased us with the prospect of higher rates once again, the Bank decides to pass up on the opportunity. So it should bite the bullet.

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


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

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

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

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

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

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

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

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

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

This is not, of course, the first time the problem of low skills and educational shortcomings in Britain has been identified. The Leitch Review, commissioned by Gordon Brown, was one in a series. Most governments have, at one time or another, tried to address the problem.

This one is applauded by the OECD for its efforts to boost vocational education, including the July 2016 plan to transform post-16 education, which included a streamlined set of 15 technical skills routes. The official aim is parity of esteem between academic and vocational education.

There have also been 2.5m apprenticeships begun since 2010, with 3m more planned by 2020, though the record on these so far has been more mixed than hoped. Some apprenticeship schemes are very good, others rather less so, Organisations, meanwhile, have grumbled loudly about the apprenticeship levy.

The government has also reformed school funding, somewhat controversially, with the intention of closing the gap between disadvantaged pupils and the rest. The OECD likes free schools, which it points out one of the highest performing groups of non-selective state schools.

Gaps in education, though, start at a very young age, as young as two. Children from disadvantaged families are eligible for free early education and childcare from two but take-up is less than it should be. And clearly, improvements that start in early childhood will take some time to feed through to adult skills and education levels.

So the problem persists. At every educational level, including those educated at university, basic skills levels among 16-34 year-olds are lower in Britain than the OECD advanced countries’ average. The proportion of 20-45 year-olds who have undertaken professional vocational education after leaving school is lower than pretty well anywhere else.

These things matter. There are still 790,000 “Neets” in the UK, young people aged 16-24 not in education, employment or training. They account for 11% of people in this age group and about 41% of them are actively looking for work.

The problem of Neets has been with us for some years, and so has the rise in the number of non-UK national employed in Britain, up from 928,000 to 3.56m over the past 20 years, split between 2.37m EU nationals and 1.2m from the rest of the world. Even at the current 42-year low unemployment rate of 4.3%. 1.44m people are officially estimated to be unemployed.

Should employers have done better and employed more people from the pool of unemployed UK nationals, including those Neets looking for work? Possibly, though there is a big difference in recruiting workers who are underqualified even for low-skilled jobs, compared with the norm for EU migrant workers, which is that they tend to be overqualified. There is also a question of attitude and reliability, which all the anecdotal evidence suggests is more of a problem for UK recruits.

I have quite a lot of sympathy with employers, who spend £45bn a year on skills, according to the CBI. They can be expected to recruit young people with the right attitude to work – 86% of employers say this is the most important factor – but they cannot be expected to nursemaid unenthusiastic applicants with very low literacy and numeracy skills, particularly when more able recruits are available. That is the job of the education system, and supportive parents, which too many children lack.

When I talk to business people about leaving the EU, the availability of workers is one of their biggest concerns. Theresa May has sought to reassure EU nationals already in Britain, though some have already voted with their feet and left.

The situation regarding future migrants, meanwhile, is up in the air. The needs of the economy look to be entirely incompatible with a net migration target in the tens and thousands.

In time, one would hope, Britain would be able to tackle her problem of low skills levels and poor education standards. It might, however, take a very long time.

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


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

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

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

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

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

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

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

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

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

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

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

High on the list of these was that problems in the banking system had prevented the normal process of creative destruction to work. The banks forgave weak businesses which in other circumstances might have failed, and failed to lend enough to new, dynamic, high-productivity firms.

Clearly, there was some truth in that. But, as the OBR again concedes: “The banking system is now much better capitalised and more robust than it was in the immediate aftermath of crisis, so this explanation no longer looks as relevant as it once did.”

That still leaves us with plenty of explanations. One, which I devoted a piece to here a few weeks ago, is that ultra-low interest rates have contributed to productivity weakness. The banks showed forgiveness and near-zero official rates made it easier for them to do so. Zombie firms have stalked the land, driving down productivity.

Sectoral shifts in the economy have also been important. I have yet to come across a business which says it is not making an effort to boost productivity and, in most cases, achieving gains. Yet if there has been a shift from higher to lower productivity activities, as there has been, it is perfectly possible for the majority of firms to be increasing productivity while the performance of the average stagnates.

The single most important explanation for the weakness of productivity, however, jumps out of the OBR report. 10 years on from the start of the financial crisis, business investment is just 5% above its pre-crisis peak. At this stage in the two previous recessions and recoveries, in the 1980s and 1990s, business investment was up by 63% and 30% respectively. This is an enormous contrast.

A couple of years ago Britain appeared to be on the brink of a significant upturn in business investment. Predicted annual growth rates of 8% or 10%, sustained for some time, were not unrealistic. Then came the referendum and, according to the Bank of England, the level of business investment by 2020 will be 20% lower as a result. We should also be concerned about Britain’s ability to attract inward investment in future.

The delayed investment upturn may mean we have to get used to weaker productivity than is healthy for a while yet. But we should not throw in the towel entirely on a productivity revival, and I would not expect the OBR to do so.
For one thing, we have a labour market that is tight, with an unemployment rate of just 4.3%, and a labour supply shock on the horizon. I do not buy the simplistic argument that EU migrants have enabled firms to employ rather than invest. In most cases a decision to employ also means a decision to invest, for example in new outlets.

But migration from the EU to Britain is already falling and, given the tightness of the labour market, we will soon facing the choice of raising productivity or not growing at all.

The shift in the mix of economic activity to lower-productivity sectors, made possible by a good supply of labour may also have run its course. It is hard to expand the number of coffee shops or sandwich bars when there is nobody to staff them. Meanwhile the latest figures for manufacturing, which had a good summer, is outgrowing services and generally has higher productivity. We may be seeing a shift back towards higher-productivity activities, or at least the start of it.

Above all, the idea of permanently stagnant productivity is too depressing to contemplate. Stagnant productivity means stagnant living standards. The OBR is right to adjust its projections in the light of productivity weakness. It would be wrong to give up the ghost entirely.

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


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

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

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

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

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

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

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

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

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

When businesses hear that the government is making contingency plans for a no deal outcome from the negotiations, they wince. Those that have looked at it in any detail also wince when they hear blustering Brexiteers blithely saying that Britain could happily manage on WTO (World Trade Organisation) rules.

Such talk misunderstands the nature of our trading relationship with the EU, and the degree to which the British economy is integrated within the EU economy. Many British businesses see their exports embodied as intermediate components of the EU’s exports, as Mark Carney pointed out in a recent speech, in a way that barely happens in the rest of the world. They are part of an EU supply chain.

British exports to the rest of the world travel long distances, taking a long time, by ship or plane. British exports and imports to the EU travel short distances, usually by lorry, and operate on tight schedules, because they are carrying components needed for just-in-time production, or perishable food products and other products where time is of the essence. Delay these movements and you have serious problems.

The Port of Dover used advertising space at the Tory conference to demonstrate that the 10,000 lorries it handles each day are cleared through the port in an average of two minutes. Extend that average time by just two minutes and there would be 17-mile queues on the English side of the Channel with something similar on the other side. Operation Stack, the occasional queues of lorries on the M20, would become a permanent feature, and worse. Without frictionless trade, there would be chaos, confusion and considerable economic damage.

We come back to a simple point. The single market has changed the nature of Britain’s economy, enabling the advantages of free trade, as well as economies of scale, to be more fully exploited. Withdrawing from it, as the Bank governor put it recently, is an example of “deglobalisation”, which comes at a time when the share of Britain’s exports taken by the EU is growing again. From a low of 46.6% in 2015, the share of UK goods exports destined for the EU was 48.4% in the first half of this year.

Given the recovery in EU economies, it may be heading back above 50%, though any rise will not survive leaving the single market. Smart detective work by Ed Conway, Sky’s economics editor, suggests the true share is already above 50%. Though Britain produces no gold, or at least no gold in significant quantities, gold exported from the London bullion market to Switzerland for processing counts as non-EU exports. The numbers are big enough to make a difference.

The big picture is that about half of Britain’s trade, taking exports and imports together, and on this basis also taking goods and services together, is with the EU, and slightly more with the European Economic Area, countries such as Norway and Iceland which are not in the EU but are in the single market. More than that, much of that trade is currently conducted with as little friction as if it were between Yorkshire and Lancashire. Whether post-EU frictionless trade is even possible remains to be seen.

In an article in the London Review of Books, London Schools of Economics’ economists Swati Dhingra and Nikhil Datta, both pour cold water on the prospect of quick and workable non-EU trade deals and point out how far they would have to go to come anywhere close to compensating for the potential loss of EU trade. China, for example, accounted for a mere 4% of Britain’s goods exports last year.

As they put it: “Countries have always traded the most with their biggest, closest neighbours. This is by far the most reliable fact about international trade and holds true no matter which set of countries, time period or sector (goods, services, e-commerce, foreign investments) is looked at. Given that the EU is within swimming distance from the UK, has a population of more than 500m and a GDP of almost $20 trillion (double that of China), an equivalent replacement is effectively impossible. EU standards on goods and labour are more acceptable to British people than those in the US, China and India.”

The view among the sensible people in government, amid growing realisation of the damage that failure to secure a comprehensive deal with the EU would do. It may be that this week will see a breakthrough in the talks that would allow both sides to move on to the future relationship, but it would be unwise to rely on it. There is fault on both sides but the EU recognises that the weakness of the government’s position is preventing it from moving the negotiations on from matters such as the divorce bill and EU citizens’ rights to more important matters.

As things stand, the best business can hope for is agreement on lengthy transition arrangements, during which very little changes. As to where Britain ends up in the long-term in its relationship with the EU, it is still not getting much of a clue.

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


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

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

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

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

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

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

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

That is not the only problem. A few days ago I attended a conference at Nottingham University with Sir Vince Cable, the Liberal Democrat leader, at which we both spoke.

He recounted his frustration at talking to young people about Labour’s economic policies, reminding them of the importance of fiscal discipline. He would tell them there was no magic money tree. They would insist there was and that he was stuck in the past.

In this respect quantitative easing (QE) has a lot to answer for. It is no magic money tree – the money created is matched by the assets purchased, mainly government bonds – but many people think it is.

Labour would borrow more, issuing apparent limitless quantities of government bonds (gilts) just to fund its part-compensation plans for its renationalisation programme and taking PFI (private finance initiative) contracts back into the public sector. Borrowing to spend more would come on top of this. With the public finances still in a shaky enough state to warrant a further downgrade of Britain’s sovereign debt rating a few days ago, this would be testing the appetite of investors for UK government debt to destruction.

There was a time when the trade unions lobbied the Labour leadership in vain on policy. Not any more. The unions’ cups runneth over. They are getting things from the current leadership they were not bold enough to ask for. And we should remember in all this that fewer than a quarter of employees, and fewer than a fifth of all workers, are union members.

Could it happen? There was a time when , faced with the risk of a lurch to the left, you would not expect Tories to be as ill-disciplined and stupid as to hand power on a plate to Labour. True, it happened before, in the 1992-97 parliament under John Major, when divided Tories made a Tony Blair landslide inevitable. Blair, of course, was no Corbyn and today’s Brexit-obsessed Tories are, if anything, even more ill-disciplined than they were two decades or so ago.

The important thing with Labour’s programme is not to assess the individual policies, troublesome though they are. Everybody can find things to criticise with individual PFI programmes, though there have been cost-savings and refinancing in recent years. Five years ago, the Treasury launched a revised version of PFI. Similarly, everybody can find things to criticise in the performance of some privatised industries.

But none of this should suggest a blanket and wasteful “taking back control” of PFI projects and wholesale renationalisation, even if ideology blinds you to the central logic behind all this; bringing private sector efficiency to the delivery of public projects and public services.

Even this, however, is not the real danger, Assuming that at some stage the stalled Brexit negotiations get started again, it is still the case that Britain will end up with a worse deal when it comes to doing business with the EU than we have now. Near-membership of the single market and a customs agreement can never be as good and frictionless as the real thing.

I do not blame the new, conciliatory Theresa May for this, though it has taken her time to come round to a sensible view on transition. I do blame those in her cabinet and party constantly snapping away at her ankles.

Brexit will make plenty of international businesses wonder whether Britain is still the best place to locate. Against the loss of single market and customs union membership, Britain can offer low corporate taxes, generally low personal taxes, and the most lightly-regulated economy in Europe.

Now replace that with a government that wants to put up corporate taxes, increase personal taxes, particularly for higher-earners and re-regulate the economy. Replace it with a government which wants to greatly extend the size of the state, taking industries back into public ownership without offering full compensation to shareholders.

As a business, would you want to invest in a post-Brexit Britain of this kind? As a business currently invested in Britain would you want to stay? The only thing flying in Britain would be a tattered red flag.

The combination of a messy Brexit and Labour’s economic agenda would be highly toxic. If it comes to pass, we will have a lot more than a run on the pound to worry about.

Sunday, September 24, 2017
It's been a woman's world in the job market
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

It would have been easy this week to focus on the latest projections from the Organisation for Co-operation and Development (OECD), which are for a slowing British economy at a time when the global economy is speeding up, something which does not normally happen.

And, while some will say you should never believe forecasts, the OECD is merely extrapolating what is already happening. The global economy is growing more rapidly this year while Britain has cooled, and you do not need to be Miss Marple, or perhaps more appropriately Hercule Poirot, to work out what is happening.

Or I could have focused on Friday evening's downgrade of Britain's sovereign debt rating by Moody's, taking the country even further away from the old AAA rating.

But, while mention of Brexit is guaranteed to send some people frothing at the mouth, which can be entertaining, the OECD forecast has been well covered. I sensed some glee behind the decision to splash it all over the front page of George Osborne’s Evening Standard, the London free newspaper. And government bond yields have not risen, despite the post-referendum ratings downgrades.

It was another aspect of the OECD’s new interim economic outlook, however, I wanted to focus on and it relates to the job market. This is the interesting fact that, across the industrialised world, the post-crisis recovery in jobs has been led by women.

For OECD countries as a whole, the male employment rate is still lower than it was in 2008, when the economic downturn as a result of the global financial crisis began to hit. The female employment rate, by contrast, is up sharply compared with the pre-crisis peak. The OECD’s index of its members’ employment rates is up by around 5% for women, while down by 1% among men.

Male employment has been recovering from its post-crisis lows. But it was harder hit by the crisis and has not got back to where it was. Female employment, in contrast, suffered a smaller hit in the crisis and has enjoyed a stronger recovery.

The picture in Britain follows a similar pattern though with some differences. Both male and female employment rates are above pre-downturn peaks, though the rise in the female employment rate – up from 67.1% in March-May 2008 to 70.8% now, has been bigger than the rise in the male rate, which is up from 79% to 79.8%. As far as jobs are concerned it has been a woman’s world.

I have been aware of the faster rise in female employment in recent years for some time. One special factor has been the move to equalise the state pension ages of men and women, a process that has increased the proportion of women in the 50-64 age group in work. As the Office for National Statistics notes, the changes mean that fewer women are retiring between the ages of 60 and 65,

But the narrowing of the gap between male and female employment rates is part of a long-term trend. In 1971, the starting point for Britain’s Labour Force Survey, the male employment rate was 92.1% and the female rate just 52.7%, a gap of nearly 40 percentage points. Now, the gap is down to just nine percentage points, and closing. While the female employment rate has never been higher than now, a male employment rates of just under 80% would once have bene regarded as quite low.

There are long-term trends at work here. That and the fact that as the OECD points out, what is happening is international in nature, suggests this goes well beyond changes in pension age.

Government policy has made a difference, both over the decades of rising female employment and more recently. Improved childcare arrangements and assistance and enhanced parental leave have had an impact, and not just in Britain.

In the mid-1990s Japan had a lower female employment rate than most other countries. Now it is in the centre of the pack thanks to targeted policy and campaigns aimed at increasing the proportion of women in work. The initiatives included additional allowances for new partners, subsidised nursery care and allowing parental leave to be shared between mothers and fathers.

The relative success of women in the workforce is also explained by the shifting patterns of employment and output in the economy. Manufacturing and construction are, despite the efforts of firms in these sectors, male-dominated.

Manufacturing and construction are, moreover, the laggards when it comes to both output and jobs. Employment in these sectors is down on pre-crisis levels, as is output. Employment in more female-friendly service industries, on the other hand, is about 2m above pre-crisis levels in Britain and output in this, the dominant sector of the economy, is also significantly higher than it was.

This, while creating opportunities, also creates challenges. In some of Britain’s old mining and manufacturing areas the absence of traditional male jobs has led to decades-long blight.

The service sector is also more likely to be associated with flexible working arrangements. Part-time employment is still relatively unusual among men; only 13% of men in work are part-timers. It is much more common among women, where 42% are part-time workers.

This relative shift towards female employment – since the crisis the proportion of women in employment has risen from 46% to 47% - is welcome. But it may have another consequence, which can be added to the explanations of why the growth in wages has been so weak in recent years.

"Employment rates for women have grown faster and are above where they were in 2008, but employment rates for men have not even gotten back to where they were,” said Catherine Mann, the OECD’s chief economist, said in an interview with the BBC World Service after the publication of its interim outlook.

“That [must be seen] in conjunction with what we know about women's wages - that women are paid less than men. You've got more women employed, as compared to men, so the algebra works out to be a downward pressure on wage growth.”

Compositional changes – shifts in employment between sectors and high and low-skilled jobs - have been an important factor in the weakness of wages in recent years, alongside poor productivity, a weak bargaining position for employees and an acceptance by many workers of 2% pay rises as the going rate. In an ideal world of pay equality between the sexes, this particular compositional change would not matter. In the real world unfortunately it does.

Sunday, September 17, 2017
The Bank can't afford to cry wolf on rates again
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

A Rip Van Winkle who went to sleep 20 years ago and woke up around midday last Thursday, when the Bank of England made its latest interest rate announcement, would be more than a little bemused. The level of official interest rates – 0.25% - the lowest in the Bank’s history would be a source of amazement; 20 years ago the rate was 7%.

So, and only slightly less so, would be the excitement generated by the Bank’s broad hints that at some stage in the coming months interest rates might rise from this extremely low level. Veterans of monetary policy remember the days when rates went up, without warning, by large amounts.

Even leaving aside special episodes like Black Wednesday in September 1992, discussed here last week, I can remember months like January 1985, when we saw two rate rises of two percentage points each, within the space of a couple of weeks.

That was in response to a very weak pound. Our very weak pound now got a boost from the more hawkish talk from the Bank on Thursday and, in particular, the phrase in its minutes that “a majority of MPC (monetary policy committee) members” think that if the economy continues on its current path “some withdrawal of monetary stimulus is likely to be appropriate over the coming months”.

It was given a further boost on Friday from hawkish comments by the MPC member Gertjan Vlieghe, previously thought to be the committee's arch dove.

Some withdrawal of monetary stimulus, to translate from Bankspeak, means in the first instance a rise in interest rates, and it has been a long time since that happened; more than 10 years.

Nor should this “hawkish” message been much of a surprise. It was implied by the Bank’s inflation report last month. It has been given added urgency by the jump in inflation to 2.9% last month, with Bank economists expecting it to exceed 3% in October.

The strength of the labour market, with the employment rate hitting a record high of 75.3% in May-July and the unemployment rate dropping to 4.3%, its lowest since 1975, has pushed the economy closer to capacity.

There are three other things to know about the Bank’s approach, and its “hawkish” hints of a rate rise on the short-term horizon. The first is that while it was prepared to used monetary policy – last August’s rate cut to 0.25%, the extension of quantitative easing and the launch of the term funding scheme to cushion the shock of the Brexit vote, it cannot prevent the long-term damage from Brexit.

As it put it on Thursday: “Monetary policy cannot prevent either the necessary real adjustment as the United Kingdom moves towards its new international trading arrangements or the weaker real income growth that is likely to accompany that adjustment over the next few years.” So, while a renewed downward lurch for the economy as a result pf Brexit uncertainty would change its plans, it cannot be expected to leave rates on hold for the years it will take for the Brexit dust to have settled.

The second important factor is that it does not take much growth these days before the economy bumps up against the Bank’s speed limits. Brexit and other factors have damaged the economy’s supply-side, to that potential or “trend” growth is only about 1.5% a year. Growth of 0.25% a quarter, the average for the first half of the year, is below that potential but only a small rise would take it above it. The economy, in other words, does not have to be racing away to justify higher interest rates.

The third point related to wages, a key factor. After Wednesday’s official figures showed average earnings growth at just 2,1%, weaker than expected, some in the markets decided that rate hikes were off the agenda. They were mistaken.

The Bank thinks that the underlying growth in pay is stronger than the figures suggest. Official statisticians point to so-called “compositional” effects in the job market; the mix of skills, sectors (some pay a lot less than others) and occupations. Adjusting for changes in these, Bank staff think the underlying growth in pay is nearer to 3% than 2%; these effects depressing earnings growth by 0.7 percentage points.

Bank economists have also gradually discovered, in their quest to find the “equilibrium” rate of unemployment – below which wages start to accelerate – that something fundamental has changed. The search for that equilibrium goes back some years. When Mark Carney became governor in the summer of 2013 and famously launched his forward guidance on interest rates, it was to say that the MPC would not consider a rate hike until the unemployment rate dropped below 7%. It did, quite quickly, but the Bank gave scant consideration to hiking rates.

Then estimates of the equilibrium rate dropped to 5%, then 4.5%. Now, even with an unemployment rate of 4.3%, wages are not accelerating. Why isn’t falling unemployment pushing up wages at a faster rate? The answer, which is implicit in the Bank’s unemployment analysis, is the crucial new factor is productivity.

If productivity is weak, as it is, employers will not give bigger pay rises even in a tight labour market. They have to be justified by higher productivity; output per worker. Looking for the inflationary impulse from wages could be the modern equivalent of Goodhart’s law, invented by the economist and former MPC member Charles Goodhart. This, which emerged during the 1980s’ monetarist era, was that any measure targeted by the authorities automatically became distorted. The same may now apply to wages.

So what happens now, and what should happen? Mention of forward guidance is a reminder that we have been sold a pup by the Bank on interest rate warnings before. The governor followed his 2013 guidance with a mid-2014 warning that rates could rise sooner rather than later. A year later, in July 2015, Carney travelled up to Lincoln Cathedral to deliver a speech warning that a decision on rates would move “into sharper focus” at the end of the year. Though in the run-up to June 2016 the Bank did not warn explicitly of rate hike in response to the weaker pound that would follow a Brexit vote, merely saying it would present a trade-off, others including the then chancellor did.

That is why the latest warning is being taken by some with a pinch of salt. Thrice-bitten, twice-shy is not a proverb but in this context it probably should be.
It is why, for the sake of its own credibility, the Bank has to follow through this time. Of course things can change, and that would be understood. The initial move on rates would be to reverse last summer’s emergency rate cut and then stake stock before embarking of further modest and gradual rises.

But doing nothing after another signal that higher rates are on the way would be a mistake. The Bank cannot afford to cry wolf again.

Sunday, September 10, 2017
Lessons from the first Brexit for Britain's EU departure
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

The Brexit process is proving slower and more difficult than even I expected. Fifteen months after the vote, and with a failed election gamble in between, we have barely got to first base. David Davis, the Brexit secretary told the House of Commons last week that nobody said it would be easy, though he and plenty of other Brexiteers suggested it would be.

The process has made some yearn for what is sometimes called the first Brexit, Britain’s abrupt departure from the European exchange rate mechanism (ERM), 25 years ago this Saturday.

I shall provide a reminder about what the ERM was – and an introduction for younger readers – in a moment. But in that episode, Brexit occurred in a matter of hours, not years. It happened in spite of government policy, which was to stay in, rather than because of it. It marked, if not the start, then the impetus for the longest period of continuous economic growth in Britain’s history, and one of the strongest.

It also, according to a new book from OMFIF (the Official Monetary and Financial Institutions Forum), one in a series of “great British financial disasters”, set Britain on a course of greater Euroscepticism, for which the bigger Brexit we have now embarked upon was a natural consequence.

By the by, it destroyed the Conservative party’s reputation for economic competence, a blow from which the Tories took “nearly 20 years to recover”, according to John Nugee, former manager of reserves at the Bank of England, observes in an introduction.

The book, Six Days In September: Black Wednesday, Brexit and the Making of Europe, by William Keegan, David Marsh and Richard Roberts, has the virtue of having spoken to the main players, either now or at the time, and uses material released from the archives.

Before coming on to what that first Brexit might mean for this Brexit, and for the outlook for sterling and the economy, as promised a brief recap.

The ERM, an attempt to bring currency stability to Europe after the turbulence of the 1970s, was part of the European Monetary System, established in 1979. Member currencies were allowed to fluctuate in either narrow bands (2.25% either side of agreed central rates), or broad ones (6% either side). Exchange rates could and did adjust, in regular realignments, usually to allow the deutschmark to rise.

As was common in EU initiatives, Britain did not join at the outset, leaving it until October 1990, by which time much blood had been spilt in the Tory party. John Major, then chancellor, persuaded a sceptical Margaret Thatcher, not least by pointing to ERM membership as a way to get Britain’s sky-high interest rates, then at a 15% level which were destroying home owners and small businesses.

Entry was messy, as the book recounts. I remember being summoned to the Treasury in the late afternoon of Friday October 5 1990 to be handed a statement, the first line of which was to announce an interest rate cut from 15% to 14%. The much bigger announcement, that Britain would be in the ERM the following Monday, was accorded second place.

It was messy in another way. Britain’s economy had entered recession a few months earlier, as a consequence of those high interest rates, though that was yet to be acknowledged within government. The German economy, meanwhile, was embarking on its post-unification boom. And a booming German economy could, as students of the Federal Republic’s inflation aversion were aware, only mean higher German interest rates. This, Keegan, Marsh and Roberts reveal, was not taken into account by British officials.

Britain struggled in the ERM for 23 months, with the government insisting it could make its attempt to put Britain at the heart of Europe work. Interest rates were brought down to 10%, and inflation fell sharply. But Britain’s weak economy needed rates of well below 10% and that could not be achieved unless Germany’s powerful Bundesbank reduced its interest rates.

Events came to a head in mid-September, as they often do (think of the Lehman Brothers collapse on September 15 2008). On September 15 1992 Helmut Schlesinger, head of the Bundesbank, gave an interview warning of the ERM’s vulnerabilities. It was seized upon by George Soros, the hedge fund titan, and others, to launch a wave of selling of sterling the following day. Interest rates were raised to 12%, with a promise of 15% the following day (which was never enacted) and the Bank expended all its foreign exchange reserves trying to prop up the pound. It was all in vain. Sterling crashed out of the ERM, never to return.

Schlesinger apologises for his part in sterling’s downfall in the book, which is unusual. But the writing was on the wall. Modesty almost prevents me from mentioning a piece I wrote on the Sunday before Black Wednesday, quoted in the book, which said that if the Treasury was waiting for a German interest rate cut to relieve the pressure on the pound it was whistling in the wind.

Are there lessons from that first Brexit for this one? Liberation from the ERM and departure from the EU are very different animals. I used to think that Britain’s post-ERM success was mainly about a rare devaluation that worked. Now, the evidence is that it was mainly that exit provided an opportunity to cut interest rates from an inappropriately high level and to do so very quickly. Rates were cut by four percentage points in four months. No such monetary stimulus is possible now.

Not only that, but it helps hugely to have a successful alternative policy framework. Within weeks of Black Wednesday, and from a standing start, the government had adopted an inflation target and given the Bank the enhanced role that paved the way for independence in 1997. That new framework not only benefited the economy but also pushed up the pound. By the end of the 1990s, and the dawn of the euro, sterling was above the level s against the deutschmark that were regarded as too high in 1990-92. Bank independence transformed international attitudes to UK economic policy. No such game-changer is in sight now.

As noted, that first Brexit proved toxic for the Tories, even as the recovery resulting from it came through. History could repeat itself, particularly with Theresa May once more being pushed by some of her hardline backbenchers towards a no deal, no divorce bill, cliff-edge departure. This would, according to The UK in a Changing Europe, an independent research body, have “widespread, damaging and pervasive” effects. And the Tories would deserve their punishment.

Sunday, August 13, 2017
Job done: How we got down to work after the crisis
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

It is time to give credit where it is deservedly due. I am referring to something that, without which, recent years would have been infinitely more difficult than they have been. The old adage, that it is a recession when your neighbour loses their job, a depression when you lose yours, has not been played out anywhere near as much as was feared. Britain’s job market has changed, and not always for the better, but it has done what it does best, which is to generate employment.

A few days ago the Recruitment and Employment Confederation (REC) reported that permanent staff placements had reached their highest level for 27 months, with overall staff demand at its strongest for nearly two years. Its survey, based on responses from recruitment agencies, pointed to continued buoyancy in employment.

That chimes with official figures showing that in the March-May period of this year total employment rose above 32m for the first time, with the proportion of 16-64 year-olds in work reaching 74.9%. This was the highest since comparable records began in 1971.

Before looking in a little more detail at what is happening now, let me first track back to the time when we first realised that the job market was behaving differently. When the financial crisis hit a decade ago, it took a while before the economy succumbed to recession.

The last hurrah for the great expansion that began in the very early 1990s was the first quarter of 2008, after which the economy dived into its deepest recession in the post-war era. Current data how that by the time the economy troughed in mid-2009, it had shrunk by 6.3%.

Previous experience might have suggested that employment would have fallen by at least as much. It did not. From an employment peak of 29.75m in March-May 2008, it dropped to a low point of 29.01m in January-March 2010.

The fall in employment in that deep recession, of 2.5%, was remarkable for how small it was. The experience of the great recession of 2008-9 stood in sharp contrast to its much milder predecessor in the early 1990s. In the 1990-1 recession, the economy contracted by just 2%, though it seemed worse at the time. It certainly was worse in terms of employment, which dropped by a hefty 6.2%. In this tale of two recessions, the later one was a mirror image of the earlier downturn.

So it has continued. After the great recession, it was widely expected that, having hoarded workers during the downturn, employers would be slow to hire during the upturn. Critics of coalition policy, including the Labour party, said that austerity cuts in public sector employment would not be replaced by an increase in private sector jobs.

Both views were wrong. Though employment growth was initially subdued, with a significant concentration of part-time work, it picked up and shifted decisively towards full-time jobs.

As for replacing those lost government jobs, public sector employment has fallen by just over 1m since 2009, with the bulk of the drop concentrated in local government. Overall employment, meanwhile, has risen by 3m. The private sector has not only replaced those lost public sector jobs but it has done so four times over.

Why has the labour market done so well? The flexibility established in the 1980s has come good, albeit with a lag, in recent years. Part of that flexibility has been reflected in the weakness of wages. No central planner could have done what Britons collectively did off their own bat when the crisis hit, which was to price themselves into jobs.

Monetary policy has also helped deliver more employment, both since the financial crisis and since last year’s EU referendum. Andy Haldane, the Bank of England’s chief economist, recently suggested that higher rates could have delivered slightly higher productivity but at the expense of around 1.5m jobs.

What about the current situation? Forecasters were wrong to assume that Brexit would result in an immediate rise in unemployment; the experience of the crisis and recession showed a far more resilient labour market than that.

Employment growth has slowed a little – in the past 12 months it has risen by 324,000 compared with 636,000 in the previous 12 months – but it remains healthy. The Bank predicts that the unemployment rate will remain at around its current 40-year low of 4.5% over the next three years. You should never say never but the prospect of a return to the double-figure unemployment rates we saw as recently as the 1990s seems remote.

The question is whether there is scope for employment to rise much further. One of the sources of Britain’s labour market flexibility in recent years has been the availability of EU migrant workers. They have not prevent employment among UK nationals rising to record levels but they have provided a key source of labour supply.

That supply has itself been flexible. It is not generally known but, after EU enlargement in 2004, net migration into Britain rose sharply until the crisis hit, but then did not get back to its 2007 level until 2014. It was responsive to the state of Britain’s labour market.

Now, net migration from the EU is falling again, to 133,000 last year from 184,000 in 2015 (new figures will be released on August 24). Employment among EU nationals continues to rise, up 171,000 over the latest 12 months, but this was slower than the 226,000 rise of the previous 12 months. And there has been a shift in recent months towards EU nationals from Romania and Bulgaria and away from those of from the EU’s Western European member states; traditionally the higher-skilled, higher-earning EU workers.

The REC’s Report on Jobs, referred to earlier, found that alongside strong demand for staff, availability is falling. Some employers are responding by offering higher pay, many others are struggling to recruit. Kevin Green, the REC’s chief executive, says parts of the economy most dependent on EU workers are under the greatest pressure. This comes, of course, before Brexit, though at a time when the weak pound has made working in Britain less attractive for EU workers.

When it comes to the labour market people will complain, sometimes but not always with justification, about insecure jobs, zero hours contracts and exploitative “gig” economy arrangements. These things would, however, be a lot worse in the context of a weaker job market in which opportunities were far harder to come by.

Britain’s labour market has been a success story, which has saved us from much worse fates. Let us hope nothing scuppers that success.

Sunday, August 06, 2017
A spanner in the works for Britain's growth potential
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

This has been like one of those moments when you get somebody to look under the bonnet of your car because it has been making a strange noise and seems incapable of maintaining any sort of speed.

The mechanic takes a look and emerges with a shake of the head. Some serious damage has been done and it is going to be hard to fix. Better find some alternative arrangements.

In the case of the economy, the man with the oily rag is Mark Carney, the Bank of England governor, assisted by his colleagues on the monetary policy committee (MPC), and the bad news he delivered was in the Bank’s latest inflation report.

Let me make clear what I mean by the bad news. It was not the downgrading of the Bank’s growth forecast for this year than next, which recent weak data made inevitable. It was not the fact that Brexit uncertainty is undermining investment by making businesses unwilling to commit. Anybody with half an eye on the economy knew that too.

They also know, to take one of the Bank’s other points, that the Brexit fall in the pound is the main mechanism for the current squeeze on household real incomes, which is hitting consumer spending and thus the growth in demand.

No, the really bad news in the Bank’s report was its assessment of what is known as potential, or trend, growth in the economy. Last week I addressed the question of weak growth from the demand side: can stronger exports and investment compensate for weaker growth in consumer spending?

The Bank’s point was a related but different one. The economy’s potential growth derives from the supply side. How fast is the economy capable of growing before its speed limit is reached, before inflationary pressures return?

The answer, according to the Bank, is a lot slower than it used to be. Even very modest growth of 1.7% or 1.8% a year will be above the economy’s “reduced potential rate”, it says. The crunch will not come immediately, but it will happen in a year or so.

Hence the Bank’s St Augustine message on interest rates; “Lord make me pure but not yet”. Two members of the MPC . Michael Saunders and Ian McCafferty, think the purity should start now, and rates should be going up. The others will give it a little while longer but were still happy to sign up to the Bank’s message to the markets, that in time rates will rise by more than they think.

Let me focus on that gloomy view of potential growth. The Bank thinks the economy is capable of perhaps only about 1.5% a year. I can remember a time when we snootily used that kind of number as representing all that the sclerotic eurozone, which now has a bit of a spring in its step, was capable of.

To put it in context, just over 10 years ago, the Treasury’s estimate for trend growth was 2.75% a year, and the “cautious” assumption for the public finances was for growth of 2.5% a year. Some Treasury officials thought that the numbers could even support a trend growth estimate of 3% a year. The economy’s potential growth rate, it seems, has roughly halved, or at the very least come down by a percentage point or so.

If you want to know what that means in practical terms, contrast two versions of trend growth, the Bank’s reduced estimate and the Treasury’s old cautious assumption of 2.5% a year. An economy capable of growing by 2.5% a year is by 2030 about 15% larger than one that grows by 1.5% a year.

There are two components to this trend growth gloom. The most important is the most familiar: the failure of the economy to generate normal, or even any productivity growth, alongside continued weak investment. It remains a problem. The level of productivity, output per hour, is lower than at the end of 2007 and has weakened this year.

The other component is population, or more relevantly, labour force growth. The Bank is still using the Office for National Statistics’ assumption of net migration into Britain of 185,000 a year between now and 2039. No official body expects net migration to be reduced to the tens of thousands, the prime minister’s target. If the Bank did, it would reduce its estimate of potential growth further.

Not all the gloom about the supply side is due to Brexit, though to return to my car analogy, that clanking sound you hear is the giant spanner that it threw into the works.

To improve productivity and the economy’s productive potential you need investment and, as the Bank noted, it now expects cumulative business investment growth to be 20 percentage points lower at the end of the decade than it did in May last year.

What else do you need to boost productivity and thus trend growth? The answers are familiar, if delivering them is easier said than done. Philip Hammond has said that if every region of the UK could match the productivity performance of London and the south-east then there would not be a productivity problem, and the London School of Economics, which published its latest Growth Commission update a few weeks ago, is doing some good work on this.

Sir Charlie Mayfield, chairman of John Lewis and head of the government-backed Productivity Leadership Group, rightly says that if the productivity performance of the weakest firms in each sector could be brought up to that of the strongest, there would be a step change in Britain’s performance. Its Be The Business initiative encourages firms to assess their own productivity performance and take steps to improve it.

We know too from successive reports commissioned by many governments over the years, that education, skills and infrastructure are the key to ensuring that individuals, and the economy, achieve their potential. The trouble is that they take time, and rather a lot of it.

They also require a lot of attention. In 1997, when Gordon Brown gave the Bank independence, it was so the Treasury could become an economics ministry, concentrating specifically on improving the economy’s supply-side performance. That was in an era when Britain achieved productivity growth we would give our eye teeth for now.

In the 1980s, under Margaret Thatcher, Britain had a productivity miracle of sorts, particularly in manufacturing. That followed a relentless focus on the supply-side through extensive labour market reform, corporate tax changes which promoted investment and personal tax changes which restored incentives.

Things are different now. As was entirely predictable, Brexit has become all-enveloping for the government and for those businesses most exposed to it. The Treasury is fighting hard its corner hard in its efforts to limit the damage. The government is struggling to get out a consistent message. Thank heavens Theresa May does not tweet.

In the meantime, there is drift, and the economy’s potential is drifting lower. And that is not good news for anybody.

Sunday, July 30, 2017
Britain's big challenge is getting out of the slow lane
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

So it has come to pass that Britain’s economy has experienced its weakest first half for five years, having undergone what the Office for National Statistics describes as a ~notable~ slowdown in growth this year.

Notable, and predictable. Slower growth has been staring us in the face since sterling’s referendum plunge guaranteed a squeeze on household real incomes and a cloud of renewed uncertainty descended on business.

Gross domestic product growth of 0.2% in the first quarter and 0.3% in the second represents a halving of the post-crisis trend, and averages barely a third of what was being achieved in the years leading up the crisis. GDP per head, which showed no growth in the first quarter and 0.1% in the second, is now stagnating.

The economy defied gravity for a while, thanks to the willingness of consumers to borrow and to run down their savings. There are still elements of that unsustainability even in the slower growth that Britain is now experiencing; the economy’s weak growth was bolstered by a rebound in retail sales in the second quarter.

Consumer confidence is falling. The latest closely-watched GfK consumer confidence barometer shows a further fall for this month to -12, taking it back to levels last seen in the immediate aftermath of last year’s referendum. Households are gloomy about the economic outlook. The brightest spot for consumers remains the strength of employment.

Despite this, the appetite for consumer credit remains very strong, according to the latest financial activity barometer from John Gilbert Financial Research, which will worry the Bank of England. This barometer, based on additional questions in the GfK survey, suggests falling savings and increased borrowings have become the norms for British households. The CBI’s distributive trades survey, suggesting warm weather kept sales strong into the first half of this month, also suggested that consumers are not quite dead yet.

But, by definition, something that is unsustainable cannot continue for long. Oxford Economics’ spending power index points to a “very subdued” outlook for consumer spending this year and next. Colin Ellis of Moody’s Investors Service predicts a “prolonged moderation” of consumer spending.

We come back to some basic questions for Britain’s economy. Where will the growth come from? And can we avoid getting stuck in the slow lane?

Before coming on to those, let me deal with a couple of puzzles. The first is the contrast between upbeat surveys of manufacturing and downbeat official data, which showed a 0.5% drop in the second quarter. The CBI’s industrial trends survey said that output in the three months to July grew at its fastest pace since 1995 and that order books, while slightly down, remained robust.

It is a challenge translating survey data into hard numbers. When firms say they are producing more than in the previous three months, in surveys they usually do not say by how much. In numerical terms, the idea that we are currently seeing the strongest output in more than 20 years, admittedly from a smaller manufacturing sector, does not stack up.

The hard evidence we have, from one of the bright spots of British manufacturing, leans towards the official data. Car manufacturing dropped sharply in June, by nearly 14% on a year earlier, and in the first half of the year was down by 2.9% on a year earlier.

The other puzzle is that something that does not normally happen, weaker growth in Britain at a time of stronger global growth, is indeed occurring. The International Monetary Fund, in its latest update, maintained its global upturn forecast of 3.5% growth this year and 3.6% next, despite downgrading both Britain and America. Stronger growth in the EU and in emerging economies has been the compensating factor.

The downgrade for Britain mainly reflected the growth disappointment so far this year. The downgrade for America reflected the fact that the much-trumpeted Trump stimulus - $1 trillion of infrastructure spending and big personal and corporate tax cuts – has not been forthcoming, and may not be.

The strengthening global economy is one of the ways in which Britain can avoid staying in the economic slow lane indefinitely. The record of sterling devaluations in delivering sustained, export-led growth is, it should be said, very poor.

What matters for growth, of course, is the difference between exports and imports. If indeed we are to see subdued growth in consumer spending, which seems highly likely, then that should be associated with a slowdown in the growth of imports.

Exports do not, in other words, have to race away to contribute to economic growth at a time when import growth is subsiding. A bigger contribution to growth from net exports is one of the factors that has been driving the hawks on the Bank of England’s monetary policy committee (MPC) to push for a hike in interest rates, the other factor being that they expect business investment to hold up better than feared.

I don’t expect the hawks, who were three in number last time the MPC voted on rates, to swing the argument for a rate hike this week. One of them has left the committee and weak second quarter growth should have persuaded other MPC members to stay their hands, though it promises to be an interesting meeting. Soon the Treasury’s chief economic adviser Sir Dave Ramsden will be joining the MPC as one of the Bank’s deputy governors, though not in time for this week’s meeting.

The hawks’ argument, that we are seeing a forced rebalancing of the economy thanks to the lower pound and the squeeze on consumers, is perhaps the best hope for the economy.

It is also, however, asking rather a lot. Periods of strong export and investment-led growth are rare in Britain. When the consumer is subdued so, in general, is the economy. A stronger global economy will help keep Britain to keep growing, but that growth may not be very strong. Maybe the best hope, unsustainable though it would be, would be for consumers to continue to binge on credit.

The certainty that business is crying out for, meanwhile, is not there. Even Philip Hammond says he cannot promise transitional arrangements for leaving the EU. Nor can he, for they are not within his gift, though they are plainly now the government’s preference.

When businesses hear the international trade secretary say a trade deal with the EU will be the easiest in history, they do not know whether to laugh or cry. What matters is not just the starting point but future arrangements and how regulatory divergence is managed and policed, as useful research from the Institute for Government points out.

The very public debate in cabinet, on everything from chlorinated chickens to immigration and the desired length of time for transitional arrangements, is also doing nothing for confidence.

So, getting out of and staying out of the slow lane is a challenge, particularly in the current environment. We have examples of economies that get stuck in the slow lane, such as Japan in recent decades. And, as we have seen with Britain’s productivity figures, weakness can become the norm.

Sunday, July 23, 2017
Inequality is down - but people don't notice when real wages are falling
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

After a week in which we have been offered a joyous glimpse into what some of the BBC’s highest paid on-air presenters and stars earn – and I know all the arguments about whether or not they could earn more in the commercial sector – it is a good time to look again at inequality.

Inequality has raced up the political agenda even though for the past quarter of a century or so it has either been falling or at worst flat, as a useful new report form the Institute for Fiscal Studies pointed out a few days ago.

The IFS report, Living standards, poverty and inequality in the UK: 2017, noted that income inequality fell significantly during the crisis and recession, particularly between 2007-8 and 2011-12, and has not increased since.

Incomes for people at the 10th percentile – in other words those at the top of the poorest 10% of the population – are up 7.7% since 2007-8, while those in the middle (the 50th percentile) are up 3.7%, and those at the 90th percentile, people better off than 90% of the population, have fallen by 0.6%.

As a result, and depending how it is measured, income inequality is either quite a lot lower than it was in the late 1980s, or is roughly the same as it was 25 years ago. The 90:10 ratio shows a distinct fall in inequality, while another widely-used measure, the Gini coefficient, shows the flatter picture. Neither show rising inequality.

The difference between the two is that the Gini, a traditional measure of inequality, takes into account the top 1%’s rising share of income. Though the figures for earnings in this group are open to dispute, in the 1960s and 1970s, the top 1% accounted for between 3% and 5% of income, rising to 8% by 2000 and nearly 9% on the eve of the crisis, before dropping back to 7% as the crisis hit, and then subsequently recovering some of its lost ground.

The 90:10 ratio, meanwhile, has fallen particularly sharply in London since the financial crisis. The capital’s streets are no longer as paved with gold as they were.

So why, if inequality is flat or falling, is it such a hot button issue? And how do you prevent public concerns over inequality from creating the climate for economically-damaging, incentive-destroying tax changes, such as those proposed by Labour in the recent election?

On the first point, we live in an age of, as well as fake news, a climate of disbelief. Any number of reports from the IFS or other respected bodies would not convince some people that inequality is not rising, to the extent that they think about or understand these things at all.

To those that do, there is the important contrast between levels and rates of changes. Yes, on one important definition inequality has fallen significantly, But the level of inequality, the gap between rich and poor, remains significant, and small steps that have reduced it are seen as just that.

In London for example, where inequality has fallen very sharply, it remains higher than in any other part of Britain.

The richer people are too, the steeper the slope gets. The IFS points out that a household with a net income of £946 a week does better than 90% of the population and has an income of nearly twice the median (£481 a week), and nearly four times that of somebody at the top of the bottom 10%. But 90th percentile man or woman would need to earn at least two and a half times as much to make it into the top 1% of incomes. Those top 1%, the conspicuously rich, help frame the debate on inequality more than any statistic.

Incidentally, there is often a confusion between income and wealth inequality, Britain’s income inequality is higher than most other members of the OECD, the advanced countries’ group. But wealth inequality, based on ownership of assets, is lower in Britain than in many other countries, including France and Germany. The explanation lies with traditionally higher levels of home ownership and occupational pensions in Britain, though both are now in decline.

This speaks to another aspect of the inequality debate, that between the generations. Median incomes for the over-60s are up by 10% since 2007-8. Those for the 22-30 age group are down by 4% over the same period. If there has been a sharper increase in intergenerational inequality than that in recent years, it is hard to think when.

The key point about why income inequality is such an issue despite the numbers, however, is that we are in an era of severely constrained growth in household incomes and falling real wages. When prosperity is scattered all around, people will believe that a rising tide lifts all boats.

Lord Mandelson could and did get away with saying that New Labour was “intensely relaxed about people getting filthy rich – as long as they pay their taxes”. When incomes are rising people may care about what their colleagues and others in their immediate circle earn, but they do not worry overmuch about how others, even BBC presenters, are doing.

When incomes are squeezed, in contrast, people do care. It is of small comfort to learn that the real wage pie is being shared slightly more fairly than it was in the past.

Falling real wages are not the norm in Britain. For a run of wage weakness of the kind we are now experiencing, you have to go back to the 1860s, and what Mark Carney recently described as the first “lost decade” since then.
Falling real wages, and the associated weakness of productivity, frame attitudes to inequality and just about everything else. There is, unfortunately, no easy way out of the torpor. Businesses have enough uncertainties on their plate to want to keep a lid on pay. Despite record employment, the vast majority of employees are unwilling to push things on pay. 1998-2007, when average earnings rose by 4.25% a year alongside low inflation, looks like a distant land of milk and honey.

Then, despite a rise in inequality in the run-up to the financial crisis, most people were indeed intensely relaxed about the filthy rich. Now, despite a fall in inequality, they are not. How that is resolved is both a challenge and a worry.

Sunday, July 16, 2017
We need more globalisation, not less
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

One of the great disadvantages of being a member of the Bank of England’s monetary policy committee (MPC) is that unless you say something about interest rates, people do not take much notice of your speeches.

That was the fate that befell Ben Broadbent, the Bank’s deputy governor for monetary policy, a few days ago. His interesting and welcome speech on globalisation steered clear of any mention of interest rates, though he offered his views on rates in a subsequent interview (he is not an early hiker).

On globalisation, which it is fair to say has had a terrible press in recent years, and is blamed for the rise of populism in many countries including Britain, he pointed out a simple truth. Yes, there will be losers from globalisation, and before her political implosion Theresa May seemed overly concerned with compensating them, but they are greatly outweighed by the winners. And the gains from globalisation are spread among the population, not confined to a small elite.

This is a frustrating time for economists. It is, as Broadbent point out, nearly 250 years since Adam Smith demolished mercantilism; the idea that trade is a zero-sum game and one country’s gains are another’s losses. It is exactly 200 years since David Ricardo gave us the law of comparative advantage, which explained why countries specialise, or should specialise, in the products and services they are relatively better at doing.

And yet, centuries later, we have an American president whose protectionism is based on a mercantilist view of the world. And globalisation, far from being seen as a route to improved living standards, is blamed for their weakness.

To illustrate his theme, Broadbent used the apparently unhelpful example of textiles and clothing. Since the mid-1970s, when import penetration began to rise sharply under the impact of lower tariffs, employment in the sector has fallen significantly; by around 90%. Then It used to count for one in 30 jobs;, now it is one in 370. So people who were employed in this sector were losers from globalisation.

British consumers were, however, significant winners as a result of falling clothing prices. Household incomes are 3% higher in real terms than they would have been in the absence of the fact that, both in absolute terms and relative to other prices in the economy, clothing is a lot cheaper than it was.

A straight comparison between these two effects results in a £36bn gain for consumers, against a £15bn loss of labour incomes for those who were employed in the clothing sector in Britain.

Even this, however, is likely to understate the gains from globalisation. As he put it: “There’s a big difference between particular jobs and overall employment. Individual jobs are lost continually … Yet aggregate employment has risen – since both the mid-1970s and the mid-1990s – and the rate of unemployment has fallen. In any reasonably flexible labour market new jobs are created as others are destroyed. “

The latest figures, indeed, showed a record employment rate of 74.9%; 32m people in work. That does not stop some people from yearning for the jobs of the past, but you cannot run an economy on nostalgia.

What if the new jobs are of poorer quality than the ones they replace? Does not globalisation then lead to a rise in income inequality? All the evidence, most recently an International Monetary Fund study in April, found that technological progress dwarfs any impact on inequality from globalisation. Technology benefits the highly-skilled at the expense of the low-skilled and unskilled.

The irony is that concerns about globalisation have been mounting as it has been struggling, even before Trump’s election. The era of “hyper” globalisation that began in the early 1990s has gone into partial reverse since the financial crisis. World trade, which once led global growth, has barely kept pace with it in recent years. Had it done so, Britain would have had significantly stronger growth.

This matters, particularly for an economy that has embraced globalisation as much as Britain’s. We aspire to be a great nation of exporters again. We are undoubtedly a formidable nation of importers, without the national ties to domestically-produced products that some other countries have retained.

Globalisation matters. When it has gone into reverse growth, productivity and living standards have suffered, as we saw most dramatically between the two world wars. Stronger growth in world trade in recent years would have been associated with faster economic growth and, most importantly, growing rather than stagnant productivity, and rising real wages. Trade stimulates rising productivity, as Smith and Ricardo taught us. Those blaming globalisation for weak living standards have got it 180 degrees wrong. We needed more of it, not less.

It matters too in the long-term. On Thursday the Office for Budget Responsibility issued its Fiscal risks report, and a sobering document it was. The OBR continues to cling to the assumption that productivity will recover to normal growth rates in the next few years; if not, and recent weak productivity trends are the “new normal”, then taxes and/or government borrowing will need to rise, even if the government sticks to its tight spending plans.

Though the clock is ticking, to coin a phrase, it is too early to say where what the OBR describes as “the risks posed by Brexit” will end up. It is less troubled by a one-off “divorce bill” payment to the EU – which will not affect the public finances in the long run - than by what it describes as “the implications of whatever agreements are reached with the EU and other trading partners for the long-term growth of the UK economy”.

The OBR reminds us that it does not take much for real problems to mount. As it put it: “If GDP and receipts grew just 0.1 percentage points more slowly than projected over the next 50 years but spending growth was unchanged, the debt-to-GDP would end up around 50 percentage points higher.”

That is easily possible, or worse. At the G20 meeting in Hamburg last weekend, countries had trouble agreeing on a strong commitment to global free trade. America, as noted, has a protectionist president from whom offers of an early trade deal should be taken with a bucketful of salt. Trade is the key to our prosperity but it is not clear how it can be unlocked.

In or out of the EU, Britain would benefit from a revival of globalisation. Things can change, and quickly, but the omens at present are not good. Aspiring to be a new global champion of free trade is not much use if nobody else is playing.

Sunday, July 09, 2017
Businesses are hungry for certainty, not thin gruel
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

Businesses are troubled, and so are consumers. The election a month ago delivered the worst possible outcome in terms of the stability and certainty that the economy needs. The combination of a minority government and a Brexit negotiation that the minister responsible has described as more complicated than the first Moon landing, is undermining confidence.

This is not surprising. I wrote on June 11 that the hung vote would hang over the economy, and so it is, and we have the evidence. All three of the purchasing managers’ surveys, for the manufacturing, construction and service sectors, showed declines in June compared with May.

Their relative strength in the pre-election period will probably mean a slight uptick in quarterly gross domestic product growth in the second quarter compared with the very weak first. But the omens are not encouraging. May official figures for manufacturing and construction were weak.

Services are the dominant part of Britain’s economy and, according to its June purchasing managers’ survey, has seen both a drop in activity and a bigger fall in business optimism.

As Chris Williamson, chief business economist at IHS Markit, which complies the survey, put it: “It is clear that the economy heads into the third quarter losing momentum. With business optimism having been hit by the intensification of political uncertainty following the general election and commencement of Brexit negotiations, at the same time that households are battling against rising inflation, the indications are that the economy’s resilience is being tested.”

The latest GfK consumer confidence barometer, meanwhile, shows households too regard the political situation with concern. The barometer dropped by five points in the wake of the election to -10, a similar bow to confidence as the one that followed last summer’s referendum.

Households have become gloomier about their personal financial situation over the next 12 months, which showed a four-point drop between May and June. They are downbeat about the economy, with a balance of 23% of households expecting it to deteriorate over the next 12 months. People’s willingness to splash out, known in the jargon as the major purchase index, slumped by eight points.

This is consistent with the drop in new car registrations reported by the Society of Motor Manufacturers and Traders (SMMT). Private new car sales last month were down by 7.8% on a year earlier, and were down by 4.8% in the first half of the year. The SMMT separately reported a slump in car industry investment in the first half of the year.

You might say that, like the legendary Brenda from Bristol and her aversion to elections, most people have lives to get on with and do not spend them obsessing about the intricacies of politics. Neither do most businesses. If you said “minority government” to most voters they would not know what you were talking about. If you asked whether they think the government knows what it is doing, you might be closer to it.

Apart from the immediate political uncertainty, however, consumers have much to be downbeat about. I have commented before that, given the ret urn of falling real wages, the prime minister’s decision to call an election was courageous. Courageous in this context is being used in the Sir Humphrey, Yes Minister, sense; in other words foolish,

New official figures show that extent of it. The Office for National Statistics pointed out that real household disposable income per head in the first quarter was down by 2% on a year earlier, a very substantial drop in living standards. To put that in context, this meant that real disposable incomes were back to their level in the middle of 2009, in the depths of the financial crisis and the deepest recession in the post-war period.

What does the piling of uncertainty on uncertainty mean for the economy? The Centre for Economics and Business Research thinks the hit to confidence will hit growth by 0.4 percentage points this year and next, reducing it to just over 1% in each case.

We have, of course, had politically-generated uncertainty before, most notably in the wake of the June 2016 referendum, but it passed. One reason for that was that, apart from the rapid transition to a new prime minister and effectively a new government, with the promise of political stability. Calming measures by the Bank of England also helped.

Jan Vlieghe, a member of the Bank’s monetary policy committee, put it well in an Independent interview the other day. “One of the reasons it didn’t happen [an immediate downturn] is there was a sense it was just too far away,” he said. “So now as it gets closer there is a risk they start worrying again. But if a very strong sense is established that there’s going to be a lengthy transition deal then we go back to that previous regime where [firms think] it might all change but it’s not going to change for a long time so I can just get on with my business and not worry about it. That would be a very positive thing for business and investment and would therefore influence our interest rate policy.”

Even amid the political uncertainty, in other words, it would be better for the economy if businesses believe that they have many years to adjust to Britain’s new relationship with the EU. This is exactly the point that the CBI’s director, Carolyn Fairbairn, and her chief economist, Rain Newton Smith, made in speeches at the London School of Economics on Thursday evening, citing a “drip, drip” of investment decisions deferred or lost.

As Fairbairn put it: “Instead of a cliff edge, the UK needs a bridge to the new EU deal. Even with the greatest possible goodwill on both sides, it’s impossible to imagine the detail will be clear by the end of March 2019. This is a time to be realistic.

“Our proposal is for the UK to seek to stay in the single market and a customs union until a final deal is in force. This would create a bridge to the new trading arrangement that, for businesses, feels like the road they are on. Because making two transitions – from where firms are now to a staging post and then again to a final deal – would be wasteful, difficult and uncertain in itself. One transition is better than two and certainty is better than uncertainty ….The prize is more investment, more jobs and reduced uncertainty for firms here and in Europe.”

The CBI plan, which is backed by other organisations including the EEF, which represents manufacturers, is close to the one that Philip Hammond is arguing for within the government, though he has yet to win the argument. It does indeed make a lot of sense.

Would it end the uncertainty? Not entirely. For some businesses it will merely delay the inevitable. Those planning long-term investments will continue to err on the side of caution. Such is the weakness of the government’s parliamentary position that any pledges it makes would fall if it does. This is a genuine difficulty, created by the election.

So far they are not getting it, Business leaders who met David Davis, the Brexit secretary, at Chevening on Friday were offered thin gruel, not certainty. That needs to change, and quickly.

Sunday, July 02, 2017
When the cap doesn't fit, worry about the deficit
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

What do you need for a successful policy of deficit reduction, of eliminating the government’s annual borrowing and beginning the process of reducing public sector debt?

Well, you certainly need a strong government which is willing and able to take unpopular decisions. You also need a belief in the policy across government. And you need political leaders looking to the long-term.

You do not have to be Sherlock Holmes to spot that, as a result of Theresa May’s election cock-up, all those ingredients are now missing. The signs of slippage are there to see. Austerity fatigue has set in, and not just among some voters. Many ministers are also baulking at the last push to eliminate a budget deficit officially projected to be £58bn this year, even a last push that was intended to take all of eight years.

A further rise in public sector net debt, currently £1.74 trillion or 86.5% of gross domestic product, is inevitable, and the weaker the economy the more it will go up.

What are the signs of slippage? The first was the cost of the prime minister’s agreement with the Democratic Unionist Party (DUP), a £1bn “bung” which old Treasury hands say will merely be a downpayment, and will lead to increased demand for extra spending from other parts of the UK. That election gets more expensive by the day.

Then there were the hints from Downing Street of a softer approach to public sector pay, as foreshadowed here a couple of weeks ago, followed by an insistence that it remains in place. The 1% pay cap may not survive the autumn, many Tories having decided that it cost them a lot of votes in the election.

Public sector pay has been falling in real terms since the cap was introduced, as a useful analysis by the Resolution Foundation pointed out. But then private sector pay has also been falling in real terms too.

It remains the case, moreover, that public sector pay levels exceed those on average in the private sector, either in absolute terms or, when adjusted for the different mix of skills and qualifications in the public sector. To head off responses from readers, I should also point out that most public sector workers enjoy more generous pensions.

Exhibit three in the evidence for slippage came with the British Social Attitudes survey, which showed what its compilers described as a “leftwards tilt on tax and spend”. People say they are willing to pay more tax to fund better public services.

So what should we make of all this? Philip Hammond is fighting to preserve the government’s fiscal credibility, though even he has admitted that the election sent a message about austerity. He is also fighting on several fronts, and doing battle with some of the government’s nuttier Brexiteers on the terms of Britain’s exit from the EU. Treasury officials are left with the task of insisting that “nothing has changed” when it comes to deficit reduction.

I fear that something has. This is not to say the May government is suddenly going to embark on a spending spree. Austerity, as defined by big real-terms benefit cuts, the continued squeeze on departmental and local authority budgets, will continue.

But there will be drift. Money will be found when the government’s survival requires it. Unpopular policies will be junked. Some already have been. Thanks to the DUP deal and the government’s weak position, the triple lock on pensions remains in place. A promise to bring forward radical proposals on social care is one that we will believe when we see it. The government’s weakness will mean weaker public finances.

There are a couple of things I would say about this. One is that, if the government is expecting any political dividends from this, beyond survival, it will not get them. The DUP deal has given public spending a bad name and, when it comes to public attitudes to politicians and their parties, leopards do not change their spots.

George Osborne did not become a hero of the working-classes when he introduced the national living wage, and the prime minister cannot expect to overcome the hostility of public sector workers when a relaxation of public sector pay policy happens. Some things are deeply ingrained and they will be not flocking to the Tories. One prominent Tory MP said to me after the election that there should be a purdah period for public sector workers, so fed up was he of the tide of anti-government propaganda, some of it sent by teachers to parents on school notepaper.

If there is a case for a relaxation of public sector pay, it should be in response to recruitment and other practical difficulties, not because of the hope that it will buy popularity and votes. It will not.

The other point is that we should be very sceptical of survey results which suggest that people are prepared to pay more tax for better public services. That was the standard result during the Thatcher years, during which people were happy to deliver large majorities to a party robustly promising and delivering exactly the opposite.

Nor was this the message of the recent election. The one party promising an across-the-board tax hike to fund extra public spending, the Liberal Democrats, did not do well. Labour’s pitch was that it could end austerity in a way that, for the vast majority of people, would not mean higher taxes. Perhaps surprisingly, many people believed it. When somebody else is making the sacrifice, it is easy to vote for more government largesse.

How worried should we be about the slippage in the public finances that we will see as the government tries to cling to power? Thanks to the progress of recent years, we have a budget deficit of 2.4% of GDP, the same as in the last pre-crisis year of 2006-7 and sharply down from 9.9% of GDP in 2009-10. In this respect, austerity certainly worked.

But 2.4% of GDP should be an upper limit for public sector borrowing, not a base for pushing it higher. The Treasury will have its work cut out limiting the damage.

Sunday, June 25, 2017
Britain's Brexit journey could yet end up in Norway
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

One year on from the vote, and a couple of weeks on from an election that threw an almighty spanner into the works, the formal negotiations to take Britain out of the European Union have begun.

There will be plenty of ups and downs over the next 21 months, though the “row of the summer” promised by David Davis, the Brexit secretary, never transpired because the government agreed to the EU’s negotiating timetable of divorce bill and citizens’ rights first, a new deal and new trading arrangements later.

There is, however, a puzzling absence from the negotiating stance of both sides, and even of the politicians pushing for a softer Brexit. Philip Hammond did not mention it in his Mansion House speech, and neither did the 50 Labour MPs, or the London mayor Sadiq Khan, who are pushing for Britain to remain in the EU single market.

I am referring to continued British membership of the European Economic Area (EEA) after Brexit, the so-called Norway option. EEA membership would provide for continued membership of the single market but not the customs union, so freeing Britain to negotiate its own trade deals with the rest of the world.

The idea of post-EU EEA membership used to be very popular, particularly among Brexiteers in the run-up to the referendum. Many argued that Britain would be mad to leave the single market, and would not need to do so, and that the be like Norway – “rich”, “happy” and “self-governing” to quote one – was the thing to aim for. One plus for them, apart from the freedom to conduct trade deals, was that EEA membership does not include agriculture and fisheries, thus sparing us the hated common agricultural and fisheries’ policies. The big minus was that EEA membership meant accepting, with one or two wrinkles, free movement of people.

People like me argued that EEA membership would be inferior to being in the EU. We would be subject to single market rules (most of the “laws” imposed by Brussels), but not be able to influence them. We would still pay the equivalent of an EU budget contribution. There were questions about whether the rest of the EU, while happy to accept the smaller economies of Norway, Liechtenstein and Iceland into the family, would be prepared to do so for Britain, or see us as a cuckoo in the nest. Switzerland like these three is a member of the European Free Trade Association (EFTA), the body Britain helped found in 1960, but its people rejected EEA membership in a referendum in the early 1990s.

Despite these reservations, time has moved on. The Norway option, EEA membership, looks better than most of the alternatives and it is not just me who thinks that.

The Institute of Directors, in its response the chancellor’s speech, said remaining in the EEA on a transitional basis “should be actively considered”. Among City watchers of the Brexit process, it is still seen as among the options, even though the May government is not proposing it. Malcolm Barr of J P Morgan puts a 25% probability on time-limited membership of the EEA, while Brian Hilliard of Societe Generale includes it in his 15% probability of a soft Brexit.

There is a view that Britain’s default position on leaving the EU is to remain a member of the EEA. George Yarrow, emeritus professor of economics at Hertford College, Oxford, argues that as a signatory to the EEA Agreement, Britain would need to formally negotiate its exit from that agreement under Article 127. Others, it should be said, say EEA membership would expire with our departure from the EU, and that is the majority view.

Is EEA membership, either for the short or long-term, an option? The reason few politicians are citing it as a possibility is because of Theresa May’s emphasis, in both her party conference speech last October and her Lancaster House address in January, on controlling immigration. Though emergency brakes on immigration are allowed to EEA members, they are limited in scope and would not be compatible with reducing net immigration to the tens of thousands.

Britain has, for this reason, begun with a negotiating position which rules out continued membership of the single market, and anything close to the existing customs union. The EU has prepared its negotiating position on that basis. Before too long it will be too late for either of those positions to change.

But these things are more malleable than they sometimes appear. The prime minister’s position is more precarious than would have seemed possible even weeks ago. David Davis, the Brexit secretary, has said that EU migration to Britain could stay high for some years. Polls suggest that to most voters staying in the single market has priority over controlling immigration, which is in any case falling.

Charles Grant, director of the Centre for European Reform, thinks that because of the impossibility of negotiating a trade deal with the EU within the remaining 21 months – May’s always unrealistic timetable having been made more so by the weeks she wasted with the election – an EEA-type transitional deal will be struck.

It will not be formal EEA membership, because the EFTA countries will not, for now, want all the hassle of readmitting a member just to see it through the departure lounge. It will satisfy the government’s desire to escape the attentions of the European Court of Justice, EEA disputes being settled by the EFTA court. It is possible that, feeling sorry for poor old Blighty, the rest of the EU would cut a bit more slack when it comes to putting the brakes on immigration.

It is even possible, looking at recent comments from Emmanuel Macron, the French president, about EU migrants undercutting wages and sowing doubt among “the lower middle classes” that EU attitudes to free movement could evolve. A temporary EEA-style arrangement could evolve into a permanent one.

It is only a possibility. One year on from the vote, the negotiation has only just begun. Reading between the lines of Hammond’s speech, the Treasury is as worried by the loss of customs union membership, for its effects on jobs and the economy, as leaving the single market. The chancellor is pushing for something close to continued membership of the customs union, “current customs border arrangements remaining in place”, for a transitional period of four years after March 2019, perhaps longer.

This is what now gets the Brexiteers uneasy. Transitional arrangements will be necessary – they were longer than four years on the way into the European Economic Community four decades ago – but the temporary has a habit of turning into the permanent. Leaving the EU could turn into a very long goodbye.

Sunday, June 11, 2017
Hung vote hangs over the economy
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

This time last week I devoted quite a lot of space to the prospect of a hung parliament, pointing out that whereas two years ago it was the expected outcome for one Tory prime minister, David Cameron, this time it would be seen as a catastrophe for Theresa May. Combine a hung parliament with EU exit negotiations scheduled for June 19, and you had a recipe for something really destabilising.

Though a hung parliament was a risk, as set out then, I thought along with most other people that the Tories would secure a somewhat larger majority than the one May inherited from Cameron. It would have been one of the least deserved majorities in recent political history. So, while a hung parliament has made us something of a laughing stock and is on the face of it bad for the country – more in a moment on whether it is or not – there was quite a lot of poetic justice in it.

Why undeserved? Any prime minister who ignores the economy in an election campaign and expects voters to troop loyally into the polling booths when their real wages are falling did not deserve victory. People need something to latch onto, some grounds for economic hope and May’s Tories did not provide it. Austerity fatigue is another factor on which no reassurance was offered.

I also think that she made a huge miscalculation, which goes back some time, about Brexit. As a Remainer, albeit a soft one, she overcompensated by either focusing exclusively on the 52% who voted to leave the EU – and implying that those did not were “citizens of nowhere” – or wrongly suggesting that the country was coming together on the issue when it was clearly not. As many people think it was wrong to vote to leave the EU as think it was right,
according to polls. Some out and out Leavers, such as the Brexit secretary David Davis, took a more conciliatory approach to Remainers.

And the hard line Brexit that she decided on – out of the single market and customs union and cutting net migration to less than 100,000 a year, even apart from the “no deal is better than a bad deal” nonsense – appeared designed to inflict maximum damage on the economy.

What does the hung parliament mean for the economy? I think it useful to split this into the short term and the longer-term.

In the short-term, the uncertainty generated by the election means weaker growth is likely to persist. Election uncertainty may have helped depress the housing market and house prices, according to Rics, the Royal Institution of Chartered Surveyors, though housing has been on a weakening trend. The election result has come at a time when the economy too has entered a weaker phase.

Figures on Friday showing weak construction and industrial production figures for April, combined with evidence that May was a poor month for retailers, suggest the economy’s weak start to the year has continued. The National Institute of Economic and Social Research estimated growth of just 0.2% in the three months to May, the same as in the first quarter.

The Organisation for Economic Co-operation and Development (OECD) attracted headlines a few days ago for a downbeat forecast for Britain’s economy, and for suggesting that the government should use the “fiscal space” afforded by low interest rates and the long average duration of government borrowing (the number of years on average that gilts have before they mature), to borrow a lot more for infrastructure investment.

The OECD thinks the Brexit negotiations will weigh heavily on the economy, producing the unusual situation for Britain in which an acceleration in the global economy, from 3% growth last year to 3.5% this and 3.6% next, is accompanied by a slowdown in Britain’s economy, from 1.8% last year to 1.6% this and just 1% in 2018.

The OECD’s forecasts brought to mind a question I am often asked: where will the growth come from? The challenge here is easily stated. Britain’s economy has been, and continues to be, highly dependent on consumer spending. When consumers sneeze, as they did in the first quarter in slowing their growth in spending to a modest 0.3% (with retail sales actually falling), the economy catches a cold.

The drivers of consumer spending are, moreover, looking much weaker. The Brexit-induced rise in inflation has produced a return to falling real wages, which is set to last for some time.

Households’ ability to carry on piling up consumer credit and run down savings, highlighted by the OECD as one of the main means by which the economy has been kept going, does not look sustainable for much longer. The credit card looks as if it is getting close to being maxed out.

When I am asked the question about where the growth will come from, my usual response is to talk about trade. Notwithstanding the disappointing performance of exports so far, the fair wind of a cheap currency and a strengthening global economy, and in particular a strengthening European economy, must surely be good for Britain’s overseas trade.

These are the circumstances in which exports should flourish and we should hope they do, although, as I noted last week, they cannot be turned on with the flick of a switch. Export disappointment is not just a short-term phenomenon. One measure of how exporters are doing is the relationship between their performance and the growth in Britain’s export markets.

As the OECD pointed out, one of those, the growth in exports, has consistently fallen short of the other, the growth in markets. Britain’s export market share has been on a declining trend. The OECD’s index of UK export performance has seen a decline of more than 30% since the mid-1990s. You can lead a horse to water but you cannot make it drink.

So the next couple of years will be a challenge, and if the OECD is right, it will not end there. It is assuming that there will not be a workable EU deal and Britain will revert to World Trade Organisation rules. Is that assumption, made ahead of the election, still valid?

One reason why the market fallout from the election has not been as big as feared is because of the belief among analysts that it will pave the way for a softer Brexit. It may be that the prime minister, if she survives, will be obliged to work with other political parties in a more consensual approach. Leaving the single market and customs union would be up for grabs, and May’s lonely Home Office pursuit of reducing net migration to less than 100,000 a year would be shelved. The no deal option would be dumped.

That would be my hope, but is it wishful thinking? Listening to May’s Downing Street statement on Friday when she declared that she was forming a government, it was hard to detect than anything had changed, including her dashed hopes of a bigger majority. That may be just her style. It is not the only thing that will need to change.

Sunday, June 04, 2017
Election uncertainties to be followed by many more
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

I know you are as keen for this general election to be over as much as I am, and that you are probably not expecting Friday morning to mark the dawn of a bright new era. We have all learned that you can have too much of politicians and that reputations can be lost, or diminished, as well as enhanced.

There is still a possibility, of course, that the election could throw up something really destabilising. Two years ago a hung parliament with the Tories as the largest party was the expected outcome. Now it would be greeted as a catastrophe, not least for the prime minister.

Combine a hung parliament with Brexit and you compound the uncertainty considerably, though some would see it is as pushing the country towards a softer Brexit. The narrowing of the polls has been driving the currency markets, and sterling, in recent days, but it should be said that markets are still assuming a Conservative majority.

If that turns out not to be the case we can expect a much bigger market reaction, though Simon Derrick, veteran chief markets strategist at BNY Mellon, points out that markets are not always averse to hung parliaments and coalition governments over the medium-term.

Sterling was stable when Labour lost its majority in 1977. It fell briefly, by around 5%, after the May 2010 election, when the election failed to deliver a Tory majority, but reached its low point a week after the election, a low point that was to last for several years. It recovered when the Conservative-Liberal Democrat coalition was formed. As he puts it: “Neither a minority government nor a moderate coalition is an automatic negative for the pound.”

Those earlier episodes did not, however, have the additional huge complication of Brexit. As in the past few months, we can expect sterling to be a Brexit barometer. For the moment, to repeat, the assumption in markets is of a Conservative majority this week, though there is not a great deal of enthusiasm for it.

The election is just the latest hurdle for the economy, and business, to negotiate. It is a reminder that these things are never as straightforward as they appear beforehand. This was, after all, expected to be a cake walk for Theresa May.

The tone and content of economic policy in the coming months is important. There have been times in the recent past when rebalancing the economy was regarded as desirable. Now it is essential, if the economy is not to stand or fall on the shoulders of debt-laden consumers.

For business, this has been a sobering time. Their strong majority view, that it was best for Britain to stay in the EU, was rejected by voters a year ago. They have seen, if the polls are anywhere near correct, a sizeable minority of voters being happy to vote for significantly higher corporate taxation and increased taxes on executive salaries.

They have had little comfort from the Tories, who under May have adopted an interventionist and anti-business tone, as highlighted in these pages. Our business manifesto today sets out some ideas for how the Tories could undo the damage.

Amid all this, businesses have been on something of a rollercoaster. One measure of confidence, the Lloyds Bank business barometer, showed confidence slumping last summer, then embarking on a jagged recovery, before slumping again last month.

The 20-point drop in overall business confidence, driven by a big drop in firms’ perceptions of business prospects, may be temporary, economists at Lloyds Bank Commercial Banking, which publishes the survey, suggest.

Another survey, the European Commission’s economic sentiment index, also pointed to a drop in confidence last month, particularly in construction and services. The latest purchasing managers’ index for manufacturing, though down slightly last month, showed sentiment in the sector holding up.

For businesses to also hold the economy up, investment and exports will be vital. Business investment has been up and down over the past 18 months. It rose a little in the first quarter, perhaps surprisingly, but has essentially been flat. The recent pattern, in which firms have been happier to recruit than invest – good for jobs but bad for productivity – persists.

As for exports, we reported last week the disappointing first quarter gross domestic product figures, which showed that in spite of sterling’s Brexit devaluation and a stronger global economy, including a pick-up in European markets, export volumes were down by 1.6% on a year earlier.

Whether this continues to be an unsuccessful devaluation – they usually are – we have yet to see. Surveys remain upbeat for manufacturing exports, though some service-sector exports are under more of a cloud.

It is sometimes forgotten that exports cannot be turned on at the flick of a switch. Developing new markets, and exploiting existing ones, requires investment, sometimes considerable investment. Doing that when future trading arrangements are so uncertain presents, to say the least, a big challenge.

The unexpected uncertainty created by the general election, together with the tenor of the election campaign, has created new concerns for business, and led to some of the drops in confidence we have seen. The great rebalancing has yet to happen.

The election uncertainty will give way to new uncertainties. Two new reports from the Centre for Economic Performance (CEP) at the London School of Economics highlight some of the dangers. On immigration, the CEP concludes that cutting it significantly will result in a lowering of living standards for the UK-born population, the extent of the fall depending on the extent of the drop in net migration. The May target of “tens of thousands” will leave us all poorer.

The report, on the CEP website, is a good mythbuster. Areas of high EU immigration have not seen UK-born workers displaced or suffering weaker wage growth. The route to lower living standards is partly via the fact that migrant workers pay more in taxes than they take out in welfare and use of public services.

The CEP’s other report looks at something that really worries businesses, the prime minister’s “no deal is better than a bad deal” rhetoric. CEP economists Swati Dhingra and Thomas Sampson, using what they describe as a state-of-the-art trade model based on comprehensive data, say that leaving the EU without a deal would result in a 40% drop in exports to the EU over 10 years and a 3% fall in GDP per capita.

Add in dynamic effects and the medium-term economic effects could be double those arising from the model, the authors say.

This leaves aside the immediate dislocation, which would be considerable, of leaving the EU without a deal, which I shall discuss in a future piece. The combined effect would be large and damaging enough to suggest that it is not a serious option for the government, even though the prime minister insists it is.

Maybe, once the election hubbub has died down, wiser heads will prevail, and wiser words emerge. We can but hope..

Sunday, May 28, 2017
Taxes are going up, whoever wins the election
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

There are only 11 days to go until the general election and there is still a lot we do not know. That is even on the assumption that we see the Conservative party returned with a larger majority, which remains the most likely outcome despite narrowing polls.

We do not know for sure whether Philip Hammond will be kept in his post as chancellor, Theresa May having so far refused to guarantee his position after reported bust-ups between 10 and 11 Downing Street.

When Hammond presented the budget in March he was happy to describe it as his first and last spring budget. What he meant, of course, was that the spring budget is being abolished but that he would be around for plenty of autumn budgets. Now that is not so certain.

I hope for his sake he is kept in the job. By the time of the election he will have been at the Treasury for 11 months. Most recent chancellors have been long-serving ones, including more than six years for George Osborne and 10 for Gordon Brown. The last short-stayer was John Major in 1989-90, 13 months, though his consolation was being promoted to prime minister.

Personnel uncertainties are one thing, policy uncertainties for the Tories another. A week ago I wrote here that the Conservative policy on social care were messy, incoherent and unfair and “will need to be revisited”. I did not expect them to be revisited, in a tyre-screeching U-turn by the prime minister, the very next day.

For the Tories too, things are more uncertain than they should be on tax. An Ipsos-Mori poll the other day showed that 54% of people expect income tax to rise in the event of a Conservative victory, not that much below the 70% who think it would happen under Labour.

Labour, it should be noted, has said explicitly that it would put up income tax, though only on incomes of £80,000 and above. But for more than half of people to think income tax will rise under the Tories is quite something. The most explicit tax pledge in a not very explicit manifesto was to cut income tax by raising the personal allowance, currently £11,500, to £12,500, and the higher rate threshold from £45,000 to £50,000.

This tells me two things. One is that for all the emphasis in recent years on raising the personal allowance – “taking people out of tax” – many people do not regard this as a tax cut in the way they would a reduction in the tax rate.
The other point is that even if people have got it wrong on the Tories and income tax, they are right to suspect that taxes will be going up in coming years.

There is the cynical argument that governments tend to raise taxes once elections are safely out of the way. There is the fact that the Tories have sensibly abandoned their 2015 pledge not to raise any of the main taxes – VAT, income tax, corporation tax and national insurance – in the next parliament, replaced by a weaker promise to keep taxes “as low as possible”.

And there is the fact that the public finances need higher taxes. Figures last week showed that the public finances got off to a bad start to the new fiscal year in April. Public borrowing for the month of £10.4bn was £1.2bn up on a year earlier, consistent with the rise in borrowing the Office for Budget Responsibility (OBR) expects this year.

Official projections for government receipts show that they are on course to rise by the end of the decade to their highest level as a percentage of gross domestic product since 1986-7, as the Institute for Fiscal Studies pointed out on Friday. Taking only the tax component of those receipts, the IFS also pointed out that they are on course to hit their highest level of GDP since 1969-70.

Some of the sources of this growth in tax receipts are known about but are only just taking effect or have yet to do so. They include the apprenticeship levy, which will raise £3bn a year form this year, the increase in insurance premium tax which will push up receipts by more than 50%, and the cut in the dividend tax allowance from £5,000 to £2,000 next year.

Some it, however, is so far uncosted, or relies on “fiscal drag” from rising incomes. The latest growth figures, revised down to just 0.2% in the first quarter as a result of the squeeze on household real incomes, suggests that revenue growth from this source may be hard to achieve. Weaker-than-expected growth, if maintained, will mean more government borrowing.

The pledge to raise the personal allowance to £12,500 and the higher rate threshold to £50,000, which will cost around £2bn a year in lost income tax revenues, is not included in the figures. That money will have to be found from somewhere.

We know that Hammond, if back in the Treasury, will want to revisit the 2% increase in Class 4 national insurance contributions for the self-employed he announced in his March budget. He was forced to abandon it before the ink was dry because it broke a 2015 manifesto commitment, and which has left him £500m a year short.

It may be brought back as part of a package which will include enhanced rights for the self-employed, to be recommended by the review undertake by Matthew Taylor. Those enhanced rights will not go down well with some firms, and nor will an increase in Class 4 contributions with the self-employed.

I should put the Tories’ tax plans, and their softer pledge to keep taxes as low as possible, in perspective. They will not, this time, raise VAT after the election, as in 1979 and 2010. Income tax, as I say, is going down not up. Corporation tax will be reduced from its current 19% to 17%.

All that can be contrasted with Labour, which wants to soak the £80,000 a year plus rich with a hike in income tax, increase corporation tax to 26% and hit the City with a transactions tax. The Liberal Democrats are also explicit about their plan to put 1p in the pound on income tax across all earnings levels.

In relative terms, the Tories clearly are the lower tax party, though have been quieter than you might expect in attacking Labour’s plans for raising taxes on higher earners, business and the City. That may reflect another set of poll findings, which is that these things are worryingly popular with voters.

We know, however, that this election will not mark the end of austerity. The public finances are still a long way from being fixed. The Tories may not be aiming to balance the budget until the mid-2020s but even that will require the restraint on spending to be maintained. Even harder hit than wage-earners during the coming squeeze will be those reliant on benefits and tax credits frozen in cash terms.

We also know that when it comes to taxation, it is mainly a question of degree. The Tories will raise tax reluctantly, and by less than their opponents. Labour will do it with gusto, while pledging no new taxes for the majority. But taxes are going up, whoever wins the election on June 8.

Sunday, May 21, 2017
Polls apart, but the Tories and Labour both pose risks to the economy
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

This election is turning out to be a bit more interesting than I was expecting although, unless the polls are spectacularly wrong, though they are narrowing, it is still unlikely to be much of a whodunnit.

It is interesting because, for the first time in a very long time – perhaps since Michael Foot in 1983 – nobody, not even the Tories, has had to speculate about what dark, left-wing ideas lurk behind a bland Labour programme.

This time, instead, the left-wing ideas are in full view. Labour has produced a manifesto in the image of its leader, which means that a fascinating experiment is now unfolding. There has always been a strand of Labour opinion which holds that the party has suffered electorally, most notably under Ed Miliband two years ago, from not being left-wing enough.

Now that proposition is being tested, though sadly it will not settle the issue. If Labour’s vote share is in the low 30s, similar or better than Miliband in 2015 (30.4%), it will be greeted as progress, with alleged media bias against Jeremy Corbyn blamed for the message not fully getting through.

There are, as with all manifestos, good and bad ideas in Labour’s proposals. A National Transformation Fund, which would take advantage of low borrowing costs to invest an additional £250bn in Britain’s infrastructure over the next 10 years, has a lot to be said for it.

Though the arguments are not as strong as they were, there is also an argument for Labour’s National Investment Bank and its proposed network of regional development banks, which would draw on private finance to generate £250bn of what Labour calls “lending power”, operating in the gaps left by the commercial banks, particularly in small business lending. Calls for such an institution, modelled on European lines, go back a very long way.

Where Labour comes over all unnecessary in its manifesto is its proposal to renationalise chunks of the economy, including the rail companies, the water industry, Royal Mail and by “regaining control” of energy supply networks. The argument that “democratic control” of these industries would bring a better deal for consumers defies the experience of the past, though it would keep the unions happy. As a priority it is a weird one.

Even weirder, though perhaps entirely predictable, are Labour’s tax plans. Raising taxes on high earners may have made sense in the immediate aftermath of the financial crisis, though it is not clear the 50% rate Labour announced then on incomes above £150,000 raised much money.

To go further at a time of Brexit, when Britain needs to prevent its high earners, particularly in the City, from heading to Frankfurt, Paris or Dublin, makes no sense at all. And yet that is precisely what Labour is proposing, and more, with a new 45% rate kicking in at £80,000 and 50% at £123,000.

Similarly, in the context of Brexit, raising corporation tax from 19% to 26% at a time when Britain’s appeal to foreign direct investors is being undermined by our exit from the single market is, as I noted last week, really dumb.

Labour’s defence, that 26% would still be the lowest in the G7, does not wash. These things do not stand still. Donald Trump, if he hangs around long enough, aims for a rate of 15%. And, as the Institute for Fiscal studies points out, the rate is not everything: other countries allow a larger share of capital spending to be offset against tax, together with other reliefs, so even at 19% Britain has “a less competitive tax base than other countries”.

The icing on the cake of Labour’s tax-raising exercise is its proposed policy of converting stamp duty, currently 0.5% on share purchases, into a “Robin Hood” tax on a much wider range of financial transactions. Again, at any time this would be very risky. At this time, making the City much less competitive at a stroke would provide an open invitation for international investment banks and others to migrate en masse to Europe.

The logic behind Labour’s tax policies, which would end up raising very little, is hard to fathom in the context of Brexit. Either the party does not expect to be in power to implement them or it believes it could blame Brexit when everything goes wrong. The worry would be if enough people believed they were the right thing to do. We are still, after all, in a strange era.

You might think after all this that it would be a relief to turn to the party we must now call “Theresa May’s Conservatives”. The prime minister has been happy to accept the soubriquet “bloody difficult woman and would be nothing if she does not come over as a sensible one.

Her Tory manifesto gets some of its economics wrong. Britain is not the fastest growing economy in the G7. Barring revisions, Germany was last year and plenty of other G7 countries were in the first quarter of this year.

Her government’s more relaxed approach to deficit reduction will mean that the public finances will be in the red until the mid-2020s, meaning one of the longest runs of deficits on record. Even then, George Osborne’s ambition of budget surpluses has been replaced by the meeker “balanced budget”.

There are, as with Labour, good things in the Tory manifesto. Though it will not make any difference for several years and not too much then, replacing the triple lock on state pensions with a double lock (pensions to rise by the greater of prices or earnings) is a modest step in the right direction, as is the proposed withdrawal of the winter fuel allowance for better-off pensioners.

The Tory proposals for social care at least address the problem, but they do so in a messy and incoherent and unfair way, particularly in comparison with the Dilnot Commission’s proposals. They will need to be revisited.

The Tories would not renationalize anything but they would intervene willy-nilly. May’s Tories are suspicious of markets and business and have an attitude to foreign investment that verges on protectionism.

There are, moreover, two particular problems with the Tory manifesto. A sensible approach to immigration would have been to acknowledge that voters believe it is too high but also to say that a lengthy period of adjustment will be needed to reduce Britain’s dependency on foreign workers. It would also have made a lot of sense to exclude students from the figures.

Instead, May has gone for a hard-line Home Office approach which will harm the economy and business and, when her “tens of thousands” target is not met, harm her. By doubling down on the migration commitment, toughening the visa requirements for students and increasing the costs for employers of bringing in non-EU migrants, she has prioritized politics over economics. Clamping down on migrants will, according to the Office for Budget Responsibility, hurt the public finances, making even that elongated balanced budget target harder to meet.
The prime minister also rode roughshod over the Leave supporters in her own cabinet who insist Brexit is not about immigration.

The other concern is that “no deal is better than a bad deal” with the EU will, if she is elected on June 8, be part of her mandate. If Britain were to suffer an abrupt, cliff-edge exit from the EU, the damage of which I have written about here before, nobody could say they were not warned, or that she had departed from the script.

People like me are supposed to compare Labour’s wish list and spectacularly ill-timed tax plans and conclude that the country would be better off with sensible Tory policies. But the contrast is less stark than you might think. We are talking mainly about different kinds of damage.

Sunday, May 14, 2017
Our nation of borrowers is storing up trouble
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

The governor of the central bank was perfectly clear. High and rising household debt “has made the economy less resilient to future shocks”. It is more likely that, in future, households will respond to an economic shock, or a rise in interest rates, by cutting their spending more sharply than in the past.

“Double-digit growth in debt … at a time of weak income growth cannot be strengthening the resilience of our economy,” he added.

This was not, for once, Mark Carney, but his Australian counterpart, Philip Lowe, governor of Australia’s Reserve Bank, in a speech a few days ago to the Economic Society of Australia, but the parallels with Britain are close.

The good news is that we are not alone in the vulnerabilities and challenges that high levels of household debt, alongside high house prices, pose. The bad news is that household debt in Britain, £1.53 trillion on Bank of England figures, higher on other measures, is higher in relation to income than in most other countries, as are house prices.

The Bank, for its part, has expressed its concern over the rapid growth in consumer credit, currently rising by more than 10% a year, its fastest since before the financial crisis. In its latest inflation report, published on Thursday, the Bank noted that the Prudential Regulation Authority is looking into whether credit quality is suffering, while the Financial Conduct Authority is examining assessments by lenders of the creditworthiness of borrowers.

Figures on Friday from the Finance and Leasing Association showed £5bn of car finance – new and used – in March, up 14% on a year earlier. Over the past 12 months, consumer car finance has totalled £32.6bn. Though this sharply rising debt is mainly on the books of finance companies and the motor industry, with 86.5% of new cars bought with finance it represents a significant monthly payments’ burden for households.

The bigger picture is what high levels of household debt mean for the stability of the economy and, for central bankers, whether they tie their hands when it comes to future interest rate hikes.

The numbers, for Britain, are striking. In the 1980s, after credit controls were abolished as part of a wave of financial liberalisation, concerns were expressed over high levels of household borrowing. Back then, however, we were merely in the foothills. Household debt in 1987 was £185bn. Including both mortgage and non-mortgage borrowing. Thirty years on it is more than eight times that, and has trebled relative to incomes.

The question of what to do about high household debt is one of the questions posed by Jagjit Chadha, director of the National Institute of Economic and Social research, in his introduction to the institute’s latest quarterly review, which has just been published.

Chadha, looking at the challenges the income government, which I guess will be led by Theresa May, not a very bold guess, will face after June 8, apart from you know what, makes the good point that household debt has to be balanced against much higher household wealth. But he notes that the composition of household wealth has become skewed toward housing; 45% of wealth now compared with 32% in the mid-1990s. Not only that, but those who have the wealth are often very different from those racking up the debt. The Bank’s figures for household debt do not include student loans, currently heading up towards £100bn.

I have always been more relaxed than others about household debt. One reason was the aggregate balance sheet; household wealth being always several times the level of debt. The other was that, until relatively recently, a healthy and necessary adjustment had been taking place. So, as recently as late 2013, the cash total for debt held by households was lower than its pre-crisis peak, meaning that debt had fallen both in real terms and relative to income. In Acacia Avenue and elsewhere, the message seemed to have sunk in: too much debt is bad for you.

Since then, however, there has been a change, most dramatically for unsecured borrowing. Debt is rising again, even before the memories of the crisis have faded. Some of that is demand – people have felt confident enough to borrow – and some supply; the lenders have been turning the credit taps on.

The process has been helped along by falling market interest rates.
It is, says Erik Britton, managing director of Fathom Financial Consulting, a familiar pattern, witnessed in Japan and elsewhere. Any pauses in the rise in debt are short-lived. Ultra low interest rates in response to recession and crisis eventually encourage more debt to be taken on.

The problem for central banks, Britton argues, is that they get themselves into a position in which relaxing monetary policy – cutting interest rates further – has little effect but raising them, even by a small amount, would have a significant negative effect because of high levels of debt.

Are we there yet? Though Britain is in the middle of a significant consumer slowdown , notwithstanding an Easter-related retail sales bounce, there is no sign of panic. The Bank, in its new inflation report, expects 1.75% growth in consumer spending this year, slowing to 1% next. In the 10 years leading up to the financial crisis, spending rose by an average of 3.5% a year.

Consumer confidence and employment are high, however, and despite the squeeze on real incomes currently coming through, there is no sign yet that fears of unemployment and being unable to keep up the payments are resulting in the feared sharp drop in spending. That would only happen if consumer became as gloomy about their own prospects as the surveys show they are about the economy, and that is not yet the case. It could become so.

That leaves high household debt as a constraint on interest rates. The central message in the Bank’s inflation report was that markets were too relaxed about the prospect of rate hike; not immediately but in 2018 and 2019. The Bank signalled that if things develop in line with its latest forecast, it would not expect to keep rates on hold until 2019, which markets had been expecting.

It is a reasonable message, albeit one reliant on a punchy forecast of a near-doubling of the rate of growth of wages (average earnings) over the next couple of years. It would enable Carney to leave the Bank in mid-2019 with a rate hike or two under his belt.

The crunch would come if there was greater urgency to push rates higher, because inflation had become more ingrained than the Bank feared. The Bank, with its annual survey of the financial position of households, carried out by NMG Consulting, is aware of the potential vulnerabilities. Some households, though only a minority, would be plunged into financial distress by even a modest rise in interest rates.

A modest rise, at best, is all that is in prospect in coming years, with the Bank aiming for a new normal for interest rates of 2%, though not for some time. But if debt continues to rise, even that could be too high for too many.

Sunday, May 07, 2017
Ultra-low rates made us lose our productivity mojo
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

There have been times in the past when voters were entitled to be nervous about interest rates in the run-up to a general election, because of the fear that nasty surprises would be on the way after polling day.

So, in the six months after Margaret Thatcher’s May 1979 victory, interest rates rose by no less than five percentage points (from 12% to 17%), while in the year after her 1983 victory they went up from 10% to 12%. In 1987, rates went up a couple of months after the election, though only briefly.

Before the May 1997 election the Bank, in the person of Eddie George, had been agitating for higher rates, without success. The task of raising them after the election initially fell to Gordon Brown – the last chancellor to raise rates – before being handed over to the newly independent Bank of England. There were six rate rises in the 12 months or so after May 1997.

It is fair to say that few are on tenterhooks this time. Under independence, the interest rate and electoral cycles have not been aligned. In 2001 the monetary policy committee (MPC) was cutting rates before the election and carried on afterwards. In 2005 the MPC held off a rate cut until after polling day. The 2010 election was held with Bank rate at a then record low of 0.5% and it stayed there for the whole five years of the following parliament.

Not only that, but the Bank has shown little inclination to budge from its new record low for official interest rates of 0.25%. It will put flesh on the bone of its intentions with an interest rate decision and new inflation report in one of its periodic “super” Thursdays this week.

But, while one MPC member, Kristin Forbes, has voted for a hike in rates and another, Michael Saunders, recently set out the arguments for doing so, it would be a big surprise if a rate hike happened this week or, indeed, if the Bank signalled its intention of moving on rates in the coming months. Forbes has one more MPC meeting after this one before she steps down.

The markets do not expect a rate hike until 2019 – the 10th anniversary of the move to ultra low interest rates – and some have not given up on the idea of a further rate cut, even from 0.25%, if the economic going gets tougher.

There may be some adjustment around the edges – economists at Goldman Sachs think the Bank may move shortly by tightening what they describe as credit easing; reversing the cut in the so-called counter cyclical buffer made in the wake of the Brexit vote – but the big picture looks to be an unchanging one.

A year ago it was possible to look forward to small and gradual increases in interest rates, but the Bank has responded to Brexit, and will continue to be influenced by its fallout. We will get a new forecast from the Bank this week, which may nudge down this year’s growth forecast, but, comparing its February predictions with those made in May last year, before the vote, it expects the economy in 2019 to be roughly 2% smaller than it did then, and the price level about 2% higher.

The first quarter gross domestic product numbers, released in late-April and showing quarterly growth of just 0.3%, will have reinforced the case from most MPC members for keeping rates on hold. Though April’s purchasing managers’ surveys point to a rebound, the Bank will wait for further evidence on that.

It is easy to forget, given how long we have lived with ultra-low interest rates, how extraordinary they are. A 0.25% Bank rate is mind-bogglingly low but even it does not tell the full story. It ahs been accompanied by unconventional measures, most notably £435bn of quantitative easing (QE). QE was undertaken to provide an additional monetary stimulus to the economy at a time when it was thought impossible to cut interest rates further.

Neil Williams, chief economist at Hermes Investment Management, has applied the rules of thumb offered by the Bank on what its QE programme was equivalent to in terms of interest rate cuts; £200bn of QE is equivalent to 1.5 percentage points off Bank rate, the Bank estimated in 2009. And, because the Bank regards the stock of QE as the key measure, £435bn is equivalent to more than three percentage points off interest rates.

So the true rate of interest, adjusted for QE, is -3% - minus 3% to spell it out, Williams calculates. He thinks, in the absence of rate hikes, the Bank should restore some normality quietly running down QE. It could do this by not reinvesting the proceeds of the maturing gilts – UK government bonds – it has bought under the QE programme. But the Bank’s current policy, most recently set out in November 2015, has been to keep reinvesting those proceeds until Bank rate gets to 2%, which is a long time away. So the stock of purchased assets will be maintained, and the extraordinary looseness of monetary policy will persist.

It is easy to forget, too, that ultra-low interest rates have consequences. One of those consequences is very weak productivity. There are many reasons for the stagnation of productivity (output per hour or output per worker) of recent years. But the weakness of productivity coincides with the period of low rates, and it is not hard to see why.

One of the aims of monetary policy during and after the financial crisis, was to avoid the wave of bankruptcies and redundancies that the scale of the recession of 2008-9 and its aftermath implied. It was supplemented by pressure on banks and other lenders to show greater forbearance to firms in difficulty.

In this, it generally succeeded. On most measures, from corporate failures through unemployment to mortgage repossessions the crisis’s impact was much smaller than feared.

But this, as is also recognised, prevented the process of “creative destruction” that normally happens in a big recession, in which weak firms go to the wall and are replaced by new, higher-productivity businesses.

This effect is acknowledged within the Bank. Andy Haldane, its chief economist, estimated in a recent speech that had interest rates been kept higher – he gave a figure of 4.25% - there would have been a big increase in failures, but also higher productivity. He suggested productivity would have risen by about 2%, though at the cost of 1.5m jobs. He said he would prefer the jobs as, given the choice, would every politician.

I think the productivity effect of ultra-low rates may be bigger than this. They enable healthy firms to coast rather than undertaking productivity-enhancing investment. When businesses cease to expect significant or indeed any rate rises, there is no incentive to invest to take advantage of low rates.

Low rates , to stress again, are not the only reason for weak productivity. But the question, as the clock keeps ticking, is how long this can continue. The near-zero rates that were a logical response to the crisis, and helped the economy trade weak productivity for more jobs, have taken on an air of permanence. So too, unfortunately, has stagnant productivity growth.

Sunday, April 30, 2017
Vive La France - and an economy that's finally on the up
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

It is not something I recall every saying before, but sometimes other countries’ elections are more interesting than our own. Theresa May’s regal progress towards endorsement by voters of what the Tories keep calling her “strong and stable” leadership seems unlikely to set the pulse rating.

When the most interesting question about the election is how badly the Labour party will do, and when many long-serving MPs have decided that their time is up, mainly Labour but also long-serving Tories such as the Treasury committee chairman Andrew Tyrie, this is no cliffhanger.

Across the channel in France, however, it really is interesting. Though Emmanuel Macron, a political ingénue, is clear favourite to beat Marine Le Pen, who was National Front leader but has temporarily stepped aside from that role, there is much more uncertainty about that outcome than there is about a May victory.

The uncertainty, meanwhile, will not end there. French parliamentary elections, on June 11 and 18, will come after Britain’s June 8 election. The starting point for them is that Macron’s En Marche! movement has no parliamentary representation and the National Front has only two out of 577 National Assembly members.

The conventional view is that, apart from these political hurdles, the next French president will face an uphill struggle in transforming a sclerotic, high-unemployment French economy into something competitive. Le Pen would try to do so via immigration and protectionism, probably pull out of the euro and replace it with the franc and offer French voters a referendum on Frexit. Good luck with that.

Macron, the more likely winner, though with health warnings attached, would relax labour laws, reduce business taxes, reform a system which he says preserves high unemployment and reduce the size of the public sector. In most respects his policies are a paler version of those of the failed conservative candidate Francois Fillon. He would also embrace closer European integration. Good luck with that too.

France does indeed need reforms but its economy is far from the basket case that it is often portrayed as in Britain. Economic growth, according to the purchasing managers’ index, which measures business-to-business activity, is at its strongest for six years.

Having suffered a big recession in the financial crisis, in line with every advanced economy, France suffered again, and badly, in the eurozone crisis and recession of 2011-13, treading water afterwards. In recent months, however, the French economy appears to have put both of those events behind it and enjoyed a growth spurt.

Figures on Thursday for eurozone economic sentiment, derived from measures of both business and consumer confidence, confirmed the improvement in France. After years in which the eurozone has been kept on life support by the European Central Bank, France has become one of the brightest, and perhaps unlikeliest, stars of its revival.

The “basket case” view of France, and her supposed economic inferiority in comparison with Britain, runs up against the reality of some of the numbers. France is Britain’s third largest export market but consistently runs a significant trade surplus with Britain, of around £6bn a year in recent years.

France in many respects has a better balanced economy and is less reliant on consumer spending, which accounts for around 55% of GDP, compared with 65% in Britain, with larger contributions to GDP from investment, net exports and, of course, a larger state.

French productivity, measured by gross domestic product per hour worked, is higher than in Britain to an almost embarrassing extent. Figures published by the Office for National Statistics earlier this month showed that productivity in France is 29.4% higher than in Britain.

Now I have always argued that this is because Britain is a higher employment, lower-investment economy than France, where restrictive labour laws discourage employment and, where it is an alternative, encourage firms to invest. While a machine gets on with it, a French worker responds with a Gallic shrug. But that French worker has significantly more capital equipment at his or her disposal than their British equivalent.

I still think that is the essential part of the story but it is not the only part of the story. A businessman I met a few days ago, who operates plants in Britain and France, told me that if he wanted something done quickly and well, he would look to his French workers, who are more efficient. I am not suggesting for a second that this is typical. Even the 35-hour week, hated by most businesses, may have the effect of making workers more productive in the hours they are employed.

I am not going to go overboard on this. We would not have just had the first round of the presidential election that we did, in which all the mainstream political parties were wiped out, if there was not widespread discontent in France. Much of that discontent arises from the state of the economy.

Though unemployment has started to edge lower, it is still 10% of the workforce, more than double Britain’s 4.7% rate. Unemployment among the under-25s is scarily high, at nearly 24%, almost twice the UK rate.

The employment rate, the proportion of 16-64 year-olds in work, is at just over 64% roughly 10 percentage points lower in France compared with Britain. Though there is no automatic trade-off, French society would benefit if some of its high productivity were traded for higher employment.

Britain still has a slightly larger economy than France, though these days it is very close, and dependent on small movements in the euro-sterling exchange rate. There have been times in recent months when the pound has been low enough to push French GDP above Britain’s.

France perhaps tells us, more than anything, that you can throw a lot of bad policy at an economy and do less damage than you might expect. France has had more of its share of bad policy in recent years but continues to have a lot of strengths. The French state is far too large and the labour market is tied up in too much red tape.

The Macron reforms have been criticised for not being radical enough. But they are a step in the right direction and he has been smart enough to recognise that if you spell out too many of your intentions, which will create some losers, you diminish your chances of election. Margaret Thatcher recognised that in 1979, with a manifesto which was far less radical than she turned out to be.
We will know next Sunday whether Macron has judged it correctly, and we will know in a few weeks whether the parliamentary elections have produced an outcome he can work with.

One thing, however, is clear. France has been a strong competitor even when held back by misguided policies. With some of the right policies, it could become a much stronger one.

PS A few months ago, 0.3% UK growth in the first quarter would have been regarded as good news. Friday’s figures were, however, widely seen as a disappointment. The economy grew, but at half the rate it averaged in the second half of last year. GDP per head rose by just 0.1%.

Though the figures were a little weaker than expected, the slowdown should not have come as a huge surprise. The rise in inflation, much of it down to the pound’s Brexit fall, has already eaten into the growth in real wages, as described here recently. Retail sales recorded their first fall for four years in the first quarter, and their biggest for seven years. As the Office for National Statistics noted, in describing the GDP figures, “there were falls in several important consumer-focused industries, such as retail sales and accommodation”.

The story of Britain’s economy is quite straightforward. Consumer spending has kept it going since the referendum. When spending slows, as it was bound to given that borrowing and the rundown in savings could only go so far in the face of a squeeze on real incomes, the economy will slow. When the dominant service sector which accounts for four-fifths of GDP slows, as it did from 0.8% to 0.3%, so will the economy. The other parts of the economy -production, construction and agriculture – grew by 0.2%-0.3%. Manufacturing was a bright spot, up 0.5%, but it is barely an eighth of the size of the service sector.

Weaker consumer sending will dominate the outlook for the next year or so, for entirely predictable reasons. As it is, growth in the first quarter was a lot weaker than the Bank of England thought – its staff expected 0.6% according to the monetary policy committee’s March minutes. So households will be spared higher interest rates for a while longer yet.

Sunday, April 23, 2017
Hard decisions will be ducked in this Brexit election
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

It is hard to think it was only two years ago. Then, in the run-up to the 2015 election, it was important to dig into the economic policy agenda offered by Ed Miliband and Ed Balls for Labour, and contrast it with David Cameron and George Osborne’s for the Tories.

Labour’s plans included, for those who have forgotten, no plan for a budget surplus but instead continuing to borrow to invest (in practice about £90bn more debt by 2020 according to the Institute for Fiscal Studies), but alongside a “budget responsibility lock”, bringing back the 50% top rate of tax and a mansion tax.

Apart from the fact that it looks as if we will end up with something like the fiscal numbers set out by Labour two years ago, and not the budget surplus promised by the Tories, so much has changed). We did not get the 50% tax rate or the mansion tax, though some say Osborne’s stamp duty reforms were worse.

And, as we head into another election, which even tests the appetite of an enthusiast like me, the rules of the game have been transformed. So far has Labour moved away from the political mainstream, and so distant is the main opposition party from returning to government, that it is not worth spending time on its economic plans.

The shadow chancellor could propose a 100% tax rate on anybody with two pennies to rub together and we could still relax in the knowledge that it is never going to happen. In all the time I have been writing about these things, there has never been anything quite like this.

The other rule-breaker, and for similar reasons, is that governments usually seek to ensure that voters are nicely buttered up in time for a general election, and feeling confident about the future. But consumer confidence, while a little higher than immediately after last summer’s referendum, is 10 points lower than it was in April 2015.

Households are more upbeat about their own finances than about the economy, with a net 20% expecting the economy to get worse over the next 12 months. The squeeze on people’s real incomes has begun, as I wrote last week. Figures on Friday showed that retail sales suffered their first quarterly fall in four years and their biggest in seven. As Andrew Goodwin of Oxford Economics puts it, the attitude of consumers “appears to have been one of jam today, which leaves very little for jam tomorrow”.

Such “pocketbook”, or wallet, concerns would normally be uppermost in the concerns of election planners. But the Tories under Theresa May are so far ahead in the polls that, as I say, the normal rules do not apply. The last Tory prime minister to gamble and fail on turning a small majority into a larger one and failing was Edward Heath in his “Who governs Britain?” election of February 1974. But, though he won the popular vote, he lost the election, and in the run-up to that the Tories were neck and neck with a more formidable Labour party, not more than 20 points ahead. Accidents do happen but this would be without precedent.

The normal rules do not apply, partly because of the state of Labour under Jeremy Corbyn but mainly because this is the Brexit election. And, from the perspective of Brexit, it makes perfect sense.

It means the negotiations do not nudge up uncomfortably against the next election. It improves the chances of a “softer” version of hard Brexit, as described in detail here three weeks ago. If the hardliners in her own party are neutered, it gives May more opportunity to make concessions, as she will undoubtedly have to do. It means that the necessary transition arrangements, beyond 2019, can be put in place.

It also greatly reduces the risk of a suicidal, cliff-edge “no deal” departure from the EU, which is why sterling has risen in the wake of the election announcement.

What is good for the Brexit timetable and the government’s negotiating position is not necessarily good in other respects. One of the fears about Brexit, that it would divert attention from everything else, is coming to fruition. The Brexit parliament was supposed to be 2015-20. Now it is 2015-17 and 2017-22 combined, unless the prime minister decides in two or three years that she has struck such a good deal that she should have it endorsed in another election. I suspect that the parliament after 2017-22, will be taken up a lot with Brexit too.

In the context of this election, it means all the hard questions will again be ducked. As Paul Johnson of the IFS wrote a couple of days ago: “At the heart of the choices we face is one over the size of the state that we want, and how to pay for it. This is a question which politicians always duck.”

They will do so more than ever this time. The Tories will leave themselves with fewer hostages to fortune than in 2015, when they ruled out increases in all the main taxes. But there will be considerable continuity, for example on arising the personal allowance and the higher rate threshold, to £12,500 and £50,000 respectively. There are hints that the Tories will take the sensible step of promising to scrap the co-called triple lock on pensions, though if so they will surely sweeten the pill for pensioners. Labour will continue to pretend that soaking the rich will pay for everything.

What this means is that, barring a sudden outbreak of candour on the part of the Tories, putting the public finances onto a permanently sounder footing will be deferred.

A few weeks ago the Office for Budget Responsibility (OBR), published its annual fiscal sustainability report. With a few other things going on it did not get the attention it deserved. It defines the country’s fiscal position as unsustainable if the government needs an ever-increasing share of national income to pay the interest on public sector debt.

On that definition, or any other, Britain has an unsustainable fiscal position. The ageing population , together with developments in health technology and the increase in chronic health conditions, will push up spending on the National Health Service and pensions, while leaving revenues broadly unaffected.

The numbers are frightening. Health spending will double from roughly 7% of gross domestic product to over 12.5% over the next 40-50 years, with state pension costs up from 5% to 7.1% of GDP and social care costs doubling to 2% of GDP. After stabilising in the short term, at 80%-90% of GDP, public sector net debt will head up to 230% of GDP and beyond.

These are long-term projections, and as somebody once said in the long run we’re all dead, but the sooner you act on a problem, the better the chances of preventing a dangerous trajectory from developing. As a rough guide, raising taxes or cutting spending by 4% to 5% of GDP, approaching £100bn, would be needed in the next parliament to put the public finances on a more stable footing.

Will we hear that spelled out in the next few weeks? No. The prime minister will surely decide, with Brexit at the forefront of her thoughts that, to coin a phrase, now is not the time.

Sunday, April 16, 2017
Pay hit again by the shrinking pound in your pocket
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

The squeeze is back. Real wages have stopped growing in Britain, a few months earlier than expected, thanks to the combination of rising inflation and sluggish pay growth.

After just over two years in which households appeared to have put the financial crisis behind them, and average earnings comfortably outstripped the rise in prices, a couple of years in which real wages fall is in prospect. Regular pay rose by just 0.1% in the year to the December-February period, and that tiny rise looks to be the last for a while.

The first and prolonged fall in real wages from mid-2008 to the autumn of 2014 was directly attributable to the crisis. It was the mechanism by which living standards fell to reflect Britain’s permanent loss of gross domestic product; the lost growth that will never be recovered.

This second fall in real wages reflects two things. Weak oil and commodity prices provided the basis for the recovery in real incomes from autumn of 2014, with the plunge in oil prices from $110 a barrel in mid-2014 to below $30 a barrel in early 2016. The partial recovery from that fall has been one factor pushing up inflation.

The other is sterling’s Brexit-related drop. The pound’s fall, which was the direct result of last summer’s referendum result, and to the Theresa May’s approach to the negotiations – no single market and no customs union – is now the factor coming through most strongly in the inflation figures.

One way of measuring the sterling effect is the difference between Britain’s inflation rate last month, 2.3%, and that in the eurozone, 1.5%. That difference will grow in coming months as inflation in Britain heads towards and possibly above 3%.

This second fall in living standards is the adjustment to what the currency markets, and the majority of economists, think will be a poorer, slower-growth future as a result of Brexit. The fact that we have been here before in terms of falling real wages, and quite recently, may or may not make it easier to bear.

Real wages are, of course, made up of two components. Inflation is one, growth in wages in cash terms, what economists would call nominal wages, the other. The fact that it only takes a small rise in inflation above the official target of 2% to squeeze real wages shows how strangely depressed is the growth in real wages.

Britain’s unemployment rate is currently a very low 4.7%, which is good news. The last time it was this low, in August 2005, average earnings were growing by 4.7%, roughly double the current. If you believe in anything like a traditional Phillips curve – in which falling unemployment pushes up the growth in wages and vice versa – earnings should be growing a lot faster.

Why are they not doing so? A couple of candidate explanations can be quickly ruled out. One is public sector pay policy, which limits most workers to a 1% increase. But, while public sector earnings are growing more slowly as a result, just 1.4% a year at present; the increase in regular pay in the private sector, 2.4%, is also much weaker than past relationships would suggest.

Is it all down to those migrant workers from the EU? We are seeing the first signs of a reduction in EU migrant workers who, contrary to what you may have read in recent days, come here overwhelmingly to work. Unemployment among EU nationals In Britain is under 4%.

There is, meanwhile, no evidence that UK migrants have pulled down wages to any significant extent. Steve Nickell, formerly of the Bank of England and Office for Budget Responsibility, saw his words to a parliamentary committee last year seized on by the anti-migrant lobby. But, as he pointed out recently, any impact on wages, even for the unskilled in Britain, has been “infinitesimally small”.

Meanwhile, migrant workers from the EU14 – the other members before Eastern European enlargement – are the highest paid of any group in Britain, according to new research from the Office for National Statistics. Two in every five EU migrant workers are overqualified for the jobs they do.

If not public sector pay and migrant workers then what? Though the rise in employment has slowed, and in the latest three months was just 39,000, its composition has improved. So one explanation for weak pay growth, that there was insecurity at the heart of Britain’s job creation machine, reflected in part-time, temporary and zero-hours jobs, is losing its explanatory power.

The ONS, analysing the latest labour market figures, noted that a “compositional shift” from part-time to full-time employment is occurring. The share of part-time employment reached a record high of 27.6% in 2012, in the wake of the crisis, but has now dropped to 26.5%, just above its pre-crisis average of 25.5%. The proportion of part-timers who cannot find full-time work has dropped from a 2013 peak of 18.4% to 12.6%. All this should be consistent with rising wage pressure.

Even weak productivity, itself a long-standing explanation for weak wages, does not tell the full story. Productivity, output per hour, is up by 1.2% over the past year, which is nothing to write home about but is a lot stronger than the rise in real wages. In fact, real wages in recent years have lagged behind even a disappointing productivity performance.

The weakness of wages, on the face of it puzzling, may be easier to explain than appears. Firms can point, not just to the fact that the past few years have been ones of uncertainty, with another layer added on to that uncertainty by Brexit, but also to other demands, from pensions through to business rates and the apprenticeship levy. Some have been particularly affected by the national living wage, which this month has risen by an inflation-busting 4.2%. They are in no mood to grant bigger pay increases than they need to.

Employees, meanwhile, seem to be happy with a 2% pay norm, and less willing to move jobs in search of higher pay than in the past. If an acceptable pay increase a few years ago was 4% or 5%, now it is 2%. Some would say that stronger unions would break us out of this new norm, and perhaps they would, but only at the expense of higher unemployment.

If pay sticks at about 2% while inflation moves higher, does that guarantee weak consumer spending? Not necessarily. During the long squeeze on real wages which ended in 2014, spending was kept going by rising employment; even if individuals were squeezed, the overall wage bill was increasing. Households can borrow, or run down savings, as they did in the second half of last year. The more they see the squeeze as temporary, the more they are likely to “look through” it, though borrowing tends to fall when real incomes are squeezed.

The “look through” point also applies to the Bank of England. Most of its monetary policy committee intends to look through this period of above-target inflation, unless or until wage growth accelerates significantly, which would be seen as embedding higher inflation into the economy. If the growth in earnings stays more or less where it is, the Bank will be reluctant to hike rates.

I am not sure about the wisdom of this. There is a danger in tying monetary policy to any one indicator. If, indeed, we are in a period when wage growth trundles along at 2% indefinitely, and this is the new equilibrium, it implies that the so-called normalization of interest rates will never happen. Rates would stay at the “emergency” near-zero levels established at the height of the crisis. That cannot be healthy.

Sunday, April 02, 2017
The inscrutable in pursuit of a softer Brexit
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

If you were looking for single word description of our prime minister it would be inscrutable. Her ability to pad away difficult questions with non-answers rivals that of Geoff Boycott. When it comes to inscrutability, the Great Sphinx of Giza has nothing on her.

It would be unwise therefore to read too much into the tone of her letter on Wednesday to Donald Tusk, the European Council president, invoking Article 50. Perhaps, apart from an eye-catching link between trade and security co-operation, which nobody in Europe seems to have much minded, she was just being polite.

But, having warned myself off, I will read something into it anyway. It is that, having talked the language of hard Brexit over the past nine months, not least to convince the Brexiteers in her party that she as a Remainer could be trusted, she is now embarking on a softer and more pragmatic course.

The hard Brexit language – no single market, no full membership of the customs union, reflecting the will of the people on EU migration, no deal is better than a bad deal – will still be wheeled out from time to time.

But it is now possible to see something softer emerging, assuming it can be negotiated and is acceptable to the other members of the EU, the so-called EU27.

What would this kind of softer Brexit entail? In talking to businesses, I have always seen it as including the following. It would involve, not single market membership but a comprehensive trade deal with the EU. Britain would have no influence on drawing up single market rules and directives, as May has conceded, but, except in the few cases where they are inappropriate or irrelevant, British business would still abide by the rules of our biggest market.

There would also be lengthy transitional arrangements, providing for a gradual adjustment for business to a post-Brexit world, as the prime minister has hinted. Nobody with any sense should have any problem with this. There were transitional arrangements stretching for at least eight years when Britain joined the European Economic Community in 1973. If they were appropriate on the way in, they are even more suitable on the way out.

There would be a continuation of significant migration to Britain from the EU27, though employers would have to go through a few more hoops, including visas and work permits. The hope is that these would not be as bureaucratic as the current arrangements for non-EU skilled migrants. Whether overall immigration would fall remains to be seen. In the short-term there is evidence of a drop in skilled EU migration to Britain.

Britain would continue to pay into joint EU-UK schemes post-Brexit, not in the sense of a direct budget contribution, but more in the way that Norway does currently. The full Norway option, which includes membership of the European Economic Area and thus the single market, is not currently open to Britain because it would require free movement of people. That may change, though it would be unwise to rely on it.

As an exercise in damage limitation, such a softer Brexit would beat the alternatives. Britain would formally exit the EU, as the referendum required. It would chime in with public opinion, which in the main wants control of Britain’s borders – hence visas and work permits – but recognises the need for EU workers and is concerned about the trade effects of Brexit. Some would baulk at any payments to Europe but that is probably not an insurmountable barrier.

Something as close as possible to single market membership would still be inferior to what we have now. Apart from losing the ability to influence the rules, Britain would no longer have the opportunity to push for greater liberalisation of trade in services, where much of our comparative advantage lies. As we are already seeing, there will be some loss of activity to the EU in services, particularly financial services, but the hope will be that this can be kept to a minimum. Employing EU migrants will involve more bureaucracy than now, which could affect smaller firms in particular.

A useful report from Open Europe, “Nothing to declare: A plan for UK-EU trade outside the Customs Union”, makes 12 good points about how to make the best of the new situation. Britain, it says, cannot be half-in, half-out of the customs union (the common external tariff and common commercial policy) if it wants to negotiate future trading arrangements with the rest of the world. But an extension of customs union membership for up to two years beyond 2019 makes sense.

Future trade between Britain and the EU will not be frictionless, it notes, creating difficulties for sectors with complex, cross-border supply chains, such as the motor industry, and there will be costs associated with leaving the customs union. But those costs can be minimised with a free trade agreement which seeks to avoid most of the difficulties over so-called rules of origin. This can be achieved by what is known in the jargon as liberal cumulation, under which products that are substantially transformed in the UK or EU, in other words put together from components imported from elsewhere, are assumed to originate there.

The Open Europe paper , recognising that it will take time, probably many years, to negotiate new trading arrangements with the rest of the world, says Britain should seek to replicate, or “grandfather” the 30 free trade agreements the EU has concluded with more than 60 non-EU countries, including the recently concluded agreement with Canada. Given that Tusk, in his reponse to the prime minister, has said no to this, some work will be required. In time, assuming it can be done, those deals may or may not be replaced with bespoke UK deals.

Where there will be scope for improvement, according to another interesting paper, “Post-Brexit trade and development policy”, is in Britain’s trading relationships with poorer countries; the developing world. The paper, published by the Centre for Economic Policy Research, by Richard Baldwin, Paul Collier and Anthony Venables, notes that it will take many years to secure new trade agreements with other advanced economies, including America.

But there will be early scope for making friends and influencing people, and standing Britain in good stead for the future, in negotiating speedy deals with developing countries. These, currently subject to EU agricultural and in many cases industrial protectionism, could be good be good for both the countries themselves and for British consumers.

As the authors put it: “While the British government faces massive complexities in its trade-policy dealings with the EU and other advanced economies, it could, almost instantly, launch bold trade-policy initiatives with respect to developing nations.”

That is food for thought. On the wider point, how likely is a Brexit at the softer, and therefore less damaging end of the spectrum? These are early days. There is the question of the Brexit exit bill, estimated by the influential Bruegel think tank to be between €25.4bn (£21.9bn) and €65.4bn (£56.4bn), and which the EU wants agreement on early. There is the question of what will be acceptable to some of the headbangers and hardliners on the Tory benches and beyond. There is the question of Gibraltar.

A deal can be done. Whether it is a good one remains to be seen. It could yet be a case of the inscrutable in pursuit of the impossible.

Sunday, March 26, 2017
Upbeat manufacturers and the drag from rising costs
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

They are the two sides of the same pound coin. Sterling’s sharp post-referendum fall has pushed inflation above the 2% target and is squeezing household incomes but it is also providing a boon for exporters.

Ben Broadbent, one of the Bank of England’s deputy governors, pointed out in a speech on Thursday that the weaker pound boosted export prices, in sterling terms, by 12% during the course of last year.

Though the pound has perked up a little in recent days that effects, which as Broadbent says “will have significantly boosted exporters’ profitability” is still coming through.

No part of the economy is more exposed to these conflicting effects than manufacturing. For manufacturers, 2.3% inflation – the latest reading for the consumer prices index – is child’s play. They have seen a 19.1% rise in raw material and fuel costs over the past year.

They are also, it is clear, benefiting from the upturn in exports as a result of the weak pound. The latest CBI industrial trends survey, published last week, showed export order books at their healthiest since December 2013, with total order books close to a two-year high and output expectations buoyant.

Surveys by the EEF, the engineering employers’ federation, which represents manufacturers, have shown a similar strong picture, as have recent official figures. The surveys show that industry’s optimism is tempered by its concern over sharply rising costs, but that there is optimism nonetheless.

So how will these two factors balance out? Is it time to celebrate the early stages of a sustained revival in manufacturing, one that we have been waiting for a long time, or will this be another false dawn? Some context is useful here.

Though the latest official figures showed a dip in manufacturing output in the early part of the year, they also recorded a rise of 2.1% in the November 2016-January 2017 period. That, incidentally, was the best three-monthly performance since May 2010.

The comparison is a reminder that there have been high hopes for manufacturing before in the post-crisis period. For a while at least, it seemed that industry would be boosted by sterling’s big 2007-9 fall during the crisis and the fact that the service sector, particularly financial services, would be hobbled by a significant post-crisis hangover.

Britain’s manufacturers were, however, quickly hit by a combination of the eurozone crisis and weak domestic demand, and had a disappointing 2-3 years. Almost as soon as George Osborne had uttered the words “march of the makers”, the sector began to struggle.

2014 was a good year for the economy and for manufacturing, with factory output up by 2.9%. The following two years were, however, disappointing, however, with output slipping by 0.2% in 2015 and growing by just 0.8% last year.

The result of all this is that, even after its recent revival, manufacturing has yet to get back to where it was before the crisis; even after its recent revival its output is 3.3% lower than the pre-crisis peak in January-March 2008. The service sector was not so hobbled after all; its output is almost 14% up on the pre-crisis peak.

What about now? In the eye of the sterling storm, it is important to remember that the same factor affects the various parts of manufacturing in different ways. George Nikolaidis, a senior economist at the EEF, points out that for high-value manufacturers, including aerospace, capital equipment and automotive, the net effect of a lower pound is positive. For these sectors exports are receiving a boost, and that more than outweighs the impact on costs. Other “commodity” parts of manufacturing, including basic metals and basic pharmaceuticals, are also receiving a leg-up.

We should never forget, however, that many manufacturers do not export at all, particularly smaller firms, and so for them sterling’s fall simply adds to costs and does not produce any offsetting benefits. Large parts of food and drink manufacturing, textiles and the building supplies sector are in this position.

How will all this balance out? The EEF champions manufacturers but is far from upbeat about prospects for the next couple of years. It expects manufacturing growth of just 1% this year, slowing to a mere 0.1% next. Weaker growth in consumer spending will hurt domestic-facing businesses, while subdued business investment will hold back firms making capital equipment. If the EEF is right, the net effect will be that manufacturing output will still be below pre-crisis levels in two years’ time, so a lost decade for industry.

What of the longer-term? As I have written before, it would be a huge failure of negotiation if Britain and the EU cannot come up with a decent trade deal for goods, and hence manufacturers. The biggest problems are likely to arise for services.

So should manufacturers be investing, at least in those sectors which benefit from sterling’s weakness, or holding back as the EEF and others expect? They face, as Broadbent pointed out, “a somewhat tricky decision”.

Even for those sectors currently benefiting from the weak pound, higher costs will eventually come through to limit any long-term benefits. That has been the story of Britain’s past devaluations. What he describes as a “sweet spot” will not last.

If, on the other hand, the currency markets have got it wrong, the post-Brexit outcome for Britain’s economy in overall terms is better than feared, then one obvious consequence would be that the pound would claw back some, or all, of its losses. The competitive advantage would be more directly lost.

Though some argue that the pound was overvalued before last summer, there is no good evidence of that. Washington’s Peterson Institute, which pioneered the measurement of so-called fundamental equilibrium exchange rates, suggested that the right rate for the pound in April last year was $1.52.

Either way, businesses may want to wait and see. That leaves, Broadbent says, an argument for investments in manufacturing with “short-term payoffs”. Some exist. Mostly, though, manufacturers like to plan and build for the longer-term. The double-edged coin that is represented by sterling’s fall makes it harder for them to do so.

Sunday, March 19, 2017
After the U-turn - thank the self-employed for Britain's jobs' miracle
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

It might be an age thing but the pace of life these days can be dizzying. There was a time when budgets rarely unravelled, and even bad and unpopular measures were seen through to the bitter end. Then, more recently, they started unravelling, but not usually for a few weeks.

Now Philip Hammond has set something of a record, though not of his own making, by dropping his main budget tax-raising measure, the 2 percentage point increase in Class 4 national insurance contributions (Nics) within a week.
Though I argued last week against this tax hike on the self-employed, I am not going to crow about the U-turn. The chancellor has enough enemies. He and the Treasury will take comfort from the argument that they were trying to do the right thing by the public finances and the tax system; correcting important unfairness in the latter. They will argue that politics got in the way of good economics.

I am not sure about that. The Nics’ increase is dead, for this parliament at least, so is water under the bridge. But the review that Theresa May commissioned from Matthew Taylor, chief executive of the Royal Society of Arts, will still be published in the autumn and could recommend enhanced rights for the self-employed. Taylor backed the increase in Nics though said it should not go any further.

The rise in self-employment has been a key contributor to the employment “miracle” in Britain in recent years. Without it, we would have seen a decent post-crisis jobs’ recovery. With the growing army of the self-employed, we have seen a record employment rates, and an unemployment rate, 4.7%, which equals the lowest since the mid-1970s.

The question is whether, once you start to tamper with the self-employment model we have in Britain, which is less-regulated, lower-taxed and on average lower-waged than employment, you kill it off. Has the self-employment boom, in other words, only been possible because of the existing model?

Looking at the numbers, there are 4.8m self-employed people in Britain, 3.44m of them full-time self-employed and 1.37m part-timers. The increase in the number of self-employed people in the past eight years, 1m, compares with a rise of 500,000 in the eight years leading up to the crisis. Without it, the employment rate would be closer to 72% than the current 74.6% record, and unemployment near to 2.5m, or nearly 7.5% of the workforce, instead of 1.6m and 4.7%.

Nor is there evidence of any slackening in self-employment growth. In the latest three months there was a rise of 49,000 in self-employment, almost three times the 17,000 increase in the number of employees. In the past 12 months the figures were 148,000 and 144,000 respectively.

What has been driving the boom in self-employment? A number of factors. Some of it has been straightforward preference. People like self-employment because it offers greater freedom and variety, and not just in the gig economy. For some businesses, it is easier and cheaper to employ contractors than take on full-time staff.

Advances in information technology, meanwhile, have made it easier and cheaper for people to work from a distance and freelance, although that does not explain why the rise of self-employment has been greater in Britain than in most other countries.

Labour market conditions matter. In the aftermath of the crisis, when there was initially a fall and then barely a recovery in the number of employees, many people saw self-employment as an alternative to unemployment. By becoming self-employed they kept their hand in and, while this may have been involuntary self-employment initially, most of those who became self-employed in this way did not return to traditional employment when the opportunities arose to do so.

No story of self-employment is complete without a reference to pensions. A good company pension was once a powerful argument for being and remaining an employee. The decline in company pensions has, however, reduced the attractions of being an employee. At the top end of the scale, where the highly paid have run up against the government’s lifetime allowance, now just £1m, the argument for staying in a company scheme, and therefore in a company, has diminished.

The years of declining pensions, thanks both to government action and ultra-low long-term interest rates have had another self-employment effect. The glory days of retirement in your 50s with a generous pension have long gone for most people. These days, many more need to top up their inadequate pensions with a self-employment income.

How much has the rise in self-employment been driven by its tax advantages? A couple of years ago the Office for Budget Responsibility identified that some of the rise in self-employment may have been driven by access to tax credits. Around a fifth of the self-employed are in receipt of such credits. At the margin this, and lower Nics, will have driven some of the rise in self-employment. I doubt, however, that it explains much of the rise.

The rise of self-employment has been an undoubted boon for the economy, contributing to much better labour market numbers and, overall, helping the public finances, when compared with the alternative of these people not working and not contributing to tax revenues, and drawing more from the state.

The Resolution Foundation, the think tank which emerged as the strongest backer of the move, surprised me more than a little. One of the debates I have had with it in recent years has been over the earnings of the self-employed. Only six months ago it reported that the typical real earnings of the self-employed are lower than they were 20 years ago, and on a like-for-like basis they have fallen significantly since the crisis. This is an odd context to hit somebody with a tax hike.

What about the question, raised by former Treasury officials and others, that if raising taxes is so difficult, we cannot be serious about deficit reduction, and so everybody should have supported the rise in self-employed Nics?

The flaw in this argument is that it is a bit late in the day. The one big tax rise during the government’s deficit reduction programme, the 2001 increase in Vat to 20%, has mostly been given back in the form of increases in the income tax personal allowance, the long freeze in excise duties on petrol, and so on. If there is a need for higher taxes to reduce the budget deficit, they should apply to all taxpayers, not smaller groups. I doubt after last week we will be seeing that from the chancellor, however.

From the government, meanwhile, it will be important to nurture self-employment, not stifle it. That should be the good news from this U-turn.

Sunday, March 12, 2017
Now, more than ever, we need productivity to move up through the gears
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

When it comes to budgets, there are some eternal verities. One is the contrast between the picture of the economy painted by the chancellor and the reality of the numbers. Another is the ability of chancellors to get into political hot water even when apparently treading with the utmost care.

George Osborne managed to do so a year ago when trying not to frighten the horses ahead of the referendum. Philip Hammond has followed his predecessor into the mire by announcing increases in Class 4 national insurance contributions for the self-employed and cutting the dividend tax allowance from £5,000 to £2,000.

In the speech the chancellor lauded the “entrepreneurs and innovators” who are the lifeblood of the economy and said he wanted Britain to be the best place in the world to start and grow a business. But fine words butter no parsnips for those facing these tax hikes.

I do not want to dwell on Hammond’s NI problem and his breaking of what was not a very sensible manifesto promise; no government should tie its hands by ruling out increases in the major taxes. But suffice it to say that the contributory principle, which he used to justify raising the contributions of the self-employed, has worn rather thin in recent years.

And, while tax neutrality is a laudable aim, the implicit understanding has always been that the self-employed deserve to be cut some slack because their incomes are less secure and because they do not enjoy the employment rights of the employed. The £500m a year the NI increases will bring in when fully in place could have been secured in other ways, notably by a modest increase in fuel duty, which would probably have been more palatable to white van man. In net terms, after other NI changes, they will bring in only £145m a year.

Not only that, but if you really wanted to tackle the discrepancies in the system – the chancellor cited a £32,000 employee attracting £6,170 of NI contributions and a self-employed person on the same income just £2,300 – you would address the biggest source of that discrepancy, which is that employers pay 13.5% contributions for their employees, but not self-employed contractors.

Anyway, no doubt this will all come out in the wash in the autumn. The Treasury seems determined not to U-turn on the NI increase, though we have heard that at this stage before.

What I did want to focus on was the big disappointment in the budget, the fact that the government’s fiscal watchdog, the Office for Budget Responsibility (OBR), sees virtually no follow-through from the recent better performance of both the budget deficit and growth.

On the deficit, the OBR attributes this year’s (2016-17) big undershoot, from the £68.2bn it predicted in November to £51.7bn now, to one-off effects and methodological changes. After five years it thinks the deficit will be slightly larger than it predicted late last year. Cumulative borrowing will still be roughly £100bn more than it predicted a year ago.

While revising growth up from 1.4% to 2% this year, largely on the back of the economy’s stronger performance at the end of last year, the OBR sees this short-term strength fully offset by weakness later. In fact the economy ends up fractionally smaller in 2021 than it expected in November.

There are a couple of reasons for this. One is that recent growth, driven by consumers dipping heavily into their savings, is seen by the OBR as unsustainable. The other more important reason is that the watchdog thinks the economy is close to full capacity, indeed slightly above it, so future growth will be constrained by the growth in productivity, which the OBR thinks will recover only gradually.

On consumer spending, it offers alternative “boom” and “bust” alternatives. Under the boom scenario, consumers carry on running down their savings and to keep on spending and the economy grows by 4% this year, before slowing abruptly thereafter. Under the bust, consumers rein back, the economy shrinks by 0.5%, and then resumes growth at a far stronger rate. But while the journey is different, the end-point for the size of the economy is the same.

As it happens, I think the OBR is right to take a cautious attitude about the outlook for both growth and the public finances, given the uncertainties ahead. Some economists think it is still too optimistic. But if you wanted to play devil’s advocate, however, you could say that its approach to medium-term forecasting, while very logical, is also rather rigid.

Spare capacity in modern economies, particularly a service-based economy such as Britain’s, is a bit of a will of the wisp. Unemployment rates that in the past would have provoked bigger wage rises no longer do so. The OBR, in common with the Bank of England, has revised down its so-called equilibrium unemployment rate as a result. Expanding service sector activity does not necessarily require a big increase in investment or staff numbers. Caution, as I say, is justified, but the economy’s ability to grow may be more flexible than the OBR has allowed for.

Where we would entirely agree is that the circle would be squared for the economy in so many ways if productivity – output per hour - were to be stronger and come back more quickly than it and other forecasters expect. The OBR expects a gradual pick-up in productivity growth to 1.9%, just below its long-run average, by the early 2020s, though it has been over-optimistic on productivity before,

That slow pick-up will mean, as Paul Johnson put it in the Institute for Fiscal Studies’ post-budget briefing: “Average earnings will be no higher in 2022 than they were in 2007. Fifteen years without a pay rise. I’m rather lost for superlatives. This is completely unprecedented.”

Suppose that, instead of a slow crawl back towards normal for productivity growth, there was a period in which it grew faster than the norm, say 2.5% or 3% a year, clawing back some of the huge gap that has opened up since the crisis.

In those circumstances, the economy’s capacity to grow would be hugely enhanced, households would spend out of real wage rises justified by higher productivity rather than savings, and the budget deficit would be eliminated within the foreseeable future.

Could it happen? Even Hammond’s best friends would concede that, welcome though his measures were, including the new “T-levels” to boost technical skills and training, they and other aspects of his productivity agenda will take very many years to make a difference, and that difference may be small.
Productivity does not, of course, rely only on government. If, within every sector of the economy, low-productivity firms matched the performance of the best, Britain’s productivity position would be transformed.

Until that happens, we have another contrast between what chancellors say in their speeches and the reality. He wants Britain to be “at the cutting edge of the global economy y”. We have an economy with low productivity which relies too much on consumers running down their savings. As the chancellor said, “there is no room for complacency”.

Sunday, March 05, 2017
Better news - but look before you leap, Phil
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

Philip Hammond would rather he did not have to present a budget this week. We know that because, in November, he told us so. The spring budget, he said, had outlived its usefulness, providing chancellors with more opportunities to tinker than is healthy. In future, there will be a single budget in the autumn.

His reluctance may also be because, not for the first time, great things are expected within Theresa May’s government, and probably on Tory backbenches, of this final spring budget. The chancellor is expected to apply some hefty sticking plaster to the social care crisis, ease the burden of business rate changes for the hardest hit firms and provide one or two crowd pleasers for households squeezed by the rise in inflation. There is a bigger demand on him, which is to ameliorate the pressure on low-income and vulnerable households from spending cuts.

For the Treasury, this week’s budget carries an added danger. Had the books been closed for a year in November, when Hammond presented his autumn statement, the Treasury would have had little difficulty fending off demands for largesse.

At the time, the Office for Budget Responsibility (OBR) unveiled a cumulative, like-for-like increase in public borrowing of £114bn by 2020-21, compared with its projections last March, mainly due to weaker actual and potential economic growth, and its resulting impact on tax revenues and spending. There was also a smaller effect from deliberate policy actions; mainly increased capital spending by the chancellor. The OBR wiped away George Osborne’s ambitions of achieving a budget surplus; under Hammond there would still be a deficit of nearly £21bn in 2020-21.

There was an even bigger addition to government debt, up £210bn by 2020-21 to £1,950bn. Debt was predicted to rise by more than the increase in borrowing because the Bank of England’s term funding scheme for the banks counts as an addition to debt.

Since then, however, as a result of methodological changes, stronger economic growth than feared and reasonably healthy revenues, the position has improved. The picture unveiled by the OBR this week will be better than it expected in November, with an upgrading of growth and a downgrading of public borrowing, though still considerably worse than it was projecting a year ago.

The Resolution Foundation, a think tank, estimates that the projected improvement in the public finances between now and 2020-21 will £29bn. John Hawksworth at PWC estimates a £45bn cumulative improvement relative to November by 2021-22.

Will the OBR agree? When the latest official figures for the public finances came out a few days ago, the fiscal watchdog took the unusual step of conceding that there will be a significant undershoot this year compared with its November forecast. Instead of the £68bn borrowing it expected then, that points to a new estimate for this year of between £55bn and £60bn.

The OBR also cautioned, however, that this undershoot did not necessarily have implications for borrowing in future years, though it will be surprising if there is not some follow-through to 2017-18 and future years.

So is the way open for Hammond to splash some cash, to spend some of this borrowing windfall? At moments like these, chancellors are like those fictional characters with a devil on one shoulder and an angel on the other, each whispering furiously into the nearest ear.

People will have different views on which is the devil and which the angel in this context but on one side will be those urging Hammond to use his mini windfall to ensure that the government’s tricky task in coming years is not made even trickier by clumsy changes in business rates, deficiencies in social care that are giving the National Health Service an air or permanent crisis, and welfare cuts that look brutal in the context of rising inflation.

On the other are the guardians of the public purse at the Treasury. They know that any improvement in the public finances since November is relative. The big picture is one in which the government is still borrowing far too much at this stage of the cycle and has yet to stabilise debt. The Treasury is also keenly aware that there are uncosted pledges within the public finances. Fuel duty, for example, seems stuck at present levels for political reasons, and that is increasingly expensive. The government has pledged to increase the personal income tax allowance to £12,500 and the higher rate threshold to £50,000, and to cut corporation tax to 19%.

Which voice will be stronger? Hammond is a fiscal conservative. He knows that one way to ensure that Britain maintains the confidence of international investors during the uncertain negotiations that lie ahead will be to demonstrate that the government retains its grip on the public finances. He knows also that there will be difficult times ahead, during which the demands for Treasury largesse will be even greater than now.

He also knows that improvements in the public finances can flatter to deceive. Osborne had a mini windfall from down the back of the fiscal sofa in November 2015, only to see it and more snatched away from him four months later. As Robert Chote, head of the OBR, observed: “What the sofa gives, the sofa can easily take away.“

The underlying picture for the public finances, meanwhile, remains challenging, as discussed here last month. That does not mean there will be nothing in this week’s budget. It does mean that the voices urging Hammond to beware the fiscal chasm will win the battle over those urging him to throw caution to the wind.

And then, in the long run-up to the first of the 21st century versions of single annual autumn budgets, we should have a serious debate on what levels of public spending the country can afford, and where the tax burden – which looks to have an upper limit of around 37% of gross domestic product – should fall. As he put it in his autumn statement, Hammond wants a country committed to “living within our means”. We are a long way from that.

Sunday, February 26, 2017
This nation of shoppers needs a new growth model
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

Every little bit of information adds to our knowledge, and changes our perceptions. In recent days we have had a flurry of such information from the official statisticians. Let me try today to steer through it, and try to answer some key questions about the outlook.

The questions are these. Can the consumer continue to be the mainstay for the economy during 2017? Will imports and exports respond to the weak pound? Are businesses already throttling back on investment and will they continue to do so?

There is another question, and it is whether Britain can move away from a growth model which depends excessively on consumer spending to something more sustainable. The London School of Economics’ Growth Commission, whose first report four years ago was very good, published a second report on last week. More in a moment on whether it has some of the answers.

Starting with those statistics, the second release of gross domestic product figures for the final quarter of last year were rather bitter-sweet. They confirmed the expected upward revision of growth to 0.7% for the quarter, which is above-trend, but they also showed a surprise downward revision of growth from 2016 as a whole from 2% to 1.8%.

Amid the uncertainty of last year, 1.8% growth was perfectly respectable, exceeding most of the G7, though just below Germany. But it was driven, to an almost embarrassing extent, by consumer spending.

While the economy grew by 1.8%, consumer spending rose by 3.1%. The consumer, in fact, accounted for all of Britain’s growth last year and a little more, 1.9 percentage points. Government spending also contributed 0.2 points of growth. The circle is squared by the fact that business investment fell, subtracting 0.1 points from growth, and that net trade, exports minus imports, also acted as a drag on growth, to the tune of 0.4 percentage points. Investment and export-led growth it was not.

Though last year’s £2.7bn fall in business investment was the first since 2009, it confirmed that investment has been a persistent weak spot for the economy. GDP is 8.6% higher than its peak prior to the 2008-9 recession, while GDP per head is up by 1.8%. Overall investment in the economy, including business investment, was however lower last year than in 2007.

What about exports? Net trade – exports minus imports – boosted growth in the final quarter of last year, but does so quite rarely, and may have been distorted, according to the Office for National Statistics, by trade in gold. Export volumes were down on a year earlier, while imports were up.

In the short-term, the outlook for the economy will be determined by the interplay of consumer spending, investment and foreign trade. As is now familiar, the issue for consumers is whether they will try to spend their way through the squeeze on real incomes arising from higher inflation.

We have information on the part of consumer spending accounted for by retail sales. Official figures show that retail sales volumes fell in November, despite Black Friday , fell again in December, despite Christmas, and in January, despite the sales. The CBI distributive trades survey suggest that they have remained subdued this month. British consumers, who you write off at your peril, may just be pausing for breath. But it will be surprising if spending growth this year and next comes close to last year’s 3.1%.

On business investment, there is little in the surveys to suggest an imminent collapse, but little to suggest much growth either. Investment looks likely to tread water until there is greater clarity about the outlook.

Exports are the wild card. The latest figures were distorted, but stronger growth in Britain’s main markets, including the EU, is helping, as should the pound’s big fall. But, while consumer spending has tended to outperform expectations, exports have tended to underwhelm. It remains to be seen whether this time is different.

What about beyond the next couple of years? The LSE Growth Commission’s new report says that now is an ideal time to tackle some of the economy’s longstanding weaknesses, which include low productivity and over-dependence on consumer spending.

The report has a string of recommendations in the four key area of skills and training, industrial strategy, openness (to trade, inward investment and people) and the supply of finance to growing businesses. Britain, it says, has relied too long on migrant labour to plug the holes in an inadequate education and training system. The rise of self-employment has further discouraged sufficient spending on training, and the playing field needs to be tilted back to employees. Britain achieves the worth of both worlds by under-investing in plant, machinery and other capital equipment, despite the tax incentives to do so, while also under-investing in training and skills.

While this country has a world-leading financial centre and a highly competitive financial services sector, there remains a problem with the provision of finance to high-growth businesses and to infrastructure projects.

What the LSE Growth Commission describes a s a new chapter in Britain’s growth story will require continued good access for the two-third of exports that go to either the EU or America, as well as the rapidly growing “frontier” economies elsewhere in the world. It will require, it says, “access to finance for businesses and innovation, including flexible regulation of challenger banks, increased support for the FinTech sector, reform of equity markets, a boosted role for the British Business Bank and a new infrastructure bank”.

There should be a new British state aid law, the LSE argues, both to allow the government to step in a more flexible way than currently allowed under EU rules but also to preserve the most useful aspect of those rules, tying ministers’ hands in a way that stops them propping up uneconomic sectors.

A record deficit on the current account of the balance of payments and a tradition of chromic under-investment speak of a badly unbalanced economy. I have barely scratched the surface of the LSE Growth Commission report but it offers plenty of ideas for turning over a new leaf. And it is more coherent and comprehensive than anything the government has yet come up with.

Sunday, February 19, 2017
Our Goldilocks job market and its three lurking bears
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

There is some news we should make a point of celebrating. The announcement a few days ago that Britain’s employment rate hit a record high of 74.6% in the final three months of last year was a good example.

What the figure meant was that in records dating back to 1971, there has never been a higher proportion of 16-64 year-olds in work. Though the records go back only 46 years, I doubt there has been a time in Britain’s history when the employment rate has been higher.

Britain’s employment rate is not only the highest on record but is around five percentage points higher than that of America and some seven percentage points above the European Union average. Among advanced economies, only Denmark, Sweden, Germany and Japan have higher employment rates. At the other end of the scale, Italy has an employment rate of 57.6%, Greece just 53%.

Think about that record for a second. Over the period since 1971 very many more young people stay in full-time education beyond the age of 16, which in normal circumstances ought to mean a decline in the 16-64 employment rate, even allowing for the fact that many students have part-time jobs.

Until recently, there was also a significant erosion of employment among older age groups. Many is the piece I have written over the years about declining employment in the 50-64 age group. The employment rate in that age group in currently just below 71%, up from 69% two years ago. And these days a different phenomenon is at work. On top of 16-64 employment, there are 1.2m people aged 65 and over in work. That may not be an all-time record but it is close to recent highs and underscores the labour market’s success.

The record employment rate is, first and foremost, a reflection of the welcome flexibility of Britain’s labour market, a flexibility which is reflected in the fact that what is now the Cinderella measure of unemployment, the claimant count, is at 745,000 in January, lower than the number of officially-record vacancies, 751,000. If that has ever happened before, it has not done so for a very long time.

Record employment is, secondly, a tribute to the rise of women in the workforce, and the huge social changes of the past half century. The employment rate among men has followed the pattern one might expect; it is lower than it was. The employment rate among 16-64 year-old men, which is now 79.3%, was a very high 92.1% in early 1971.

The employment rate among 16-64 women, in sharp contrast, has risen from 52.8% in early 1971 to 70% now. It will converge further on the male employment rate as the male and female state pension ages are equalised.

The record employment rate also reflects the fact that, under David Cameron and George Osborne, Britain had a particularly job-rich recovery, with a 2.75m rise in employment from early 2010 to the middle of this year. There was a time, you may remember, when some predicted that we were due an employment and unemployment disaster, as a result of public sector job cuts and the more general austerity squeeze on the economy. Precisely the opposite happened.

Whenever I have written before about the miracle of the post-2010 job market, people have always reminded me about falling real wages, insecure self-employment and employment, including zero-hours contracts, the shift from high-quality public sector jobs to some lower-quality private sector ones, and the weakness of productivity growth. These days such observations are supplemented by overwrought, easily wound up oddballs blathering on about Project Fear.

It is fair to say that in the background of Britain’s Goldilocks job market – not too hot to force a wage explosion, not too cold to push unemployment up – there have always been a few bears lurking. Today, behind the good headlines, there are least three of those bears.

Though the employment rate is at a record, the rise in employment has plainly slowed. Not so long ago, Britain was adding half a million or more jobs a year. No longer, the rise over the latest 12 months was 302,000. Moreover, the rate of employment growth slowed sharply in the second half of last year. Of the 302,000 growth in employment, 216,000 or 72% came between the final quarter of 2015 and the second quarter of last year.

There were, in addition, real signs of fatigue as the job market made it over the finishing line to that record 74.6% employment rate. The 37,000 net rise in employment in the final three months of last year was a rather motley collection. None of it came from a net increase in the number of employees in businesses. All of it came from a rise in self-employment (13,000), an increase in numbers on government-backed training and employment schemes (21,000), with the rest unpaid family workers.

Self-employment, which has been responsible for a significant proportion, roughly 40%, of overall employment growth during this job-rich recovery, is controversial. While much of it is what self-employment has always been, an increasing proportion reflects insecure “gig economy” work, which Theresa May’s government has commissioned an investigation into.

The Institute for Fiscal Studies this month highlighted the tax headache for the chancellor in the rise of the self-employed and owner-managers, which will mean £3.5bn less tax at the end of the decade (an Office for Budget Responsibility calculation) than if these people had been employees. It remains to be seen whether Philip Hammond will respond to this in his March 8 Budget.

There are other job market issues. One, highlighted by many firms, is that skill shortages are biting and set to do so harder in coming years. Another is that when it comes to pay, the labour market is a bit too Goldilocks for its own good. The growth in average earnings slipped back from 2.8% to 2.6% in the latest figures, and looks set to drop further at a time of rising inflation. The squeeze on real wages will be one of the stories of this year. Perhaps in anticipation, retail sales volumes have fallen for the past three months.

Finally, there is productivity, a very significant bear. Official estimates last week suggest it rose by a mere 0.3% in the final quarter of 2016, its smallest quarterly increase during the year. We are approaching an interesting test for productivity. It is unlikely that the employment rate can rise much further from here, and workforce growth is set to slow. Prosperity will depend on faster growth in productivity. Can it be achieved? That is something we will all be keeping a very close eye on.

Sunday, February 12, 2017
Spending down, taxes up - but we will keep on borrowing
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

The Institute for Fiscal Studies has been producing its “green” budget for 35 years, through changing economic and political circumstances. The latest, the final one (for now) at this time of year because Philip Hammond is moving the budget timetable to the autumn, is a bit of a humdinger.

The IFS pulls few punches in laying out the scale of Britain’s fiscal challenge, leaving me a little punch-drunk. Seven years after the start of post-crisis deficit reduction, the budget deficit is 4th largest, relative to gross domestic product, of 28 advanced economies. Public sector debt, on the same basis, is 6th largest among the same group of advanced countries. It has not been higher relative to GDP since the mid-1960s, when the post-war unwinding of debt was still in full swing.

This is despite a fall in real-terms public spending of 10% since 2009-10, the longest and biggest on record, with more to come. By 2019-20, on present plans, real departmental spending will be 13% lower than in 2009-10.

For every Scylla, meanwhile, there is a Charybdis. With £17bn of tax rises planned for the rest of this parliament, the tax burden will rise to more than 37% of GDP by the end of the parliament, its highest since 1986-7, when the Thatcher government was in the process of aggressively reducing income and corporate taxes. Even then, we will still have a budget deficit.

I have always adopted a “something will turn up” approach to the public finances. In the past, time and economic growth proved to be great healers. In the 1980s, economic revival turned a budget deficit of 4.3% of GDP into a surplus within eight years. In the 1990s the timetable was even shorter. Britain went from a 6.7% of GDP deficit to a budget surplus in just five years.

This time the challenge was greater, with a deficit of 10.1% of GDP in 2009-10. Progress has been made. The latest full-year deficit, for 2015-16, was 4% of GDP. But that is still high, as is this year’s projected deficit of 3.5% of GDP. As the IFS points out, in the 60 years before 2008, Britain has run a bigger deficit in only 13 years, mainly when the economy was in recession.

If ever the economy needed a positive growth surprise, in other words a few years of above-trend economic growth, this is the time. Unfortunately, for reasons I do not need to spell out, that is highly unlikely, notwithstanding Friday’s good manufacturing and construction figures for December.

Oxford Economics, which provides the macroeconomic forecasts which underpin the green budget, is less gloomy on Brexit than most but it sees the next three years as ones of weak growth, with 1.6% this year, 1.3% in 2018 and 1.6% in 2019. At a time when a growth boost would have helped the public finances, the opposite is occurring. The idea that leaving the EU would mean healthier public finances has been exposed for the fantasy that it was.

There is more than just Brexit, of course, weighing on the economy. The loss of underlying oomph, which matters hugely for the public finances, has been with us for some time. Oxford Economics says potential growth over the 2017-21 period is a weak 1.5% a year, barely more than half the 2.7% of the 1996-2006 period, which now seems like another age.

Subdued growth is a problem, but so are the measures that will be required to tackle the underlying or “structural” budget deficit. As anybody who has been anywhere near a television screen or a radio in recent weeks will be aware, the National Health Service is in the middle of a winter crisis which is more severe than most. The pressure on the government to give the NHS and social care a sizeable cash injection, if not £350m a week, is intensifying.

The NHS, of course, benefited from its budget being ring-fenced. In other parts of government the spending squeeze in recent years has been intense. Even ring-fenced, however, the squeeze on NHS spending is considerable. As the IFS points out, the five years to 2015 saw the slowest growth in spending since the mid-1950s, shortly after the NHS came into being.

On present plans, NHS spending per head will be lower by 2020 than it is now, and even lower when adjusted for the fact of an ageing population. Big cuts in welfare are also built into the government’s plans. A four-year cash freeze on most working-age benefits and tax credits will bite hard at a time of rising inflation.

Within the spending numbers, the government is trying to increase the amount spent on capital, including infrastructure, relative to day-to-day spending. So, while in 2012-13 capital spending was 13% of current spending, the aim is to raise that to 21% by 2020-21. Such are the pressures on day-to-day spending, however, that may be unachievable.

Austerity fatigue has set in. When George Osborne aimed to complete most of the job of fixing the deficit by 2015, it was in the knowledge that there was a limit to how long a government could continue to bear down on spending. Hence the relief when some of his successor’s early pronouncements were interpreted, wrongly as it turned out, as an end to austerity.

All this is rather gloomy. The damage to the public finances from the financial crisis and the years of aggressive spending increases under Labour in the roaring 2000s has proved enduring.
It has been compounded by decisions made under both the coalition and the post-2015 Tory government. While the spending cuts have been genuine, the pill has been sweetened for households in other ways. Some taxes have gone up, but others have been cut, notably corporation tax, the prolonged freeze on petrol and diesel duty and the substantial raising of the personal income tax allowance, currently £11,000 and due to rise to £12,500 by the end of the parliament. In contrast, when the Thatcher government wanted to show it meant business on deficit reduction in 1981, it did so by freezing the personal allowance at a time of high inflation. This time, the 2011 VAT hike is the only surviving major tax hike.

So things are different. In the 2020s, remember, demographic pressure for higher government spending will kick in with a vengeance. Perhaps we will have to get used to a world in which borrowing of 2% of GDP or so is the norm, perhaps more, as are higher levels of government debt than we have been used to for most of the past half century.

That, as things stand, looks much more plausible than a future of budget surpluses, or even balanced budgets, and falling government debt. As long as the markets are prepared to lend what Britain needs to borrow, the debt and deficits will be manageable, though with a rising debt interest bill. If not, there will be a problem.

Sunday, February 05, 2017
Basic income, an old idea whose time has not come - until the robots take over
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

Sometimes ideas that have been around for a long time suddenly build up a he
ad of steam. So it is with one such idea at the moment, that of a universal basic income, an unconditional payment to every individual in the country, regardless of their circumstances.

A universal basic income (UBI) was last week endorsed by the Indian government’s 2016-17 economic survey, as “a powerful idea …. whose time is ripe for serious discussion” and which would be more effective than the existing system of state benefits.

A trial of the system began at the start of this year in Finland, and there are plans for similar trials in Fife and Glasgow in Scotland. It is part of the policy platform of Benoit Hamon, the French Socialist presidential candidate, admittedly a very long shot for the Elysee Palace. It was part of the Green party’s manifesto in the 2015 general election. Groups like the Citizen’s Income Trust have been advocating it for years.

UBI attracts some strange bedfellows. Though usually associated these days with the political left, it has sparked the interest of Silicon Valley tech entrepreneurs. In the 1960s both Milton Friedman and Martin Luther King advocated versions of it as, more recently, has the libertarian Charles Murray, who has written extensively for this newspaper. Friedrich von Hayek, beloved of Margaret Thatcher, though this was one of his ideas she did not take up, also favoured a guaranteed minimum income.

Why is the basic income idea, sometimes known as a guaranteed or citizen’s income, having been around a very long time, gaining new interest now? There are two main reasons.

One is the rise of what Professor Guy Standing of SOAS (The School of Oriental and African Studies) has described as the rise of the “precariat”. Standing, who presented his arguments at this year’s Davos world economic forum, describes the precariat as the “many millions of people experiencing a precarious existence, in temporary jobs, doing short-time labour, linked strangely to employment agencies, and so on, most without any assurance of state benefits or the perks being received by the salariat or the core.”

His precariat is not the same as Theresa May’s “just about managing” families but is in similar territory, and speaks strongly to the idea of swathes of people being left behind by globalisation, a phenomenon on both sides of the Atlantic.

The second reason for the UBI’s revival, which has particular resonance in Silicon Valley, is the rise of the robots. If robots are indeed set to make serious inroads into employment, as some predict, one estimate suggests that 47% of jobs in America will be automated over the next 20 years, then providing people with a stigma-free alternative income courtesy of the government might be the way to go.

There is a pretty good chance we end up with a universal basic income, or something like that, due to automation,” the tech entrepreneur Elon Musk, responsible for Tesla cars and SpaceX, said recently.

Another argument favoured by advocates of UBI is that it offers the opportunity of radically simplifying current highly complex systems of welfare benefits, tax credits and taxes. A simple handout would replace the current confusing system.

So why not? Many people instinctively smell a rat about basic income, and they are right to do so. Though an unconditional handout would not prevent people from working, and for most would be in addition to their existing earned income, the risk of paying people to be idle, the “why work?” syndrome, would increase.

The flaw in a UBI also comes down to simple maths. If you pay everybody a fixed amount, including the very many who currently receive nothing from the government, the cost of the policy, could be enormous.

As the economist John Kay wrote recently, if you set the basic income at 30% of average incomes, the public spending cost will equate to roughly 30% of gross domestic product, or 50% if it was set at half of average income. Before Swiss voters rejected a basic income in a referendum last summer, their government told them that it would double welfare spending.

To get around these difficulties, proponents often pitch it at a very low level. In Finland, a country of high prices, the experiment is with a basic income of €560 (£480) a month. A proposal for this country by the Royal Society of Arts envisages a basic income for adults of some £3,692 a year at 2012-13 prices.

The problem with this is that it would not cover anybody’s needs, and you would still need a system of welfare arrangements to provide for those with disabilities, caring responsibilities, the long-term unemployed and other additional needs catered for by the benefits system. Welfare is more complicated than it should be, but it is complicated for a reason. People’s needs are complex and varied.

There is no easy way around these problems. A UBI means giving money to people who do not currently get it, and who do not really need it, with the only way of making it affordable being to reduce the benefits going to those who are in genuine need. If that was politically unacceptable, as it would be, then the consequence would be higher overall spending, and significantly higher taxes to pay for it, neither of which we need.

The intriguing aspect to the current debate is, however, the link to automation, and the rise of the robots. I have taken a generally sceptical view of this phenomenon. There will be jobs created in coming years of a kind and in activities that we are currently unaware of. Previous predictions of the death of the job as a result of new technology have been wide of the mark.

Suppose, however, this time is different and the rise of the robot resulted in a dramatic fall in employment, and a dramatic rise in the profits of companies using the new technology. In such circumstances, but probably only in such circumstances, there would be a case for taxing those profits much more heavily and using it to guarantee people a basic income. Which is why this idea, far from going away, will probably , despite its flaws, increase in popularity.

Sunday, January 29, 2017
Smooth so far - but plenty of Brexit bumps on the road ahead
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

The scores are in, and they show that Britain’s economy held up very well in the second half of last year, in the aftermath of the vote to leave the EU. I and many others expected weaker growth, and we have yet to see it.

Right to the last, with the 0.6% rise in gross domestic product (GDP) in the fourth quarter reported by the Office for National Statistics on Friday, the numbers surprised on the upside. The expectation was 0.5%.

And, while last year’s growth rate was the weakest for three years, it was the strongest in the G7, and far better than the overwhelming majority of economists expected in the immediate aftermath of the referendum.

The figures are a vindication for those who said that, while the medium and long-term consequences of Brexit would be significant, the impact on growth in 2016 would be negligible. This was the conclusion, for example, of the National Institute of Economic and Social Research (Niesr), in a May 2016 article, The Short-Term Impact of Leaving the EU.

The Treasury, which has a close relationship with Niesr, should have taken a leaf out of its book, though it was under political direction. GDP is the best overall measure of economic activity, though it has its critics and often fails to tell the full story.

The story we have is that in the final quarter of 2016, and indeed in the second half of the year. Buoyant consumer demand led to strong growth in the dominant service sector of the economy. That the service sector is dominant – its output in the final quarter was 1.8% up on the April-June quarter – was a good thing. Had we relied on manufacturing, overall industrial production, construction or agriculture, the economy would be in the doldrums. All ended 2016 with lower output than in the second quarter.

What else do we know? Employment growth has flattened in recent months and inflation is on the up. But this looks like a year in which the chancellor will not have to admit that the official forecast for public borrowing – the budget deficit - was too optimistic. Admittedly that forecast was revised up, to £68bn, in November, but figures last week suggested the deficit may come in below that, though still some way above the Office for Budget Responsibility’s pre-referendum forecast of £55bn.

How should we respond to the economy’s post-referendum resilience as we move from the phoney war over Brexit to the real thing? Though there is no evidence he ever said it, is this a good example of the dictum often attributed to Keynes: “When the facts change, I change my mind. What do you do, Sir?”

In one very simple sense, the economy’s resilience in the second half of 2016 has to change minds about growth forecasts for 2017. Non-economists may find this a puzzle, but the higher the level of GDP at the start of a year, the stronger that measured growth is likely to be for that year. This is because growth is measured on a calendar year basis – the average for 2017 versus the average for 2016 – and GDP starts the year 0.8% above its 2017 average.

Forecasters would also admit to other effects, however, and I would agree with them. Does the strength of consumer spending so far – the 52% celebrating and the 48% spending to ease their pain – tell us that the spree will continue? The Resolution Foundation think tank, in a report today, says the recent mini boom in living standards has ground to a halt because of rising inflation. But household borrowing, currently rising very strongly, could limit the spending slowdown.

We will not know for some time. Early evidence suggests some loss of retail momentum, with the official retail sales figures showing volumes down by 1.9% last month and this month’s CBI distributive trades survey very downbeat. But this could just be a temporary reaction to the strength of spending in earlier months.

Similarly, the extent to which businesses will reduce investment and recruitment, or maintain it, depends on whether they are reassured or concerned by the prime minister’s greater clarity on her Brexit plans. Article 50, and the invoking of it, has been seen as a significant moment for business. We will soon know whether it is.

Most economists who have taken a downbeat view of Brexit, are sticking to their guns. As Simon Tilford of the Centre for European Reform puts it: “The British economy has not weathered the Brexit storm. It is just that the calm before the storm has lasted a bit longer than many had assumed. There is no reason to think Britain will escape serious and permanent damage to its foreign trade and investment and hence living standards.”

Fathom Consulting, which will hold a seminar this week, “Brexit: a storm in a teacup?”, has come to the view that it most definitely is not.” Despite the economy’s resilience in the second half of 2016, its forecasts are resolutely downbeat, just 0.9% growth this year and 0.4% in 2018.

For Fathom’s Erik Britton and Andrew Brigden, Brexit has exacerbated the economy’s other weaknesses, notably persistent weak productivity. Last week’s industrial strategy green paper form the government identified the large productivity gap between Britain and our main competitors but without offering too much hope for closing it.

According to Fathom, weak productivity is not just a temporary post-crisis phenomenon but the new long-term condition. It is exacerbated by ultra-low interest rates, which prevent the process of “creative destruction” – getting rid of older inefficient firms and replacing them with newer and more productive ones – which drive productivity improvements.

In theory, the Bank of England could start the process of “normalizing” interest rates this week. The economy has been notably stronger than it expected when it made its emergency post-referendum cut in Bank rate to 0.25% in August. For a second time since then, it will revise up its 2017 growth forecast, currently 1.4%. It is much more optimistic than Fathom. The upward revision, and the prospect of sustained above-target inflation could provide the Bank with an excuse to reverse last August’s rate cut.

Will it do so? No. Simon Ward, an economist with Henderson Global Investors, has a statistical model that predicts what the monetary policy committee does. It “predicts” that four members of the Bank’s monetary policy committee (MPC) should vote for higher rates this week.

But, as Ward laments, “today’s MPC is a different animal”, with Mark Carney more dominant in its decision-making, and an early rate rise would be interpreted by his many critics as an admission that last August’s decision was a mistake. So it would be sensible not to expect a rate hike for a while yet.

Sunday, January 22, 2017
An EU cliff edge looms - May has to avoid taking us over it
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

Certainty and uncertainty. The certainty from Theresa May that Britain will be leaving the European Union’s single market is enabling some businesses to prepare now for that eventuality.

For some that is a good thing and for some it will make no difference. But those who need more of their operations to be inside the single market can now plan for that. The car industry is worried. So are others. HSBC and UBS have already told us what they are intending in terms of moving some jobs from London. Others will do so.

Those who think the loss of some investment banking jobs is nothing to worry about, something I hear quite a lot, should remember that the City generates a disproportionate amount of the tax revenue needed to pay for public services.

It still will; on any plausible scenario London will remain comfortably the biggest financial centre in Europe. But such is its lead that it will remain the biggest even if it were to lose a chunk of it activity, and its generation of tax revenues, which seems likely, and which will be bad for Britain.

On top of the certainty of leaving the single market, of which more in a moment, there is the massive uncertainty of what happens after two years. The two-year article 50 period, intended to set the terms of Britain’s departure from the EU, is now intended by the prime minister to also include a “bold and ambitious” trade deal with Europe. That looks not merely ambitious, but unachievable.

In setting a high bar, and an over-ambitious timetable, May has significantly increased the chances of failure. Britain’s combined Brexit and free trade agreement talks with the EU could founder for any number of reasons, including the cost of the divorce settlement, with Brussels talking about a figure of at least €60bn (£52bn).

If not a good deal then, as the prime minister has promised, she will walk away. The “cliff edge” that many thought should be avoided at all costs, and which the government would seek to avoid at all costs, is now part of the official negotiating position. The logic is that the EU would be hit by such an abrupt breaking-off of economic relations, which it would. But Britain would be hit very much harder. That is not bold; it is irresponsible. The prime minister is not only given us a harder Brexit than business feared, but has also inserted a “hardball” element.

Positions will adjust, on both sides, over the next two years. Avoiding the cliff edge, and ensuring what Philip Hammond, the chancellor, describes as a “phased process” of leaving the EU, will be vital.

The prime minister was right last week to say that Britain wants a successful EU, though I am not sure that she was speaking for all, or even most, Brexit voters in saying so. She was also right to say that a strong and close relationship, and not just on economics, is in the interests of both the EU and Britain.

As for her rhetoric about a global Britain being a new force for openness, “the strongest and most forceful advocate for business, free markets and free trade anywhere in the world”, all that is exactly what a prime minister trying to make the best of Brexit should be saying.

But we also have to be realistic. Depending on how it is done, and we have yet to see a successful system, including for non-EU migrants during her six years as home secretary, slashing immigration numbers will be hard to square with the prime minister’s declared aim that “openness to international talent must remain one of this country’s most distinctive assets”. In many parts of the world, and not just in the rest of the EU, Britain is already seen as less welcoming.

Not all of that is the prime minister’s fault. She would like to guarantee the rights of EU citizens already in Britain, but requires reciprocal guarantees for British citizens in Europe, which the EU will not offer until the article 50 process is underway.

The bigger problem is trade. Many things influence trade, and not just trade agreements. Though the share of Britain’s trade conducted with the rest of the EU rose last year, the trend in recent years has been downwards. That reflects a drop in North Sea oil exports and the faster growth of emerging economies such as China and India. Britain’s exports to China have fallen over the past couple of years but the trend has been upwards.

Seven of Britain’s 10 biggest export destinations are, however, elsewhere in the EU (the others are America, China and Switzerland) and membership of the single market is greatly superior to any free trade agreement, particularly as far as services are concerned. In these, as the National Institute of Economic and Social Research (Niesr) put it in its most recent review, “non-tariff barriers such as regulatory constraints play a more important role, especially for high value-added business services such as financial services, legal services or accountancy”.

Calculations by Monique Ebell, an economist at Niesr, suggest that replacing single market membership even with a comprehensive free trade agreement would over time reduce Britain’s exports to the EU by 22% compared with the status quo.

What about the government’s mission to strike trade deals with the rest of the world? Would that not make up the difference? No, not even close. Even on the optimistic assumption of free trade agreements with the rest of the world, Ebell calculates that these would only lift goods exports by 11%-12% to non-EU countries, implying a 7%-8% rise in total trade (goods and services), relative to the previous trend. Most free trade agreements do not cover services in any meaningful or comprehensive way. Unless this changes, in rough terms we will lose nearly three times as much from leaving the single market as we gain from our new buccaneering trade deals with the rest of the world, if an when they can be negotiated.

These numbers can never be precise but they underline the scale of the challenges that lie ahead, at a time when, according to a new EY Item Club forecast to be published tomorrow, Britain faces three years of weak economic growth.

Preventing that sluggish growth from turning into something worse will require an avoidance of the cliff edge exit from the EU, the “walking away” spectre raised by the prime minister a few days ago. Turning Britain into a new post-Brexit global trade champion, on the back of a sustained improvement in export performance and market share, looks even harder.

Sunday, January 15, 2017
Inequality is falling - somebody should tell Theresa May
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

Inequality has become the fallback position for politicians in need of a theme, or organisations which want to show they care. Inequality, it seems, is driving political change – pushing voters to extremes - and uncomfortable electoral outcomes.

Inequality threatens the very survival of capitalism, which is why the World Economic Forum, as it gathers in Davos this week, has named it as one of the three key risks facing the world economy over the next 10 years and has as its theme “responsive and responsible leadership”.

Inequality provided the backdrop to Jeremy Corbyn’s populist relaunch and his proposal for a pay cap. Or was it a pay ratio? The maximum wage, last seen in British football in the early 1960s (it was £20 a week, now some earn that a minute), seems to appeal to the Labour leader.

I don’t worry too much about the World Economic Forum, which has to find something to talk about and has a habit of picking the wrong themes. I don’t worry very much about Corbyn either. The idea of a populist relaunch is to make yourself popular, and he is a very long way from that, and from power.

I do, however, worry about somebody who is in power, our prime minster. In her first big speech for a while, Theresa May warmed to a theme which I fear will become a motif for her premiership. Though her speech on the “shared society” focused on mental health, a worthy topic, it was interspersed with other references.

“We need to address the economic inequalities that have emerged in recent years,” she said, so that everybody shares in the country’s prosperity. She criticised “politicians who supported and promoted an economic system that works well for a privileged few, but failed to ensure that the prosperity generated by free markets and free trade is shared by everyone, in every corner and community of their land.”

You might think, if the prime minister is saying this, Britain must be suffering from a crisis of rising inequality. In fact, as official figures released shortly after her speech showed, inequality has been falling. The Office for National Statistics (ONS) reported that in the 2015-16 tax year inequality in Britain measured by the Gini coefficient fell to its lowest since 1986. As the ONS put it: “There has been a gradual decline in income inequality in the last 10 years, with levels similar to those seen in the mid to late 1980s.”

If we take the period since the start of the financial crisis, the poorest fifth of households have seen a 13.2% rise in real incomes (adjusted for the increase in the consumer prices index) since 2007-8, compared with 6.6% for the next quintile, 3.9% for the middle fifth and 4% for the next-to-richest quintile. The best-paid fifth of the population have, in contrast, seen a cumulative drop in incomes of 3.4%, the only group to be worse off than before the crisis.

The experience of the top fifth of the population demonstrates that, apart from the fact that some high-paying occupations have suffered in recent years, redistribution through taxes and tax credits works, as the Institute for Fiscal Studies pointed out on Friday, (and is of course much more sensible than silly ideas such as pay caps).

George Osborne deliberately targeted the lower-paid with his tax changes, excluding those on higher incomes from most or all of the gains from, for example, raising the personal income tax allowance. That and the government’s generosity towards pensioners, of which more in a moment, explain why inequality has been falling.

You may say at this point that it is one thing for those on higher incomes to have suffered a bit since the crisis. In some cases perhaps they deserved to, but that is a small price to pay for having lived high on the hog in the period leading up to it. Surely these global citizens cleaned up then?

Again, no, or at least not disproportionately. The rising pre-crisis tide lifted all boats. Figures from Matthew Whittaker, chief economist at the Resolution Foundation, show that all income groups enjoyed healthy and sustained real income rises in the period 1990 to 2007-8. For those in the bottom fifth, real incomes rose by an average of 2.3% a year, rising to 2.7% for the next band of income. The middle quintile saw an average rise of 2% a year, while for those in the top two groups, the increases were 1.7% and 1.8% respectively. Income inequality has fallen to a 30-year low because lower income groups have done relatively well over a long period.

There are, of course, caveats. Some would say the gains made by the top 1%, or 0.1%, are of greater concern than what has happened to these larger groupings such as the top 20%. Nobody should excuse the excesses, often apparently unrelated to performance, in some boardrooms.

The prime minister’s “privileged few” language, however, risks not only undermining the generally successful growth story of recent decades but deliberately setting different groups against one another. May, who is an unlikely champion of working class people, is in danger of stoking up class war.

There are bigger issues here. One, highlighted by the Resolution Foundation’s Whittaker, is that more important than the distribution of income is the fact that, in the post-crisis period, everybody’s incomes have grown very slowly, and that what in the past was regarded as a normal, unremarkable rise in living standards, has not been achieved. So the middle fifth of the population, having seen their real incomes rise by 2% a year in the two decades leading up to the crisis, have had an annual rise of just 0.5% since then. That should mean a focus on raising productivity, and hence real wages.

The other big issue is how prosperity, particularly in recent years, has been distributed between the generations. As the ONS pointed out, retired households have on average seen a 13% rise in their real incomes since 2007-8, while non-retired households have yet to put their heads above water; their incomes are on average 1.2% lower than they were in 2007-8. Retired households have benefited from government policy on uprating state pensions and have benefited from wealth gains, thanks to policies such as quantitative easing. Though the incomes of younger households have been rising in recent years, this has been a lost decade for them and is not sustainable for the longer-term.

So, while income inequality is a natural target for politicians and businesses wanting to show that they care, generational inequality has been the problem of recent years. And the need for policies, and economic performance, which raise incomes in general is more pressing than ever. Blaming the privileged few is bad economics and questionable politics.

Sunday, January 08, 2017
Shock news: forecasters called the economy about right in 2016
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


My regular column is available to subscribers on www.thesundaytimes.co.uk This is an excerpt. The table to accompany the piece is available in the newspaper.

Of all the experts to be castigated in recent months in this strange climate in which we find ourselves, none have got it in the neck more than economic forecasters.

Those who try to predict the economy’s performance in uncertain and in some respects inherently unpredictable times have been attacked for getting things so badly wrong that we would have been better off consulting Paul the Octopus, who developed a reputation for correctly predicting the results of World Cup games, or popping along to the nearest fair and the fortune teller’s tent.

Even Andy Haldane, the Bank of England’s chief economist, has joined in, saying that forecasters had a “Michael Fish moment” in failing to predict the financial crisis, and an echo of it in overestimating the short-term damage from the Brexit vote. The profession, he said, was in something of a crisis.

It may surprise you, therefore, that had you taken most of the economic forecasts published this time last year, you would have been rewarded with a pretty accurate picture of what has happened to Britain’s economy over the past 12 months. In fact, in the very many years I have compiling my annual forecasting league tables, I cannot remember quite so many forecasts clustered around the outturns for the main economic variables.

At the start of last year forecasters were on average a little more optimistic on growth than turned out to be the case. But they were pretty close on inflation, expected the labour market to continue to improve and saw Britain’s balance of payments problem either persisting or getting worse.

Most, of course, would concede that the numbers are one thing, the economy’s story during 2016 another. So, while forecasts made a year ago turned out to be pretty accurate, it was a bumpy ride. This time last year we did not even known for sure whether there would be a referendum on EU membership. When it happened some, not all, responded by revising down their 2016 growth forecasts a little, though most of the serious slashing was reserved for 2017, of which more in a moment.

There are many moving parts in the economy’s performance, and the story of 2016 is instructive. A year ago the growth story most economists had constructed was one in which the economy would be subdued in the run-up to the referendum because of uncertainty and then rebound quite strongly afterwards as that uncertainty was lifted.

As it turned out, growth was not quite as subdued as surveys had suggested in the run-up to the vote – few expected second quarter gross domestic product to be as strong as 0.7% (revised down to 0.6% before Christmas) – though some elements of that weakness remain.

Business investment, for example, looks to have fallen last year, having been expected to rise. Instead of a strong post-referendum bounce, the economy maintained its momentum in the third quarter, and the purchasing managers’ surveys suggest it continued to do so in the final three months of the year. Both, admittedly, showed more resilience than economists expected – and surveys suggested – in the immediate aftermath of the referendum.

Inflation, while ending up more or less where forecasters expected, again did so by a different route. The collapse in oil prices at the start of the year, with a drop into the mid-$20s per barrel, was not widely expected. Its effect was to push inflation lower, averaging less than 0.5% in the first half of the year, providing for stronger growth in real incomes and therefore consumer spending. The rise in inflation now coming through strongly is mainly via a significantly weaker pound, coupled with a later than expected recovery in oil prices.

Interest rates were one area where forecasters were comprehensively wrongfooted. A year ago nobody was predicting a cut in rates; the debate being whether they stayed at 0.5% or began to rise gently. Instead, the Bank of England’s August response to the Brexit vote took them down to a new all-time low of 0.25%.

Having agonised about it, and recognised the strong possibility of another year of unchanged rates, I was among those who thought we would see toe-in-the-water rise to 0.75%. A cut in rates was a surprise, though not in the circumstances.

If forecasters are surprised about rates this year, it will be in the opposite direction. Economists think the Bank will either stick at 0.25% throughout the year or could even cut if the economy weakens sufficiently. I think that may underestimate the chances of a hike but, having been so low for so long, the smart money has to be against it.

As for my other predictions, I thought growth would be stronger, at 2.5%, and inflation a little weaker, at just below 1%.

Forecasters, as I say, did generally well, even if the path to the numbers was sometimes not exactly what they expected. Two did exceptionally well, jointly leading my league table. They were Chris Scicluna and his team at Daiwa Capital Markets, the investment banking arm of Japan’s Daiwa Securities, and Alan Clarke of Scotiabank, the Canadian bank which takes its name from its Nova Scotia roots. Both scored nine out of a maximum 10 in my league table and were impossible to separate. Congratulations to them.

At Daiwa, Scicluna and his colleagues are relatively downbeat about this year, expecting growth of just 1.2% and inflation by the end of the year of 3%. They also fear that the Brexit hangover will last well beyond 2017.

Scotiabank’s Clarke, taking his lead from the strong purchasing managers’ surveys and a model he helped develop which links monetary conditions to economic growth, thinks there is momentum in the economy yet. Monetary conditions are exceptionally loose, largely reflecting 0.25% Bank rate and sterling’s fall.

He thinks growth will come in this year at 1.6%, which is above the consensus, with most of the slowdown being delayed until later in the year when rising inflation really begins to bite into the growth in real incomes.

We shall see. Economists do not get everything right but they do a lot better than they are usually given credit for. Apart from the expected slowdown in growth – the consensus is for 1% to 1.5% this year – most forecasters do not see any significant improvement in Britain’s Achilles heel, the current account, with the average prediction a deficit of over £80bn. The public finances, meanwhile, will improve only at a snail’s pace, from £70bn this year, 2016-17, to £66bn in 2017-18, limiting any room for the manoeuvre for the government.

Though slower growth and higher inflation is predicted for Britain, we start 2017 amid more optimism about the global economy than for some time, particularly in financial markets, and certainly a lot more than this time last year, when George Osborne was warning of a “dangerous cocktail” of risks. The fact that quite a few of those hopes rest on the Trump presidency should perhaps make us a little wary. What, after all, could possibly go wrong?

Sunday, January 01, 2017
Peering through the fog of 2017 uncertainty
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

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

A new year is upon us, and with it the challenge of trying to plot a path through the uncertainty. That there is more uncertainty than usual is not in doubt, as is the fact that there is a range of possible outcomes – good and bad – for both Britain and the global economy.

Forecasting, meanwhile, has become more challenging. Even for those who correctly guessed the outcome of the momentous political events of last year, predicting the market and economic response to them was another story.

I thought, rather than getting bogged down in precise numbers for growth, inflation and other economic magnitudes – don’t worry there will be plenty of those in columns to come shortly – it would be useful to sketch out some broad themes.

The broad themes that will occupy us over the next 12 months, and no doubt there will be more, are Brexit, European politics (and the interaction of the two) Donald Trump’s America and China )and the interaction of those two too).

Let me take them in turn. In the next few months we will move from the phoney war on Brexit to the actual process. Theresa May, who has promised a big speech soon setting out the government’s priorities – it would be unwise to expect too much detail – remains committed to triggering article 50 by the end of March, whatever the Supreme Court decides.

The logic of that timetable, that we will clear the formal two-year Brexit process in time for us not to have European parliament elections in 2019, and well ahead of the 2020 general election, is not that strong. It will be better to have a proper strategy in place than rush it. But, one way or another, it is reasonable to expect article 50 to be triggered in the coming months. That in itself is testimony to how rapidly events have moved. This time last year we did not even know for sure whether there would be a referendum in 2016.

There are two key questions for the post-Brexit vote outlook for Britain’s economy as the process gets underway. One is the response of consumers to higher inflation and the expected squeeze on real incomes. There is some anecdotal evidence, including from the Bank of England’s regional agents, that some people have been bringing forward buying ahead of expected price increases. But the big picture lies elsewhere. When we had a bigger squeeze on real incomes than is in prospect this time, between 2010 and 2012, consumer spending slowed to a crawl.

Whether it does so this time depends partly on the second question; the ability of the government to keep business on side as it embarks on Brexit, and thus to maintain confidence. If not, we can expect weaker recruitment – already evident in the official labour market numbers if not in the surveys – and business investment.

There is a plausible argument that the real issue for business comes later, with the question of whether there will be a “cliff-edge” exit from the EU in 2019 accompanied by the immediate imposition of tariffs. But there will be uncertainty ahead of that, including this year, and with the notable exception of Nissan, the government has so far done a poor job of reducing it.

The Europe Britain will be leaving could, of course, be a moveable feast. How much will this year’s elections change it? The link between politics and economics can be seen clearly in the problems for Italy’s Monte dei Paschi bank – and others – following voters’ referendum rejection of constitutional reforms.

The March election in the Netherlands, where the anti-EU Party for Freedom is ahead in the polls, could result in an in-out referendum there. France’s presidential election, the first round of which will be on April 23rd, is another significant political event. Germany’s autumn election will follow, and will be a significant test for Angela Merkel, not least after recent events in Berlin.

My working assumption is that the Netherlands, a founder member of the EU, will not be leaving. As Capital Economics puts it: “There is little chance of March’s Dutch election resulting in a referendum on EU membership.” The far-right party only commands just over a fifth of the vote.

In France, Marine Le Pen of the National Front should get to the second round but lose, probably to Francois Fillon. A weakened Angela Merkel should still be German chancellor at the end of the year. That assumes the political forces that forged 2016 spread in only a limited way to Europe. But life, as we have seen, is full of surprises.

When it comes to America, the Trump surprise has led most forecasters to revise up their short-term projections for US growth, though few expect a doubling of the growth rate, but also to expect more interest rate rises from the Federal Reserve. Both seem plausible. If aggressive tax cuts and a big infrastructure programme do not result in stronger growth then something has gone wrong somewhere, and small rises in interest rates should not get in the way too much.

Consensus forecasts for US growth this year are still quite modest, 2.3% versus 1.6% in 2016. The risks, as Oxford Economics puts it, are to the upside, largely resting on how aggressive the Trump fiscal expansion is. It sees the strengthening of the dollar as a result of “Trumponomics” pushing the euro down to parity with the dollar by the end of the year. Sterling is likely to come under further downward pressure against the dollar.

Oxford Economics has a useful grid to assess the president-elect’s impact. Its baseline is tax cuts eventually worth $1 trillion (just over £800bn). The upside would be $2 trillion, the downside a “mere” $500bn. Similarly for his infrastructure plans. On trade, its baseline is only limited and targeted restrictions. The upside would be if nothing happens, the downside a serious escalation of protectionism.

This is where America runs up against the global economy, and China. Forecasts for global growth have been nudged higher in recent weeks, partly as a result of the outcome of the US election. China is predicted to grow by 6.4% this year and 6.1% next, according to the OECD (Organisation for Economic Co-operation and Development).

I remain sceptical of a spontaneous hard landing for China, fears of which were at their height a year ago, and may return. Yes, China has had a huge run-up in debt since the financial crisis, and that will come to a head at some stage. I would be surprised, however, if it was imminent.

The bigger risk to China comes from America, and the Trump administration. Chinese growth has had a fair wind for many years, on the basis that its re-emergence into the global economy had many more benefits than costs for the world as a whole.

US-Chinese friction, and Trump’s promise to pull out of the Trans Pacific Partnership, will not prevent China leading in Asia, and may cement its role. But it creates unpredictability for the world economy we could do without.

Sunday, December 25, 2016
A year when all roads led to Brexit
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

Well. I am spoilt for choice. Do I write about Donald Trump and whether his tax-cutting, infrastructure-boosting plans will mean a new dawn for the American economy? Or, as is also possible, that his protectionism and unconventional way of doing political business will hasten a new dusk for the world economy.

It is tempting. For the moment the conventional wisdom – and the view of the markets - is that good Trump will triumph over bad protectionist Trump, though the president-elect still has plenty of issues with China. We will only know for sure, of course, when he has moved beyond tweeting and into the White House. A sustained boost in US growth, which is what has been driving markets, would be very welcome if it happens.

Or, I could focus on the loss of a prime minister and chancellor, both of whom appeared to have established themselves as semi-permanent fixtures. David Cameron and George Osborne have not exactly disappeared from view but the political waters closed over them with remarkable rapidity, leaving them to ply their trade on the speaker circuit, and their successors made competent starts.

One day, perhaps, there will be a yearning for the Cameron-Osborne era. Even in the Tory party, perhaps especially in the Tory party, that day has yet to arrive. It may be some time coming.

How about the Bank of England and monetary policy? Mark Carney rendered himself permanently unpopular with some sections of the political community by warning that the result of the June 23rd referendum would have consequences, and then by acting on those warnings by leading the monetary policy committee (MPC) into cutting interest rates and further stimulus measures in August.

The reduction in Bank rate in August cut short one record – the longest period of unchanged official interest rates since shortly after the war – but established another. At 0.25% we now have the new lowest official interest rate in the Bank’s history, and that history stretches back to 1694. The rate cut was right at the time, though if the monetary policy committee (MPC) wanted to re-establish the position that rates can go up as well as down, it could do so by taking away that “emergency” August cut.

All roads, however, lead back to June 23rd, and the vote for Brexit. Whether Trump would have won in the absence of the Brexit vote I cannot say – it is certainly possible that it was a decisive factor – but everything else flows from it. Without the vote for Brexit, Cameron and Osborne would still be in power, and the Theresa May era would never have got started.

Without Brexit too, the Bank would not have cut rates. One of the questions for 2017 will be that, with the Federal Reserve plotting several more rate hikes following its move on December 14, and sterling likely suffer as a result, the Bank feels pressured to start following suit.

What is there to left to say about the Brexit vote? When, two years earlier, Scottish voters rejected independence, its referendum followed a well-worn script. The economic risks of going it alone outweighed the emotional and sentimental appeal of independence, particularly for older voters.

The Brexit vote turned this on its head, and notably for older voters. Control of EU immigration, and taking back economic control in general, just about trumped the economic warnings. Maybe those warnings were laid on too thickly, particularly by Osborne – for many his warning of a punishment “emergency” budget to follow a leave vote was the last straw – but this still broke the normal rules. People do not normally vote for a poorer and more uncertain future.

The arguments for staying in the EU, as set out here, weres not that it would suddenly reform itself into a dynamic region of strong growth but, rather that Britain had enjoyed the best of both worlds as a result of our often semi-detached membership, gaining from the single market and continuing to attract the lion’s share of inward investment without being encumbered by membership of the euro.

The figures spoke for themselves. Since the euro came into being in 1999, the Italian economy has grown by a cumulative 4%, which is astonishingly weak, compared with 21%-22% for France and Germany and a very strong 34% for Britain. Since the single market came into being growth in Britain’s per capita gross domestic product has exceeded that of America.

There was no reason why this outperformance could not have continued. The challenge, when Brexit is finally completed, which will no doubt be long after I have stopped writing this column, will be to replicate it on the outside. As things stand, the government is embarking on an exercise aimed at preserving as many of the advantages of EU membership as it can. The EU has an interest in ensuring that it does not preserve all of them.

What about the economy’s performance since the referendum? A smooth change of government, the long run-up to the triggering of Article 50 and the Bank’s actions kept uncertainty to a minimum and allowed growth to continue. Manufacturing and construction have struggled since June but services, and in particular consumer-facing services, have done well. Retail sales have boomed, at least on the official figures. The job market has slowed but not collapsed.

This was a period when, for Brexit supporters, any growth was better than no growth. The economy was unbalanced before and it has become more unbalanced since. The hard part, of course, is yet to come. Whether or not sterling’s fall will produce export-led growth which will offset the malign effects of higher inflation has yet to be seen. Whether businesses can be persuaded to keep investing, and recruiting, during what could be a bruising negotiating process is another central question.

These are issues for next year and beyond. For the moment, we should be pleased that the economy has so far help up well, and that the uncertainty associated with both the referendum and Trump’s victory in America were contained.

This is genuine. I hope we can make the best out of Brexit and I hope that American voters do not quickly come to regret electing Trump. Meanwhile, in this last column of 2016, I can also hope that things are as interesting next year as they were this. Maybe that is too tall an order.

Sunday, December 18, 2016
Clouds start to gather over Britain's households
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

For many people reading this, and for many whose businesses depend on healthy household finances, two trends will dominate the outlook in 2017. One is the extent of the rise in inflation, now clearly coming through in the figures. The other is how far the slowdown in the job market, also evident in the data, extends.

Inflation, which disappeared entirely last year, is ending this year on a rising trajectory. It was 1.2% last month, or 1.4% on the new CPIH (consumer prices including housing) measure favoured by official statisticians, or 2.2% for nostalgia buffs who still follow the old retail prices index.

Most of its rise, and most of the rise yet to come, is a direct reflection of sterling’s post-referendum fall, although some of it is explained by both the reversal of earlier energy and commodity price falls, and those falls dropping out of the inflation comparison.

Indeed, there are some spectacular increases coming through in costs. Industry’s raw material and fuel costs rose by a hefty 12.9% in the 12 months to November. Not all of that will feed through to final prices but some of it certainly will.

In a year’s time, according to most forecasters, consumer price inflation will be close to 3%, though the Bank of England has suggested that the pound’s recent small recovery may mean a slightly lower inflation profile than it feared last month. But the sweet spot we have been enjoying for a while, in which even modestly rising earnings comfortably outstripped the rise in prices, looks to be coming to an end.

The question for household budgets, which will also be of intense interest to the Bank of England, is whether there is an acceleration in pay in response to rising inflation. In the past, when we used to talk about the wage-price spiral, that would have been regarded as a certainty. Now it is not.

One reason for that is because of the softening of the labour market. The other sweet spot of recent times, a prolonged job market recovery, one of the great achievements of recent years, has been fraying around the edges since the summer. The quality of employment growth, which until then had been dominated by full-time employee jobs, has since been deteriorating. Now, according to the latest official figures, the employment recovery itself has stalled. Overall employment fell by 6,000 in the August-October period compared with the previous three months.

Plenty of caveats should be applied to these figures. In an economy in which nearly 32m people are employed, 6,000 is tantamount to a rounding error. Employment surveys have tended to show that many businesses are adopting a business as usual attitude to recruitment, though others point to greater caution.

The details of the job numbers were, however, quite soft. The drop in employment would have been bigger if not for an unusual increase in public employment. There was a fall of 51,000 in full-time employment, partly offset by a rise in the number of part-timers. Unemployment, which is rising on the claimant count measure, would have shown a big across-the-board rise if not for a significant increase in inactivity. Some tens of thousands of people dropped out of the labour market. As it was, the latest published unemployment total, 1.616m, was 12,000 up on the figure published a month ago.

The figures, while confirming that employment remains close to record highs, and that unemployment remains low, reflecting earlier momentum, chime in with the view that employers have become more cautious since the summer. Again, this is expected to continue. Forecasters on average expect a rise of around 200,000 in unemployment over the next 12 months.

This is a miserable, if predictable, way to end the year though none of it, it should be said, is catastrophic. If the peak in inflation is indeed just below 3%, this is high compared with the past couple of years but lower than in 2011, when the rate exceeded 5%. Any rise in unemployment is unwelcome but an increase of 200,000 would not be huge by past standards. What it would so is reverse the improving trend of recent years.

Will it keep a lid on pay? Pay has been the dog that has not barked for many years. Every time the job market has tightened, wages have failed to respond. The latest figures have average earnings growth of 2.5%, split between 2.8% in the private sector and 1.4% in the public sector, where pay restrictions continue to operate.

The Bank expects pay growth to slowly pick up to 2.75% in a year’s time and 3.75% in 2018, though its previous predictions of a strengthening in pay growth did not come to fruition. Many economists think there will be no acceleration in pay growth next year. That is also the broad message from pay surveys.

How will households respond to a squeeze on real incomes and a softening labour market? The consumer picture has been a little more mixed in recent months than it sometimes seems. Retail sales have continued to be very strong. Helped by Black Friday – one US import we could happily export back to them – retail sales volumes rose by 0.2% last month and were a meaty 5.9% up on a year earlier. If you took these figures on their own, you would say retailing has been enjoying a boom of Klondike proportions.

The British Retail Consortium, which represents the sector and produces its own sales data, suggests the picture is rather more subdued and will become even more so during 2017. It is puzzled by what it describes as the “extraordinary” growth in sales the Office for National Statistics finds for smaller retailers.

Other measures of consumer activity also point to a more restrained picture. Private new car registrations have been falling for a few months. Housing transactions are running below the levels of a year ago, though some of that reflects stamp duty changes.

Consumer demand is not about to fall off a cliff. You write off the British consumer at your peril. Equally though, its growth will slow. Household debt, as noted here recently, has been rising quite strongly but I would be surprised if people try to borrow their way through the squeeze.

As for the economy, consumer spending has been what kept it going in the second half of the year. It will need other strings to its bow in 2017, and some of those have their own challenges.

Sunday, December 11, 2016
We need more globalisation and technology, not less
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

These are risky times, in which the dangers of policymakers getting things badly wrong are greater than for a very long time. The lure of populist policies, which appear to help beleaguered voters but will end up doing them harm, is tangible and dangerous.

A few days ago Mark Carney used a speech in Liverpool to pick up on one of Theresa May’s themes. The prime minister, in her Lord Mayor’s banquet speech last month, had repeated her argument that globalisation has left too many people behind.

The Bank of England governor, while absolving monetary policy of the blame the prime minister tried to heap on it a couple of months ago – and doing so quite successfully – also had worries about globalisation. Many people in the advanced economies, including Britain, lament a loss of control and have lost trust in the system.

And, as he put it: “Measures of aggregate progress bear little relation to their own experience. Rather than a new golden era, globalisation is associated with low wages, insecure employment, stateless corporations and striking inequalities.”

The “left behind” arguments about the consequences of globalisation have been seen as key drivers of this year’s dramatic political developments, including the Brexit vote and the election of Donald Trump. As Carney noted, the fact that a more open and connected world economy has lifted over a billion people out of poverty and resulted in a considerable rise in living standards – world gross domestic product per head is two and a half times what it was in 1960 – cuts little ice if people in Britain are in the first “lost decade” for real wage growth since the 1860s.

Add in technology and the rise of the robots, where Carney quoted his chief economist Andy Haldane’s figure that up to 15m current British jobs are at risk of automation, and progress appears to bring only bad news. Automation and its possible consequences for employment is worth a piece on its own, which I shall save for another day.

There is, however, a risk of serious misdiagnosis here. Carney is fundamentally sympathetic to globalisation and new technology, as is the prime minister. Both are right to address the need for growth, not just to be more inclusive, but to be seen as so. “It is not surprising that people are largely ignoring pieties about the virtues of open markets and new technologies,” he said.

Whether ignored or not, however, some things are fundamentally true. One is that trade, and other forms of globalisation, brings benefits, and opportunities for growth, that far outweigh the costs. The other is that new technology is much more likely to be productivity-enhancing, something we desperately need at the moment, than job-destroying.

So how do we answer the arguments against globalisation? The past few years, far from representing a high watermark of globalisation, with jobs being outsourced right, left and centre to lower-cost locations, has seen something of a pause in it.

Just as world trade growth has been subdued since the global financial crisis, so have other manifestations of globalisation. As far as trade is concerned, where it has struggled in recent years even to grow as rapidly as global gross domestic product (GDP), we need more globalisation not less.

Trade is a generator of stronger productivity. Open economies do better in raising productivity, and thus living standards, than countries which close themselves to the world. As the governor argued, the fundamental challenge for monetary policy, and the need for both near-zero interest rates and unconventional policies such as quantitative easing, has been to try to offset the malign effect of a 16% shortfall in productivity since the crisis.

Where does that shortfall come from? Some of it arises from the fact that the globalisation impetus has slackened. Some of it has been due to a reluctance by firms to invest, and in some cases an inability to raise the finance to do so.

For both productivity and living standards, however, a far better culprit than either globalisation or technology is the fact that we have been living with the hangover of the biggest financial crisis in history. It has always been known that the crisis would reduce living standards below what would otherwise have been expected, and that these effects would last a number of years.

The fiscal hangover, mainly as a result of the crisis’s impact but also the public spending boom that preceded it, meant that this expected hit to living standards was compounded by the post-2010 “austerity” years of tight control of government spending.

The banking hangover from the crisis meant that the normal process of creative destruction in and after a big recession – the inefficient being shut down and replaced by new and vibrant businesses – did not operate as it normally should, because lending was rationed.

The performance of real wages in recent years better reflects a post-crisis hit than an ongoing squeeze from globalisation. Real wages fell from 2008-9 to 2013, but have since been recovering. If we are heading for another squeeze now, that will be largely the consequence of the pound’s post-referendum fall.

Broader measures of household income have held up better, partly because of government actions like the raising of the personal income tax allowance, partly because of low interest rates. So real household disposable income per head is 8% above pre-crisis levels. It fell in 2011 and 2013 but rose strongly last year.

As for employment, this remains a very considerable success story. Whether it is measured by the workforce as a whole, or UK-born, or UK nationals, there has never been a higher proportion – roughly three-quarters in all cases – of people of working ago (16-64) in work. This is a vibrant job market, not one where jobs are being stolen by globalisation or robots.

Averages, of course, are averages and some will say that their experience comes nowhere near matching those averages. Some will choose to look at the labour market through a Sports Direct prism and the rise of insecure jobs but that, while regrettable, is not representative.

I am not falling into the trap, identified by Carney, of suggesting we have never had it so good. But things have been a lot better in the wake of the crisis, than they might have been. Anger about the crisis is still justified. Blaming globalisation and technology is mainly not.

In fact, the argument needs to be turned on its head. We need more globalisation and technology to raise productivity and living standards, not less. And in these strange times we need to keep saying it.

Sunday, December 04, 2016
Britain's households are swimming but not drowning in debt - yet
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

Household debt is back in the headlines. Official figures show that consumer credit is rising by 10.5% a year, its fastest since well before the crisis, while the Bank of England has warned that the debt being accumulated by households is one of the risks it sees to financial stability, among several others.

How worried should we be about this household debt build-up, which is running in parallel to the rise in government debt described here last week?

Let me start with some numbers. Consumer credit, as noted, was up by 10.5% in the 12 months to October, it fastest rate since October 2005. Consumer borrowing, on this measure, hit a total of £190.1bn. Of the latest 12-month rise, there was an increase of 9% in credit card borrowing and 11.4% in other loans and advances.

The sharp-eyed among you will have noticed that while £190bn is a lot of money, it does not represent anything like the total for the amount that individuals owe to lenders. That total is a chunky £1,508bn - £1.5 trillion – overwhelmingly in the form of mortgages. It is also growing, though at more sedate 4% a year.

Do these figures suggest a return to the pre-crisis bad old days of binge borrowing? No, or at least not yet. The annual growth of consumer credit has been in double figures since June, a mere five months. In the 1990s and 2000s, it was consistently above 10%; from 1994 to the autumn of 2005. In that period, consumer credit growth was often in the mid to high teens, peaking at 17.6%. I would be surprised if that were to happen again.

As for the overall growth in lending to households, it has been running at its strongest levels since the crisis for much of this year but- driven by the mortgage boom of the pre-crisis era – grew much faster in the past. Growth in overall lending peaked at more than 15% in 2004. In the 10 years to September 2008, the amount owed by households rose by almost 160% to £1.39 trillion.

This is where it gets interesting. After the crisis households changed their behaviour, or were forced to do so by cautious banks and other lenders. It took until the autumn of 2013 for household debt, in cash terms, to get back to where it was in September 2008. Mortgage rationing and falling consumer credit played a big part in this.

That was one reason to be fairly relaxed about household debt. Yes, it was high when the crisis hit. But a five-year period in which it did not grow at all constituted a significant repair. More to the point, debt fell in relation to income.
In both respects, however, that process has come to an end. Since recovering to its previous peak in the autumn of 2013, household debt has risen by more than 8%. It has also started to rise again in relation to income, which is one of the reasons why the Bank is concerned.

At its peak, household debt rose to just over 150% of annual household income, dropping to just over 130% in the second half of 2014. Now it is creeping back up again, to 133%. To put that in perspective, 20 years ago debt was less than 90% of income.

For the Bank, both the level and the recent rise in debt are causes of concern. As it put it in its latest Financial Stability Report: “The level of household indebtedness remains high by historical standards. Although average debt servicing rations remain low, the ability of some households to service their debt could be challenged by a period of higher unemployment. These households could affect broader economic activity by cutting back sharply on expenditure in order to service their debts.”

On the recent rise in unsecured consumer credit, the Bank notes that it stands on sharp contrast to expectations of a a weaker outlook for the economy, and that “it raises the prospect of a further rise in household indebtedness as increases in unsecured debt outpace growth in real incomes”.

There are some fascinating snippets in the Bank report. People are borrowing longer. Roughly 35% of new mortgages are for terms of more than 30 years, rather than the 25 that used to be the norm. Just over a quarter of new mortgages are for four or more times income, while a fifth are now for 90% or more of the value of the property. The Bank remains convinced, in spite of this, that there has been no slippage in mortgage lending standards.

Some of the rise in debt, it should be said, reflects changes in buying patterns. New car purchases, together with those of many used cars, are now overwhelmingly on finance and, as the Bank says, “growth in dealership car finance has been particularly strong in the past three years”.

But in the end, the issue of household debt comes down to the question of how well people are placed to cope with two things which, if not as certain as death and taxes, will happen at some stage. One is a rise in unemployment from current very low levels. The other is a rise in interest rates towards more normal settings.

A meaningful rise in unemployment would double the number of households in serious difficulty, according to the Bank, while many hundreds of thousands would struggle if Bank rate, currently 0.25%, were to rise to 2%, even gradually, and other rates in the economy adjusted accordingly.

So how worried should we be? The fact that the post-crisis repairing of household finances has come to an end is a little disturbing, though the rise in debt in relation to income has so far been modest. The Office for Budget Responsibility (OBR), which until now had predicted a sharp rise in debt, said a few days ago that it now thinks the process will be a gentle one. Using a slightly different, and larger, measure to that used by the Bank, it sees a rise in debt from 142% of income now to 149% by 2022.

The key question is whether the recent strength of credit growth reflects a determination by households to borrow their way out of trouble – or into it – or whether it will slow as household incomes are squeezed and the job market softens. The GfK index of consumer confidence took a sizeable five-point drop last month as people began to fret about the economic outlook, and adopt a more downbeat attitude towards major purchases.

That should signal a more cautious attitude towards greater indebtedness, though perhaps not until after Christmas. The experience before the crisis, however, was that once people get the debt bit between their teeth, they are reluctant to let go. It is easy to see excessive debt as somebody else’s problem. So we should keep a close eye on the credit and debt numbers.

Sunday, November 27, 2016
Why Brexit will mean a bigger debt burden
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

In announcing that Wednesday’s autumn statement will be the last (at least until a future chancellor decides to reinstate it), Philip Hammond abandoned one tradition.

He has, however, established another. This is that when he presents and responds to new forecasts from the independent Office for Budget Responsibility (OBR), as he will be required to do twice a year, it can be guaranteed that a storm of criticism will be unleashed.

In the toxic post-Brexit vote environment that we are in, we have already had plenty of prattle, as some Tory MPs and unnamed ministers queued up to attack the OBR for predicting that Brexit will mean somewhat slower growth and significantly higher debt and deficits. Most of those doing the attacking, I suspect, will not even have opened the OBR document.

Next year, when we will have two budgets, the last spring budget in March and the first of the new autumn super-budgets in November, I suspect we will see some more of this. The fact that Brexit, as well as causing an inflation-inducing drop in the pound, will mean more government borrowing and higher public sector debt is unsurprising. It was pointed out, including here, on many occasions before the referendum, and it is happening.

The striking thing about the OBR’s forecasts, notwithstanding the attempts by critics to undermine it, is that they could have been a lot gloomier. It sees a temporary and modest slowdown in growth to 1.4% next year, picking up to 1.7% in 2018 and 2.1% (in line with its pre-referendum forecast) in 2019.

Its predictions for growth are thus above-consensus and, incidentally, stronger than those from the Bank of England. It could have been a lot gloomier, particularly about prospects towards the end of the decade. Its forecast is supposed to be based on government policy, so naturally it asked the government for its policy on Brexit. In return it was sent two anodyne paragraphs from Theresa May speeches, which said nothing more than that the government will aim to achieve the best of all possible worlds. To assume a normal rate of growth in 2019 on the basis of a policy vacuum was more than generous to the government.

The OBR, similarly, is not as gloomy about inflation as most forecasters, some of whom think it will hit 4%. It sees a peak of 2.6%.

Nor has the OBR laid it on thick when it comes to the details of the forecast. At a time when business organisations fear sharp weakness in investment, notwithstanding its small rise in the third quarter, the OBR’s forecast – a tiny 0.3% drop in business investment next year followed by a 4.1% rise in 2018 – are optimistic.

In terms of longer-term damage, in the absence of a Brexit vote the OBR was ready to revise up the economy’s growth potential because net migration was clearly rising at a rate well above the “tens of thousands” targeted by David Cameron’s government. Now, in the light of the referendum it has abandoned that upward revision and revised growth potential lower, on the assumption that net migration drops gradually to 185,000 a year, from 330,000 last year.

The biggest uncertainty about the economic outlook as it affects the public finances is productivity. The lower productivity growth – output per hour – the weaker the prospects for tax revenues. Fathom Consulting points out that the OBR has been assuming a gradual return to normal rates of productivity growth since its inception in 2010. It is doing so again, predicting that by the end of the decade productivity will be growing by 2% a year. Other forecasters say this will be hard to achieve given the recent record of disappointingly weak productivity and the likelihood that one of the drivers of productivity growth – international trade – will be hit during the government’s efforts to negotiate new trading arrangements.

The chancellor’s £23bn national productivity investment fund (NPIF) showed that his priorities are right: infrastructure will be one of the keys in the long-term to raising productivity. Long-term is, however, the operative word here.

So the OBR’s prediction of a £122bn deterioration in the public finances by 2020-21, of which just under half, £59bn, is directly attributable to Brexit, looks reasonable, even cautious. Public sector debt, on its forecasts, will top £1.9 trillion by the end of the decade, up from £500bn 10 years ago and £1 trillion in 2010. The Brexit effect is an addition to government debt we could have done without.

Nor is the pressure over for further additions to debt and deficits. Hammond fought off Downing Street demands to do more this time, but that was just one battle in what will be a long war. When the squeeze on real wages hits next year, it will revive the disappointment over income growth that has led to so much disenchantment.

As Paul Johnson, director of the Institute for Fiscal Studies, memorably put it, in the wake of the autumn statement: “Real wages will, remarkably, still be below their 2008 levels in 2021. One cannot stress enough how dreadful that is – more than a decade without real earnings growth. We have certainly not seen a period remotely like it in the last 70 years.”

People will say that that is not what they voted for in June, or indeed were promised. But reality is sinking in. Markit’s UK household finance index, using data from Ipsos-Mori, asked people in July whether they expected economic prospects to be better or worse over the next 10 years as a result of Brexit.

In July there was optimism. In the North East, for example, a net 7.5% of people thought the next 10 years would be better for the economy as a result of Brexit; now a net 19.1% believe it will be worse. In the South East net optimism of 8% in July has turned into net pessimism of 30.4%. Across all income groups there is pessimism about prospects. Only the oldest age groups are positive, though by a smaller margin that they were.

The backdrop to this, as well as that provided by the IFS, was the conclusion by the Resolution Foundation, a think tank, that the poorest third of households face falling living standards over this parliament, with overall living standards stagnating. It is a pretty grim backdrop and one which might require an easing up on welfare cuts.

The chancellor, who has also been criticised for not responding to the crisis in social care, within an overall squeeze on NHS funding, has left himself some room for manoeuvre – about £27bn – within his looser fiscal rule of getting the budget deficit below 2% of gross domestic product by the end of the parliament. That would mean yet higher government debt. He may well have little choice.

Sunday, November 20, 2016
Hammond has no room for populist giveaways
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

Chancellors of the exchequer do not normally elicit much sympathy, usually falling effortlessly into the role of pantomime villain. It is hard, however, not to feel a bit sorry for Philip Hammond, as he prepares for his big day on Wednesday, his autumn statement.

If the new chancellor discovered a “there’s no money left” note from George Osborne in his Treasury office when he took over in the summer he has not yet let on. But he inherited the task of completing the job of restoring the public finances to health, and a continuing austerity programme.

Hammond also inherited, thanks to the Brexit vote – and perhaps his predecessor’s campaign tactics – a deteriorating outlook for the public finances. We do not know exactly what the Office for Budget Responsibility (OBR), the independent fiscal watchdog, will come up with on Wednesday. It is unlikely, however, to be too different to the cumulative £100bn underlying overshoot by 2020-21 (compared with the OBR’s March predictions) estimated by economists at PWC, the professional services firm.

Faced with a worsening of the public finances of this sort, due to the expectation of slower growth in the years ahead as a result of Brexit uncertainty, it would make little sense for the chancellor to weigh in with tax increases or additional spending cuts to try to bring his predecessor’s deficit reduction programme back on track.

This has already been acknowledged by the government, indeed by the new prime minister. No longer will the government aim for a budget surplus by the end of the parliament. The “automatic stabilisers” – tax revenues down and some government spending up as a result of slower growth – will be allowed to operate. That makes perfect sense.

What also makes sense is for the chancellor to focus on the two areas which need extra spending and support: infrastructure and business investment. The abandonment of Osborne’s fiscal rules – all three have been dumped or missed since the May 2015 election - gives him plenty of room for the former.

Fiscal rules, as the Institute for Fiscal Studies has noted, have not been built to last. Of the 12 adopted since 1997, 10 were broken, the others superseded. Chancellors still need them, however. In spite of their record investors and the ratings agencies need to know that governments operate under some fiscal constraints and are not free simply to let rip.

Fortunately for Hammond, there is an off-the-shelf fiscal rule that would work well for him, and permit a substantial increase in infrastructure spending, spread around Britain’s regions. Combined with tapping into private sector funding of infrastructure, and the chancellor should be able to unveil a decent-sized “rebuilding and upgrading Britain” package. It will not come close to rivalling Donald Trump’s $1 trillion (£800bn) mainly private-sector funded and delivered infrastructure plan, though we have yet to see whether that will be deliverable.

How can Hammond spend if the public finances are in a worse state? The answer is to revert to the fiscal target Osborne originally had, which in turn had a powerful echo of Gordon Brown’s original 1997 rules. This is to concentrate on balancing the current budget deficit – the balance of day-to-day spending and receipts – while leaving room to borrow to invest.

A target of balancing the current budget should be achievable by the end of the parliament – PWC suggests a 0.6% of gross domestic product surplus on this measure in 2019-20 - provided that Hammond is able to restrict his giveaways in other areas. Most projections suggest eliminating the current budget deficit remains on course in spite of Brexit. Markets, meanwhile, would not go out of their way punish a government that chooses to spend more on infrastructure. The international tide is turning.

That, with a bit of help for business, should be that. Firms would like to see the back of the apprenticeship levy, want extra help on business rates and would like more incentives to invest during a time of uncertainty. Anything Hammond does is unlikely to prevent business investment being weak over the next couple of years but could mitigate it.

Unfortunately, it seems, that will not be that as far as the autumn statement is concerned. The chancellor is being leaned on by Tory MPs, and more importantly by Downing Street, to announce some populist measures. Wednesday would be a great opportunity for Hammond to pause the policy of raising the personal income tax allowance and the higher rate threshold by more than inflation. But the indications are that he will press on with it.

Fuel duty, successive freezes on which add up to a lot of lost revenue for the Treasury, is also part of the populist agenda. The chancellor should not be trying to shield motorists from the higher petrol and diesel prices, much of which is directly linked to sterling’s post-referendum fall. It seems, however, that he will.

When it comes to populism –and the perceived need to help the prime minister’s "jams", the just about managing families (which has now replaced “hard-working” families) – the list is endless. Does it mean extra money for the National Health Service? It might well do so. Does it mean scrapping or at least modifying Osborne’s planned four-year cash freeze on most working-age benefits, including tax credits? Again, that is very much on the agenda.

As always, there are good arguments to be made for all sorts of things. But this is not a time for fiscal largesse across the board, for the chancellor to play Lady Bountiful. The public finances still need to be repaired.

Nor, looking at the numbers, can it be argued that households are showing great signs of distress, in fact the opposite. Retail sales figures three days ago showed a 1.9% jump in sales volumes last month, for an increase on a year earlier of an extraordinary 7.4%; the fastest rate of spending growth since April 2002. At one time, remember, some feared that consumer confidence would be hit so hard by the Brexit vote than an emergency Vat cut would be on Hammond’s autumn statement agenda.

Now, I am quite prepared to accept that some of the strength of spending reflects foreigners taking advantage of bargain-basement prices. I am also quite prepared to accept that many households are in no position to splash out and that the figures were are seeing now represent something of a last hurrah for consumers, before higher inflation begins to put a serious squeeze on their real incomes.

Even so, the chancellor should be treading carefully. Money is tight and his priorities should be clear. Giveaway measures aimed at households will leave him with a messy and unconvincing hotch-potch statement. He should stick to infrastructure and investment.

Sunday, November 13, 2016
The last thing we need is a protectionist president
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

The way we used to worry about the intrusion of politics into the economy and business now seems quaint and old-fashioned, belonging to a very different era. It is hard to believe it is only 18 months since the Conservatives and Labour squared up in the 2015 general election.

And, despite everything written at the time, including by me, the economy’s path under the economic policies put forward then would not have been very different whatever the outcome, though Labour would not have had a referendum.

2016 has changed that. Politics has become predictably unpredictable. Brexit and Donald Trump’s victory will bring much more change than any conventional election. Change, after all, is what people voted for. And, with important French and German elections coming up next year, there is plenty of scope for more unpredictable outcomes.

Even in Britain, the next election would at least throw up the possibility, however remote, of a shift away from the narrow territory around the centre-ground; in the form of a Labour government under Jeremy Corbyn.

What will the latest intrusion of a different kind of politics mean for Britain? If you were looking for historical precedents, Donald Trump could be seen as a hybrid of Dwight D Eisenhower and Ronald Reagan; rebuilding America’s crumbling infrastructure and slashing taxes to boost America’s growth rate.

That, notwithstanding the impact of this expansionism on America’s debt and deficits – which will worry some - together with his pledge that Britain would be at the front rather than the back of the queue when it comes to new trade deals, sounds very positive.

America, after all, is Britain’s single biggest export market, accounting for 17% of exports of goods and services. It is also a country that, unusually, Britain runs a sizeable trade surplus with, even in goods. That surplus was £14bn last year, and will be helped by sterling’s post-referendum fall to the lowest level in three decades. There is also a good platform for future trade growth. Britain’s exports of goods to America, £47bn last year, were up by nearly a fifth on two years earlier.

But then there is the other Trump; the protectionist Trump, the America First Trump who also wants to cut America’s admittedly large financial commitment to Nato. In 1930 Herbert Hoover signed into law the Smoot-Hawley tariff on a huge range of imports, provoking the trade war which deepened and prolonged the Great Depression.

Trump as Hoover proposes a 45% tariff on Chinese and 35% on Mexican imports. He would revisit Nafta, the North American Free Trade Agreement, inevitable if he carries out his threat on Mexican tariffs and building a wall. The Trans-Pacific Partnership (TPP) would be sunk, as would the the barely-alive Transatlantic Trade and Investment Partnership (TTIP).

All this arises from a very different attitude towards globalisation than that taken by the British government. Theresa May and her ministers recognise that there are losers as well as winners from globalisation and that more should be done to help them. Trump appears to want to tackle the problem at source, on the argument that globalisation mainly benefits other countries and big corporations and should be reined back.

This is an argument that should have been challenged more aggressively, particularly in the years since the crisis. Economists have taken it as given that free trade delivers sustained economic gains, which is supported both by theory and the post-1945 growth and prosperity of the world economy.

Now the argument is in danger of being lost. Clemens Fuest, president of the Munich-based Ifo Institute economic think tank, said: "If Trump goes ahead and erects trade barriers as planned, the damage will be huge.”

There would never be a good time for a president with highly protectionist policies to be elected, but this is a particularly bad one. The missing ingredient from the world economy since the crisis has been world trade growth. Before 2008, world trade grew significantly faster than global gross domestic product, usually around twice as fast, sometimes more.

Since it, it has struggled to keep pace with global GDP. World trade has not been a driver of global growth because of subtle protectionism, constraints on trade credit, and so on. The World Trade Organisation says 2016 will be the weakest year for world trade growth since the crisis and will be the first in 15 years in which world trade grows more slowly than global GDP. It has called on countries to “heed the lessons of history and re-commit to openness in trade”.

There are, it should be said, other forms of globalization than physical trade. A recent report by the McKinsey Global Institute pointed out that cross-border data flows are 45 times larger than they were a decade ago. Digital globalization continues apace.

But the weakness of conventional trade matters a lot, particularly to Britain as an open economy, a trading nation. Britain’s exports have been going nowhere fast in recent years. Last year the total, for exports of goods and services, £509bn, was down in their level two years earlier and a mere 2% up on 2011, making a mockery of George Osborne’s target of doubling exports by the end of the decade. Some of this was due to a drop in oil exports, from £39bn in 2011 to £21bn last year, but exports of goods excluding oil have also disappointed, down from £270bn to £262bn.

This was partly as a result of the eurozone crisis but largely down to the post-crisis weakness in world trade. The last thing Britain’s exporters want is a president whose policies will mean a further reduction in world trade growth. Any advantage bestowed on Britain by Trump’s renewal of the special relationship would be more than offset by the danger of tit-for-tat protectionism and a modern-day trade war.

Will it happen, or was Trump’s campaign bark on protectionism a lot worse than his presidential bite will turn out to be? China’s vice-minister for finance Shi Yaobin said as much on a visit to London last week, suggesting that Trump’s tough words on China and trade were to win election and that the president-elect would soon realise the benefits of co-operation with China.

He may be right, though it is too early to say. Trump as Eisenhower-Reagan, emphasising infrastructure and cutting taxes, including America’s higher 35% corporate tax rate, would be positive for Britain and the world economy. Trump as Hoover most definitely would not be. We have to hope that the right one wins out.

Sunday, November 06, 2016
Sterling's ill-wind could blow us back to balance
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

You would have to say that it has been bracing, not least for the pound. Blown in one direction – down – by the referendum result and government indications that it will be pursuing a harder form of Brexit – sterling was blown back up a little on Thursday by the High Court’s ruling that Parliament must have a vote on the triggering of the formal Article 50 process and ended the week above $1.25.

But the pound remains very substantially lower than it was, which will have some of the consequences, notably higher inflation, we are familiar with. It is an ill wind, however, which blows nobody some good.

Manufacturers are benefiting from the lower pound. The latest purchasing managers’ survey for the sector from Markit showed that export orders are driving a mini-revival in Britain’s factories.

That is good news but perhaps most remarkably, if a new forecast is right, one of Britain’s longstanding Achilles’ heels will, in just a few years, have been eliminated. I am referring to the current account deficit, the balance of payments gap, the amount that this country is in the red in its transactions with the rest of the world. Times have changed, but it used to be regarded as one of the best measures of the nation’s economic health.

The deficit, as regular readers will know, has been running at record levels. Last year it was no less than £100.2bn, 5.4% of gross domestic product. In the first half of this year it averaged 5.8% of GDP. It was this that led Mark Carney, who has had a busy week, to say that Britain would be dependent on the kindness of strangers to fund all this red ink.

The good news then is that Britain may not be dependent on this kindness for too much longer. The latest forecast from the National Institute of Economic and Social Research (Niesr) attracted a lot of attention a few days ago because of its prediction that inflation will rise to 4% during next year, putting a big squeeze on real – after-inflation – household incomes, and thus restraining spending.

Also in the forecast, however, was a remarkable set of numbers on the prospects for Britain’s current account deficit. Niesr expects this year’s figure to average out at 4.5% of GDP, a small improvement on last year. Next year there is a bigger drop in the deficit, to 2.7% of GDP. It is what happens next, though, which really caught my eye. The deficit is predicted to virtually disappear in 2018, dropping to a mere 0.1% of GDP. But then this is followed by three successive annual surpluses beginning in 2019, of 1.2% of GDP, 1.2% and 0.9% respectively.

Before explaining how this is expected to come about, it is worth taking a moment to record how unusual a single current account surplus, let alone three in a row, would be. Britain has not had an annual surplus in the past three decades. The Office for National Statistics’ dataset, going back to 1987, shows that the nearest we had to one was a 0.2% of GDP deficit in 1997. Last year, as noted, it was a record 5.4% of GDP. So this would be a very big change.

How does it happen? There are three main things happening in the Niesr forecast. Though it notes that Britain’s exports often respond disappointingly to falls in the pound - in the jargon the elasticities are low - it does expect some impact on export growth. But, as far as trade is concerned, weaker domestic demand and higher import prices have the effect of reducing growth in the goods and services we buy from abroad. This indeed is what it sees as the main channel through which the trade picture improves.

The result is that net trade (exports minus imports) having made a negative contribution to growth in recent years, despite post-crisis hopes of export-led growth, makes a significant positive contribution next year and beyond. The trade deficit in goods and services, £39bn last year, is predicted to disappear before the end of the decade.

The second big factor is investment income, which has been responsible for much of the lurch into record current account deficit in recent times. This was the phenomenon under which foreigners were earning larger returns on their investments in Britain than British people and institutions were on their investments overseas.

The lower pound affects this in two ways. It boosts the sterling value of foreign assets and thus improves Britain’s net international investment position; while leaving the sterling value of foreign-owned assets in Britain unchanged. It also boosts the sterling value of foreign income. It is enough to return to surplus this component of the balance of payments, the so-called primary income account, perhaps even before the end of this year.

Finally, in what Simon Kirby, who runs Niesr’s UK forecast, admits might be a heroic assumption, another source of improvement is that Britain stops paying contributions to the EU in 2019-20. That assumes exit by March 2019, an assumption perhaps complicated by the High Court judgment, and assumes exit is not followed by the kind of arrangement Switzerland and Norway have with the EU, which involve contributions.

Anyway, the prospect of a return to surplus on Britain’s current account, particularly from a position of record deficit, is encouraging. The Bank of England, by the way, also sees the deficit narrowing significantly but its forecast does not run as long as Niesr’s.

Will it happen? Forecasts – good and bad - are forecasts, and subject to the usual health warnings. I had thought the big fall in the pound from the autumn of 2007 to early 2009 would lead to a big improvement in Britain’s current account position but the outcome was disappointing, not least because of the weakness of Britain’s export markets in the eurozone (one reason for the decline in the EU share of exports).

Niesr assumes the pound stays roughly where it was at the time of its forecast, $1.22 and €1.11, which implies a prolonged period in which sterling is below both fair value and historical averages. Currencies move, as we saw on Thursday. Depending on what happens on Tuesday in America, the dollar could move quite a lot. Currency market indications in recent days are that it would fall a lot on a Donald Trump victory, pushing the pound higher.

There is also, of course, that elephant in the room of Britain’s future trading arrangements. Niesr expects the trade and current account positions to start deteriorating again in the first half of the 2020s. If Britain fails to secure good trade deals with the EU and the rest of the world, that deterioration could be very significant indeed. We should enjoy this return to surplus while it lasts.

Sunday, October 30, 2016
Hard or soft Brexit? Britain needs a middle way
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

To the frustration of many MPs, and the concern of many businesses, the shape of Britain’s post-EU future remains clouded in uncertainty. When Jeremy Corbyn said to Theresa May a few days ago that her cunning plan was that she did not have one, it was not just his own MPs who nodded in approval at a rare hit for the Labour leader.

The prime minister continues to insist that she will seek combine maximum possible access to the single market with controls on EU migration. The fact that the economy has so far held up well in the face of the Brexit vote, with third quarter gross domestic product rising by 0.5%, may strengthen her hand, and those of the Brexiteers in the government. It is, though early days, and Brexit will be a long process. Even more encouraging was the decision by Nissan to build the new Qashqai and X-trail in Sunderland. It has clearly been led to expect than any future deal will involve something close to existing single market arrangements for cars.

As I noted last week, second-guessing the government is probably not the most productive thing to do at the moment. Fortunately, there is plenty happening outside government, which one would hope will have an impact on the official negotiating position. Does Brexit have to be “hard” or, given that a “soft” Brexit – one involving continued unrestricted free movement – is unlikely, is there a middle way that would work to the benefit of both Britain and the EU?

Let me begin with some definitions. Economists at HSBC, in a useful recent report “Brexit getting harder”, took eight conditions and applied them to different arrangements between Britain and the EU. As an EU member Britain is in the single market, has duty free trade in goods, market access for services but cannot negotiate its own trade deals. It must adhere to EU social and employment rules, contribute to the EU budget, is in the Common Agricultural Policy (CAP) and cannot restrict EU migration.

Of the six other models HSBC looked at, the hardest were the WTO (World Trade Organisation) and Canada models. Under a WTO model none of the eight conditions of EU membership would apply. Under a Canada-style agreement, similar to the on-off-on comprehensive economic and trade agreement between Canada and the EU, there would be duty free trade in goods and partial access for services.

In between these extremes, if it is right to call EU membership an extreme, there were however other options. The most interesting of these is the so-called Continental Partnership, proposed a few weeks ago in a report from Bruegel, the Brussels-based think tank.

The continental partnership proposal, authored by Jean Pisani-Ferry, Norbert Rottgen, Andre Sapir, Guntram Wolff and our own Sir Paul Tucker, former deputy governor of the Bank of England, sees the Brexit vote as an opportunity for restructuring Europe in a more fundamental way. In essence, it would head towards an inner circle of countries committed to monetary and political union and an outer circle, including Britain, more interested in economic relationships, including trade and financial services, as well as security co-operation, while limiting free movement.

As the paper put it: “We propose a new form of collaboration, a continental partnership. The UK will want to have some control over labour mobility, as well as leaving behind the EU’s supranational decision-making. The proposed continental partnership would consist in participating in goods, services, capital mobility and some temporary labour mobility as well as in a new system of inter-governmental decision making and enforcement of common rules to protect the homogeneity of the deeply integrated market.

“The UK would have a say on EU policies but ultimate formal authority would remain with the EU. This results in a Europe with an inner circle, the EU, with deep and political integration, and an outer circle with less integration. Over the long-run this could also serve as a vision for structuring relations with Turkey, Ukraine and other countries.”

The authors have since come back with a follow-up, prompted by criticism that the continental partnership sounded a bit too much like allowing Britain to have her cake and eat it. They say, on the contrary, that it would not be a route to allowing EU members to restrict free movement of people, or risk what they describe as “political contagion”. Instead, they say, it would be the best way for the EU “to maintain strong economic and security cooperation with the UK, while defending themselves against dumping and vetoes”.

Will the continental partnership fly? From a British perspective it should, though the rest of the EU may see it differently. As Lord Hill, Britain’s former European commissioner, put it recently, it is a common view in Brussels that Brexit will not actually happen. For those who believe it will the language so far has pointed towards an acrimonious rather than an amicable divorce. Politics and punishment may take precedence over economics.

That leaves Britain to think about how to secure its best interests in future EU negotiations. Another useful paper, from the Centre for Economic Performance at the London School of Economics, sets out the four principles Britain should adopt.

The four principles: you get what you give; where negotiations start from matters; bargain from a position of strength, and invest in negotiation capacity, make a good deal of sense. So the author, Thomas Sampson, argues that a bold gesture like unilaterally removing Britain’s tariffs, as advocated by some, would remove an important bargaining chip.

Britain has the advantage of already being in the single market, which is the status quo, so any negotiation starts from that position rather than with a blank sheet of paper. But one potential advantage, the timing of the start of the notionally two-year Article 50 process, has been lost. Sampson says Britain should neutralise this by seeking an agreement on transitional trading arrangements between the EU and Britain, in which things would continue as now until such time as a new and comprehensive deal, which could take many years, was concluded.

There is, very clearly, a lot to play for. It is in Britain’s best interests, as well as those of the EU, to co-operate once the rancour fades. A hard and damaging Brexit would hurt Britain most, but it would also harm the EU. For both sides, there has to be a middle way.

Sunday, October 23, 2016
Stormier weather ahead for a nation of shoppers
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

For Britain’s retailers – at least those who are not threatened with having their knighthood taken away – this should be a time of celebration. The latest official figures show that the volume of retail sales in the three months to September was 5.4% up on a year earlier.

That was mighty strong. You have to go back to early 2015 for anything stronger. A jump in retail sales in July, the month after the referendum, was followed by a flat August and September. Even so, it is hard to see anything resembling consumer retrenchment in these figures.

So why the long faces? Some of the strength of sales was because, perhaps because of all those staycations, we bought more petrol and diesel. Even excluding those, however, retail sales volumes were up 5.1% in the third quarter.

Some retailers have always had difficulty reconciling their own experience with the official figures but they can agree on one message from the numbers. This is that they have to work hard, though discounting and special sales events, to achieve their sales.

In more normal times – times of higher inflation than in recent years – the growth in sales values always exceed that of volumes, Two things drove shop takings; the number of goods sold and the price, usually rising, at which they were sold. That, however, is not the case now. While volumes of retail sales (excluding fuel) were up by 5.1% in their third quarter, values – which are what we really count – were up only 3.4%.

The bigger worry is what comes next. Last week brought news of a bigger rise in inflation than expected. True, consumer price inflation only rose from 0.6% to 1% (inflation on the old retail prices index is 2%) but pretty well everybody thinks this is the beginning of a long climb. The median expectation among forecasters is of a rise in inflation of 2.5% next year, with the gloomiest expecting something closer to 4%. Last year, when we had no inflation at all, on the consumer price index measure, looks to have been a one-off.

These days, of course, it does not take much of a rise in inflation to overtake the growth in wages, leading to a fall in real incomes. Both including and excluding bonuses, average earnings are currently rising by 2.3% a year, which is where forecasters expect them to stay. Will they? Won’t employees seeking compensation for rising prices?

In the past they would, whether represented by trade unions or not, but this mechanism appears to have changed, as has the old Phillips curve trade-off between unemployment and wage inflation. We have low unemployment by modern standards but weak wages. These days, 2% is something like the norm for wage increases.

The EEF, the engineering employers’ federation, which represents Britain’s manufacturers, finds that the most common pay rise among its members is “up to” 2% and that a growing number of businesses have imposed pay freezes this year, which it ascribes to greater uncertainty.

Pay is not the only potential source of a squeeze on real incomes. One of the decisions for the chancellor in his November 23 autumn statement in whether to persist with the freeze to 2020 on working-age benefits and tax credits bequeathed to him by George Osborne. This freeze, which will hit many of Theresa May’s “just managing” families, will cost the average household in receipt of benefits and credits £360 a year by 2020 according to new calculations by the Institute for Fiscal Studies. Excluding those families which only receive child benefit, the cost rises to £470. Just managing will become more difficult.

When it comes to consumer demand, real income growth is important, but so is growth in employment. A rising number of people in work can keep spending going even when individual real incomes are being squeezed. That, indeed, was what happened in much of the last parliament. And, on the face of it, it is continuing. Employment rose by 106,000 in the June-August period, new figures show, and was a very strong 560,000 up on a year earlier.

There were, however, one or two signs in the figures of a softening in job growth, even apart from the small rise in unemployment the figures also showed. So the latest quarterly rise was dominated by an increase in part-time employment.

Over the past year less than a quarter of the rise in employment has been in traditional full-time employee jobs; the increase has been mainly due to self-employment and part-time employee jobs. There is nothing wrong with those, though research last week by the Resolution Foundation showed that the typical earnings of the self-employed are lower in real terms than they were 20 years ago. Business surveys suggest, meanwhile, that firms are becoming more cautious about recruitment.

If the outlook for real wages and employment has deteriorated, could the retail sector, and the economy in general, be saved by borrowing. Will households ease the pain, and maintain their spending, by running up more debt? It is happening now. Consumer credit, according to Bank of England figures, is up by 10.3% on a year ago, its fastest rate of increase since 2005.

In the years after the crisis, households ran down their borrowings. Now they are running them back up again, to the concern of some. While ultra low interest rates are a powerful incitement to borrow, debt-driven consumer spending is probably not the way we should be going.

Fortunately, if not for the consumer spending outlook, we may not be. Household debt, particularly consumer credit, is not an alternative to growth in real incomes; it is more usually an accompaniment. People borrow when they are feeling confident about their jobs, incomes and prospects. The strong growth in consumer credit over the past couple of years has accompanied good growth in real wages, not been a substitute for it.

Nor, I would suggest, can one of the saving factors of this summer – shopping tourists, or tourist shoppers taking advantage of the pound’s fall to buy goods in Britain – be expected to be more than a passing phase. Given that many of the things they have been flocking to buy are imported, the price advantage will soon be self-correcting, because new stock will be cost more to import as a result of the pound’s fall. Again, you cannot build Britain’s economy on selling Swiss watches to tourists.

None of this means consumer spending is about to collapse. The environment will, however, get tougher. Forecasters expect consumer spending to grow by just over 1% next year, its weakest since 2011, when households were hit by a combination of a Vat hike and rising oil prices. Consumers will struggle to beat this renewed squeeze.

Sunday, October 16, 2016
Uncertainty to choke off business investment
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

What is the biggest risk to Britain’s economy over the next couple of years? Anybody watching sterling’s gyrations in recent days might conclude that, as on so many occasions in the past, it is the exchange rate, itself the product of the government’s uncertain steps towards the Brexit door.

The pound’s performance is, however, merely the canary in the coalmine, a symptom of a wider uncertainty. Its average value, its trade-weighted index, fell to an all-time low last week. Its volatility adds to that uncertainty; for businesses, individuals and for the government. Whether or not a downward adjustment in sterling was needed, which is debatable, the process itself is unsettling.

When it comes to being unsettled, there are three central risks to growth over the next couple of years. They are that, in an atmosphere of uncertainty, businesses will be very cautious about investing, that a similar caution will affect recruitment, and that the inflationary impact of sterling’s fall will squeeze real incomes and consumer spending, more than offsetting any beneficial effect on exports. After that, the risks will centre on the nature of Britain’s new relationships both with the European Union and the rest of the world, including trade and migration.

Let me this week take just the first of those risks; business investment. If you were looking for an explanation of Britain’s poor productivity performance, business investment would be high on the list. It has been lower, over time, than most of our competitors. Some but not all of that reflects the larger decline in manufacturing, which is more investment-heavy than other sectors.

On the most recent official figures, business investment surprised on the upside in the second quarter, rising by 1%, though it was nevertheless down on a year earlier, and its rise mainly reflected additional spending on transport equipment; cars, vans and lorries.

Overall, business investment is 7% higher than it was before the global financial crisis hit the economy, similar to the rise in the overall economy; gross domestic product. It has, however, been a very patchy recovery. It has fallen in nine of the 28 quarters since the economy hit its recession low point in the middle of 2009. The normal post-recession exuberance of business investment was missing, not least because of the difficulties of raising finance.

What about now? The past is another country and March this year seems very different indeed. At the time of George Osborne’s last budget the Office for Budget Responsibility (OBR) predicted a 2.6% rise in business investment this year and a 6.1% increase next year.

The OBR is currently running through the numbers for the chancellor’s November 23 autumn statement, and they will make interesting reading. In the meantime we have a new forecast, to be published this week, from the Ernst & Young (EY) Item Club, which uses the Treasury’s model of the economy. It predicts that business investment will drop by 1.5% this year and by 2.3% next year. Some other independent forecasters are significantly gloomier about the outlook for business investment. The fall predicted by the EY Item Club, and the difference between it and the rise predicted by the OBR in March, is however almost enough on its own to account for the expected drop in overall economic growth next year from more than 2% to less than 1%.

Before the referendum a big concern was whether Britain could maintain her appeal as a magnet for foreign direct investment in the event of a vote to leave. That remains a big concern, particularly now that leaving the single market looks increasingly likely, if not certain. There will still be some investment flowing into Britain, not least to snap up what, thanks to sterling, are bargain-basement assets. But the loss of appeal is real.

Foreign businesses do not, however, operate in a vacuum. The concerns they have are shared by many domestic businesses, some of which need to be in the single market, some of which are just concerned about an uncertain future.
Fears of a drop in investment are not just forecasters’ guesswork. Investment intentions have weakened since the referendum. The Bank of England’s regional agents, who regularly survey firms in their areas, record what are known as agents’ scores across a range of measures of business activity. Its latest reading showed that these scores for investment intentions have dropped to their weakest since the financial crisis. The “animal spirits”, to use Keynes’s expression, have dropped.

The British Chambers of Commerce, in its latest quarterly survey, published a few days ago, recorded an eight-point drop in manufacturers’ investment intentions and, perhaps as worryingly, a 12-point decline in plans to invest in training by service-sector firms.

Worries over investment were at the top of the Bank’s concerns when it chose to cut interest rates in August, and why it may yet do so again, though probably not this year.

Ben Broadbent, one of its deputy governors, set this out very clearly in a recent speech. Investment decisions are, as he put it, “at least to some degree – irreversible. Once made, they can’t be easily or costlessly unmade.” They are also closely correlated with uncertainty.

The Bank’s own index of economic uncertainty has, Broadbent demonstrated, been closely correlated with business investment during the past three decades. Even when firms go ahead with investment during periods of uncertainty, they are only likely to do so when the rate of return is high; uncertainty raises the investment “hurdle”. Uncertainty also makes businesses more likely to employ temporary workers rather than take on new permanent staff.

Broadbent also made two points directly relevant to post-referendum Britain.
The first was that the longer-lasting the investment, the more that business will want greater certainty than currently exists on Britain’s future trading relationships. The second was that the flow of new investment matters more than the flow.

As he put it: “A lack of clarity about the UK’s future trading relationships needn’t result in visible, headline-grabbing closures of productive capacity. The effect is likely to be more insidious: decisions to expand, that might otherwise have been taken, are delayed.”

What can be done to maintain investment in this time of uncertainty? Philip Hammond is being pressured to announce some short-term measures to help firms overcome their doubts. The annual investment allowance, currently £200,000, was raised to £500,000 from April 2014 to the end of 2015 and was associated with generally stronger investment. Whether the same trick could work again remains to be seen. The priority is to put an end to the uncertainty, and that may not be in the chancellor’s gift.

Sunday, October 09, 2016
More nasty lurches ahead on this sterling rollercoaster
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

The pound in your pocket is worth a lot less than it was, as Harold Wilson did not quite say. Actually, the reference to the most famous devaluation broadcast in history is not inappropriate. The former Labour prime minister was trying to tell people in 1967 that a 14% fall in the pound would not make them any poorer. After another torrid week, sterling’s average value is also 14% lower than it was in late May, before referendum jitters set in.

It was torrid even before the “flash crash” that hit sterling in the early hours of Friday morning, and which pushed it as low as $1.15, before it settled at a weak $1.24.

The current prime minister, who last week declared herself untroubled by the pound’s renewed tumble, will not be broadcasting to the nation about it. She also broke the unwritten rule, adopted by ministers and prime ministers since independence in 1997, of not criticising the impact of the Bank of England’s policies. This was not the first time she had criticised low rates and quantitative easing (QE), though I doubt it will have any impact on what the Bank decides to do in coming months.

Is Theresa May right to be sanguine about the pound’s drop to new 31-year lows against the dollar and a five-year low against the euro?
In the short-term, up to a point. A weak pound is providing a safety-valve for the economy now, as it did in 2007-9, when the global financial crisis hit.

Together with the actions of the Bank, it represents a dramatic loosening of monetary conditions, at a time when the economy needed it. The rebound from the July wobbles owed at least something to the sterling safety-valve.

And, while the pound in your pocket will be worth less as the inflationary impact of sterling’s fall comes through via higher import prices, it is better that that process starts when inflation is very low (0.6%) and oil and commodity prices relatively weak. One of the reasons that there has been less of an inflationary uptick so far is that we had a weak summer for oil prices.

Has the pound, thanks to the Brexit vote, merely found its natural level? One useful way of thinking about where sterling should be is looking at long-term averages. The 10-year average for the dollar against the pound is $1.64, while the 30-year average is very close, $1.65. So $1.24 looks very cheap. The average for the euro to the pound since the beginning of 1999, when the single currency was launched, is €1.37. So, again, €1.11 – sterling’s new five-year low against the euro - looks very cheap. It is enough to push Britain down from fifth to sixth largest economy in the world; back below France.

A more sophisticated approach, pioneered by the Peterson Institute for International Economics in Washington, is to calculate what are known in the jargon as fundamental equilibrium exchanges rates (Feers). It redoes the calculation twice a year. When it last did so, in May, the “right” rate for dollar-sterling was $1.52 and, using its calculation for dollar-euro, the appropriate euro-sterling rate was around €1.26.

All of which suggests that the pound has fallen to a level at which it is now undervalued. That could mean a short-term bonanza for exporters; short-term because currencies do not stay undervalued for too long. Or it could mean that Britain’s economic prospects have deteriorated so much that a significantly lower exchange rate is justified.

The pound’s latest tumble came as ministers – and the prime minister – were setting out their stalls at the Tory conference in Birmingham. It dashed hopes, for now at least, that the EU settlement will involve something close to existing single market arrangements but with some restrictions on free movement. That may never have been a possibility but the Tory conference, with its sometimes xenophobic emphasis on immigration, and a clear message that controlling immigration takes priority over the single market, confirmed it. “Smexit” – single market exit – is now seen as a certainty by the City, and damaging certainty at that. Philip Hammond, the chancellor, is fighting the fight on that, and the battle to remain in the EU customs union, but he is outnumbered by the Brexiteers.

So sterling has sold off, bringing memories of previous episodes of pronounced weakness. It might have been expected to recover some ground on the evidence that the short-term damage from the Brexit vote has been less than feared. In Wilson’s day it was the “gnomes of Zurich” who did all the selling. These days it would probably be the wolves of Wall Street or, given London’s dominant role in currency trading, perhaps the cheeky chappies of Chigwell. Or maybe the robots.

How worried should we be? In a piece for the OMFIF (Official Monetary and Financial Institutions’ Forum) website, Desmond Lachman, a fellow of the American Enterprise Institute said he found it difficult to understand the complacency “surrounding the likely fallout from a ‘hard’ Brexit – particularly at a time when the UK is suffering from acute external; vulnerabilities that are heightening the prospects of yet another sterling crisis”. Having witnessed a few of those over the decades, my ears pricked up.

The biggest vulnerability is, of course, the current account deficit, nearly 6% of gross domestic product. It will be helped by the pound’s fall, but perhaps not quickly enough to remove the danger.

A falling pound only turns into a proper sterling crisis when action – notably higher interest rates – is need to stem the slide. In January 1985, when the pound fell to all-time lows against the dollar (a smidgeon above parity), interest rates were pushed up from 9.5% to 14%. That was just one of many episodes of sterling-generated pain.

Lechman raises the possibility of a monetary response to sterling’s weakness though, with the Bank having only just cut rates – and signalled its intention of doing more – that looks a long way off.

Even so, we should take note of sterling’s weakness. Theresa May says she does not want to give a running commentary on Britain’s Brexit negotiations. Then again, she would not want a feeble pound to provide the backdrop for her government. It is saying that a struggle lies ahead, at the end of which the uplands will be far from sunlit.

Markets, of course, do not have perfect foresight. Hammond, interviewed by Bloomberg on his post-Tory conference visit to New York, suggested a “win-win solution” in Britain’s negotiation with the EU; one that starts with hard positions on both sides but which develops into a mutually beneficial outcome. He appears to have the task in government of trying to clear up the mess created by his colleagues, including May. We have to hope his optimism is justified. The pound’s future performance will tell us whether it is or not. Expect, as he has acknowledged, some more sickening lurches on this rollercoaster.

Saturday, October 01, 2016
The lessons of history - and don't expect a borrowing spree from Hammond
Posted by David Smith at 04:24 PM
Category: David Smith's other articles


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

It may be the nature of the beast, but economic anniversaries tend to be unhappy ones. Fortyyearsago,Britainwas in the middle of one of the most humiliating episodes of the post war era, the bailout by the International Monetary Fund.

The IMF rescue,which came only three decades after Britain was instrumental in the creationof the organisation, is the stuff of legend. Denis Healey, the chancellor, had tried to spend his way out of recession. On his way to a finance ministers’ meeting in Hong Kong on September 28, 1976, he was forced to turn back at Heathrow to formally apply for the IMF loan.

It was an important time for economic policy in Britain. Three years before Margaret Thatcher came to power, theLabour prime minister James Callaghan signalled a shift away from the Keynesian consensusofthe postwar era,tellinghisparty conference that you can’t spendyourway out of recession.

That did not mean Labour was grateful for the IMF’s intervention. Healey, one of the great characters of British politics, looked forward to what he described as IMF “sod-off day”. He went to his grave last year believing the $3.9bn rescue was unnecessary.

That is not how it looked at the time but the numbers now suggest that the picture, while bad, was not as dramatically bad as we have experienced recently. In terms of the twin deficits — the budget deficit and the current account of the balance of payments — the situation in 1976 was that the budget deficit peaked at 6.4% of gross domestic product in 1975-6, while the current account was in the red by 0.9% of GDP, having peaked at 3.8% in 1974.

The recent peak in the budget deficit — public sector net borrowing — was much higher than during the IMF crisis,at 10.1% of GDP in 2009-10. The latest annual reading for the current account deficit, 5.4%, also exceeds anything in the 1970s. The deficit in the second quarter was 5.9% of GDP.

Those who ignore the errors of history are condemned to repeat them. I am not suggesting Britain is about to turn to the IMF for another bailout — it has other things on its plate—but if Labour has anything to do with it, we might at some stage take a trip down that particular memory lane.

Shadow chancellor John McDonnell managed in his party conference speech to both criticise the level of government debt, £1.6 trillion, and promise to add at least£250bn more to it than implied under government plans. After the mild tax and spend of Ed Miliband and Ed Balls in last year’s general election, we now have the full-blooded socialist version.

Fortunately, rather than being the “government in waiting” that McDonnell claimed his party was, Labour looks to be destined for opposition for many years to come. That, however, does not necessarily eliminate the risk. Political parties compete. McDonnell’s pledge ofa£10 an hournational living wagewas a ratcheting up of George Osborne’s policy, which implies a rate of just over £9 by 2020. When it comes to fiscal policy, there is also the possibility of competition. Though chancellor Philip Hammond will not take many of McDonnell’s ideas and run with them, an expectation is growing that his “reset” of fiscal policy will imply something significantly looser than his predecessor’s.I say expectation, because we are still pretty much in the dark on this, as we are about quite a lot from this government. There is talk of an end to austerity, as part of Theresa May’s attempt to reach the parts of society the recovery left behind. There is talk, more plausibly, of a new infrastructure drive, aimed particularly at the regions. With the government able to borrow over 10 years at a rate of 0.7%, what could be more sensible?

Let’s be clear. If the government could ring-fence a set of infrastructure projects and fund them at the current very low borrowing rates, it would make a lot of sense. Britain needs more and better infrastructure,and theeconomywill need the boost that it could bring. Reallife is,however,a bitmore complicated than that. Infrastructure projects are prone to delays and big cost overruns. The burden of those — and the risks — would staywith taxpayers and addtogovernment debt. This is why, so far at least, we have had a lot of talk of infrastructure bonds but very little action.

The assumptions of economic models, that infrastructure projects pay for themselves because of the boost they provide, can be elusive in practice. The widerpoint, when it comes to both austerity and infrastructure, is that the public finances are a long way from being fixed. Yanis Varoufakis, the former Greek finance minister, won last week’s pot-kettle-black award when he said on BBC radio that Osborne had been a“particularly inept”chancellor.

But Britain has addedalot of public sector debt in recent years—it has more thantripled fromjust over £500bn in April 2007 — and the deficit has been more stubborn than hoped. At 4.1% of GDP in 2015-16 it is smaller than it was when Britain had to turn to the IMF, but not that much smaller. Meanwhile, the Office for Budget Responsibility will surely confirm in the autumn statement on November 23 what bodies such as the Institute for Fiscal Studies have already told us. This is that while there are swings and roundabouts, including the help thatlower debt interest will provide, the net effect of Brexit will be to make the public finances worse.

What about those low interest rates? Surely any government would be foolish not to borrowwhenitis socheap to do so? Again, it is not as simple as that. Governments are not households, but sometimes the standard advice for households is useful.Do not assume interest rates will be this low for ever. Debt has to be rolled over, and in time it will be rolled over at higher rates than now.

All of which should mean that Hammond, whose instincts appear to be fiscally conservative, willnot take toomuch of a leaf out of his Labour opponent’s book. The aim, I judge, will be to keep the budget deficit on adownward track,while announcing some eye-catching but inexpensive initiatives. That will disappoint some, but it would demonstrate that at least one party has learnt the lessons of history.

Sunday, September 25, 2016
Central banks try to squeeze out the last drop
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

A few days ago it was announced that Minouche Shafik, who joined the Bank of England as one of its deputy governors two years ago, would shortly be leaving. Her departure, to take up the post of director of the London School of Economics, was perhaps understandable; she described it as an opportunity that was impossible to resist.

It was a reminder, however, of what an extraordinary period we live in as far as monetary policy and the actions of central banks are concerned. When Shafik was appointed in 2014 she was given the role of managing the unwinding of the Bank’s quantitative easing (QE) programme, in others words organising the process by which the £375bn of gilts (UK government bonds) it has purchased were sold back to investors.

At the time, with the effects of the crisis fading and the economy enjoying strong growth, reversing QE was firmly on the agenda, as were higher interest rates. In August 2014, the Bank was working with financial market assumptions that interest rates would be 2% by now.

Things have turned out rather differently. The Bank, rather than running down QE, has just announced £60bn more of it, together with £10bn of corporate bond purchases. Interest rates have been cut to 0.25%, with the Bank’s latest minutes saying most members of the monetary policy committee (MPC) are minded to cut further, to just above zero (which could mean 0.05% or 0.1%), later in the year. It should be said that one MPC member, Kristin Forbes, has said she is not yet convinced of the need for a further cut.

When will the Bank’s QE be reversed? Will it ever be reversed? Given that it has just cut interest rates and may do so again, and given that it has just launched another QE round, any reversal is years away. The Bank, as it told us last November, will not even contemplate a back-door reversal of QE – not reinvesting the proceeds of the maturing gilts it has in its portfolio – until interest rates have reached 2%.

That suggests a timetable stretching well beyond Mark Carney’s stint at the Bank, which is currently due to end in mid-2018 although, no doubt to the fury of some Brexit headbangers, he may stay on until 2021. It suggests Shafik could go away and pursue a successful LSE career lasting many years, and come back to the Bank in time to administer the QE reversal, not that I think she will.

The Bank, of course, was responding to Brexit, without which it is very unlikely there would have been an interest rate cut or more QE. But it is part of a wider phenomenon in which central banks, after years of near-zero interest rates, are still attempting to squeeze the last drop out of monetary policy.

Last week saw two interesting announcements from the big central banks. The Federal Reserve in America came closer than it has for a while to a hike in interest rates, with a 6-3 vote for no change. The fact remains, however, that last December’s token quarter-point rise in rates, intended to be the first in a regular sequence, still stands alone.

By this time, according to the guidance then, we would have had the third of four Fed rate hikes in 2016. We have yet to have any. And, while last week’s strong guidance from Janet Yellen, the Fed chairman, was that markets should expect a rate rise at its December meeting, there is many a slip ‘twixt cup and lip, not least the uncertainty that would follow a Donald Trump election victory in November.

Even more interesting was the Bank of Japan (BoJ). It has already adopted negative interest rates and expanded QE at a faster rate than any other major economy. The central bank is in the forefront of “Abenomics”, the effort by the Japanese prime minister Shinzo Abe to shake the economy out of its torpor.

Ahead of last week’s meeting, some in the markets expected the BoJ to announce even more negative interest rates and expand its already large QE programme. In the event it did something slightly different. It announced that it would continue with QE until Japan’s inflation rate, currently -0.4%, is both positive and above 2%. It will keep pumping money in, in other words, until deflation – a falling price level – has been comfortably eliminated.

Even more interesting was that it set a target for the yield – the interest rate – on 10-year government bonds. The BoJ will aim to keep that yield at exactly zero , indefinitely, implying that the Japanese government will be able to undertake its borrowing, or at least its 10-year borrowing, free of charge.

What should we make of all this? Ben Bernanke, the former Fed chairman, earned the nickname “Helicopter Ben”, for a speech he gave in 2002 outlining the mechanics of a so-called helicopter drop of money.

Helicopter money has its advocates, including Lord Adair Turner, the former Financial Services Authority chairman who now chairs the Institute for New Economic Thinking. It takes many forms, ranging from the central banks creating money to hand out to households to what is known as monetary finance.

Monetary finance is a bit like QE without the safeguards. Central banks create money to fund the budget deficit, without governments having to issue new bonds. As Bernanke has put it using the example of the US, “the Fed credits the Treasury with $100bn in the Treasury’s “checking account” at the central bank”, with those funds being used for boosting public spending or tax cuts. Governments can expand budget deficits without having to go near the markets. Monetary and fiscal policy go hand in hand.

Many people, myself included, regard this with deep concern. Where would the process end, if not with irreversible reputational damage for the central bank, and the prospect of significantly higher inflation in future? And, while we may trust our current politicians to be reasonably responsible, once the rubicon was crossed what would there be to stop future politicians taking enormous liberties with the public finances? The discipline of the market is quite a useful one to have.

Central bankers, on the face of it, agree. Haruhiko Kuroda, the BoJ, governor has spoken out against helicopter money. Carney said last month: “I can’t conceive of a situation in which there would be a need to have such flights of fancy here in the UK.”

The question is whether central banks are drifting into helicopter money by default. Bernanke, analysing the BoJ’s announcements for the Brookings Institution, wrote that “a policy of keeping the government’s borrowing rate at zero indefinitely has some elements of monetary finance”.

In the case of the Bank of England, there is a finer line than Carney would like between helicopter money and a QE programme that may not begin to be reversed until the 2020s, if then. Its effect has been to reduce the government’s cost of borrowing – to zero in the case of the gilts bought by the Bank – and make it easier to run large budget deficits, something the new chancellor may be glad of. Monetary and fiscal policy have overlapped. The helicopters have not yet taken off but there are a few drones already buzzing around.

Sunday, September 18, 2016
Hammond needs to get Britain's productivity mojo back
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

One of the challenges Philip Hammond has set himself for his autumn statement on November 23, among many others, is to boost Britain’s productivity. In this, the new chancellor is very much following in the footsteps of his predecessors.

Gordon Brown had his productivity agenda – even at a time when productivity (output per hour worked) was growing at a rate we would give our eye teeth for now – while George Osborne had his productivity plan. Every occupant of 11 Downing Street has sought to raise Britain’s productivity game both in absolute terms and in relation to other countries. Most have struggled to make any discernible difference.

The issue is more pressing for Hammond. The productivity performance he inherits is a particularly feeble one. Though there has been a modest improvement since the depths of the crisis in 2009, output per hour across the whole economy at the end of last year was lower than at the end of 2007. Nor is there any sign of improvement. The latest labour market statistics showed a rise of 2% in the number of hours worked over the past year, roughly in line with the growth in the economy.

Eight years without any growth in productivity is extraordinary. In the previous eight years, when Brown was trying to improve it, it rose by 19%, and in the eight years before that by 20%. Something has snapped and the new chancellor’s task is to try and fix it.

Most countries have experienced weaker growth in productivity since the crisis but Britain’s performance is particularly stark. GDP (gross domestic product) per hour worked is 36% higher in Germany, 31% higher in France and 30% higher in America than in Britain. Even Italy is 11% more productive.

The weakness of productivity is not just a statistical curiosity or a matter of international bragging rights. Most people know the American economist Paul Krugman’s famous remark that “productivity isn’t everything but in the long run it is almost everything”. Productivity – getting more output out of a given input – is the key to prosperity; to living standards.

It also matters hugely for the public finances. You may remember that Osborne’s final autumn statement a year ago was notable for the £27bn that the Office for Budget Responsibility (OBR) discovered down the back of the fiscal sofa, thanks to changed assumptions about tax receipts and the interest on government debt. Less well remembered, because other things dominated the headlines, is that the OBR took away roughly double that £27bn in Osborne’s final budget in March, because it took a gloomier view about productivity after the publication of poor official data.

Even its gloomier view assumed a significant pick-up in productivity growth, to 2% by 2019, not far from its long-run average. Without that, the prospects for growth, living standards and the public finances would have been notably worse.
Hammond is a fiscal conservative and will not let rip with the public finances. He also knows, because he mentioned it in giving evidence to the House of Lords, that there are huge regional variations in productivity in Britain. Put simply, if the rest of the UK matched London’s productivity performance, which is 30% above the national average (measured by gross value added per hour worked) this country would be near the top of the international comparisons rather than languishing near the bottom.

This tells us, for a start, that anything that seriously damages the London economy over the next few years would hurt the economy as a whole. Undermine your highest-productivity region and the country’s ability to improve living standards and fund public services would suffer. The aim must be to lift the rest of the economy up to London’s high value-added, high productivity levels, not drag the capital down. George Osborne, who on Friday launched his Northern Powerhouse Partnership think tank, understood this very well.

Can Britain become a high-productivity economy? Everything these days has to be seen through the prism of the Brexit vote, and it could go either way. To the extent that employers have found it too easy to find labour as a result of immigration, and have chosen employment over investment, there could be a positive effect on productivity. After all, one reason why French productivity is so much higher than in Britain is because of its inflexible labour market. French businesses choose to invest rather than recruit, though high unemployment is the unfortunate side-effect.

A new system of controlled immigration, prioritising skilled migrants, could help to boost productivity, partly because of their direct contribution and partly because a reduction in the numbers of unskilled migrants would force employers to more aggressively seek productivity improvements.

Against this there are factors which could push Britain towards even lower productivity. One is the threat to the London economy, and particularly the financial services sector, from leaving the single market. London will still be the financial capital of Europe, indefinitely, but it could retain that position even if it lost 20% or 30% of its activity. Any such loss would, however, be negative for the economy.

The other is the outlook for business investment, including foreign direct investment. Foreign investment has been an important driver of productivity improvements in Britain. On average, foreign-owned businesses demand and achieve higher levels of productivity than their domestic competitors.

When business investment – both domestic and foreign – boomed in the 1980s, the talk was of a British productivity miracle under Margaret Thatcher. When it did so again, in the 1990s, the healthy productivity numbers described above were the result. But it is a long time since business investment has boomed, and bodies such as the British Chambers of Commerce and Institute of Chartered Accounts have warned that it is likely to fall over the next couple of years.

Productivity could go either way in this new era. As a first step on the road to improving productivity, Hammond will need to come up with measures that encourage business investment in an uncertain environment and provide reassurance to a City of London that fears land grabs from the rest of Europe and the rest of the world. Can it be done? Nobody told him that his new job was going to be easy.

Sunday, September 11, 2016
May starts on the long and winding road to Brexit
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

Summer is turning to autumn, though the weather has yet to adjust in some parts of the country. An Indian summer is perhaps appropriate for post-Brexit Britain, though readers will be aware that the term originated in North America, not the subcontinent.

We are, of course, not yet post-Brexit Britain, though at some point we will be. In a moment I shall talk about the three stages of Brexit.

First, what do we know so far? The shock predicted here duly happened, reflected in a sharp fall in sterling and an immediate drop in confidence and activity. Despite a small recovery, the pound’s average value against all currencies remains 9% below pre-referendum levels and 13% lower than a year ago. Many people who in the past would have regarded a big fall in the pound as a sign of failure have become enthusiastic devaluationists.

The shock has been contained. No prediction of an immediate dive into recession was ever made in this column – I can’t speak for George Osborne – and indeed I was surprised at the extent of the slump in some of the surveys in July, which deteriorated at a faster pace than when the global financial crisis hit.

On July 31 I wrote that confidence could be rebuilt and the shock contained, as long as common sense prevailed and policymakers reacted. So it has proved.

The Bank of England, despite much misplaced criticism, has been instrumental with its “whatever it takes” measures, in turning sentiment around. All the August survey improvements followed its actions.

The swift transition to a new administration under an apparently sensible prime minister has also been very helpful. Remember that we could, by now, have only just seen the end of a bruising Tory leadership contest. Anybody who needs reminding of how unsettling that could have been should recall Andrea Leadsom’s brief leadership campaign, the strange bunch of Tory MPs on their “Leadsom for leader” march down Whitehall, and Boris Johnson’s odd endorsement of her. For that, even more oddly, he was rewarded by Theresa May with the job of foreign secretary.

There have been other confidence-enhancing factors. The Brexit vote did not provoke a wider crisis in Europe. Markets, meanwhile, remain obsessed with monetary policy. Brexit meant, not just lower rates in Britain but less likelihood of higher rates elsewhere, so boosted stock markets. Perhaps disturbingly, the market reaction to a Donald Trump victory in America might be dominated by what it means for the Federal Reserve’s next interest rate decision.

This is the first stage of Brexit, and we are only a little way through it. It is, if you like, the phoney war stage, when nothing important has actually happened. The second stage will begin when the government invokes Article 50 of the Lisbon Treaty, probably in the first half of next year, and begins the formal two-year process of exiting from the EU.

Stage three is when that process is “complete” and Britain begins the formal task of negotiating her post-EU future with the rest of the world. Complete is in inverted commas because nobody expects Britain to have fully or even mainly extracted herself from the EU within two years. Many EU laws will remain on the UK statute book.

Sharp-eyed readers will have noticed that there might have been only two stages of Brexit. Before the referendum Downing Street suggested that Article 50 would be invoked immediately in the event of a Brexit vote, a view endorsed – at least for a few weeks – by the Labour leader Jeremy Corbyn.

Stage one has some way to go and, while most of the recent evidence has been reassuring, it would be wise not to get as carried away as some of the tabloids have. Long experience has taught me that upside surprises are often followed by downside ones.

The very level-headed Institute of Chartered Accountants in England and Wales (ICAEW) said in its new forecast on Friday that the government needs to act quickly to prevent a slump in business investment this year and next. The big worry in stage one is that falling business investment coincides with weaker consumer spending, as households are hit with rising prices. It does not have to happen – the pass-through from a lower pound to inflation may be less than feared - but it is a significant risk.

The National Institute of Economic and Social Research says the economy has been close to flat-lining since April, and that there remains a heightened risk of a technical recession – two successive quarters of falling gross domestic product, between now and the end of 2017.

That covers the period straddling the end of stage one and the start of stage two. What the government does between now and the invoking of Article 50 is important, not least Philip Hammond’s first big set of announcements in his autumn statement on November 23. The new chancellor is clearly not one to rush things, though has hinted at more infrastructure spending.

Even more important is what the government says when it invokes Article 50. May said last week she does not want to give a running commentary on Brexit, or reveal her negotiating hand, not least because she is not yet sure what it will be. But clarity, if not full detail, will be needed when the formal process of exiting from the EU begins. Business will need much greater certainty than it has now.

Achieving that certainty, particularly when it comes to stage three and Britain’s post-Brexit future is perhaps the greatest challenge. Sir Andrew Cahn, the former head of UK Trade & Investment, the official body, knows what he is talking about when he says it will take a decade or more to negotiate post-Brexit trade deals with the big global economies. That process will not start until we have formally left the EU.

Where Britain ends up, despite the bullish talk of early trade deals with countries such as Australia, represents a huge challenge, and is a recipe for continued uncertainty. One example of that was provided a few days ago by the Construction Products Association, whose industry forecasts are closely-watched in the sector.

Normally it produces forecasts for five years ahead, important for a sector that has to plan for the long-term. This time, it has decided it can only do so to cover the period until the end of 2018, beyond which, it says, there is just too much uncertainty to produce sensible forecasts. Its central forecast is for a mild construction recession next year, with optimistic and pessimistic scenarios on either side of it.

The government will need to work hard to minimise uncertainty and maintain confidence through the long process of forging Britain’s new place in the world. Nobody in government pretends that will be easy.

The prime minister does have one important advantage, however. Because there was no workable policy content in the Brexit campaign, and certainly no useable economic policy content, she starts with a blank sheet of paper. As we have seen with her dumping of the Australian points-based system, described here on May 29 as thoroughly unsuitable for Britain, it is up to her to define what she means by Brexit. A pragmatic approach beckons, which could succeed. In coming weeks, when events permit, I shall describe some elements of what that pragmatic approach should involve.

Sunday, September 04, 2016
Now is not the time to get rid of cash
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

The other day I was queuing up at the bank, waiting while the woman in front of me handed over a large bundle of cash to pay her gas, electricity and phone bills. As we waited patiently she explained to the cashier she did not have a bank account, preferring to do everything in cash.

If some economists have their way she will not be able to do this much longer. The Bank of England is about to release the new, long lasting plastic (polymer) £5 note but some economists say physical cash is a relic of a bygone age, which should be consigned to the incinerator of history.

You may recall Andy Haldane, the Bank’s own chief economist, who has been saying one or two controversial things in these pages over the summer, floated this idea in a speech a year ago. Willem Buiter, chief economist at Citi, the global bank, and a Bank alumnus, has also done so.

Now Kenneth (Ken) Rogoff, former chief economist at the International Monetary Fund (IMF), a longstanding abolitionist, has devoted an entire book to scrapping cash. The Curse of Cash, from Princeton University Press, is published this week.

Rogoff is always worth listening to. His work with Carmen Reinhart on previous financial crises – eight centuries of them – was invaluable in informing the path out of the 2007-9 crisis. His related work on government debt and the safe limits on it, while it did not go unchallenged, was influential.

Surely all this is very different from the case for abolishing cash? After all, though we do not use notes and coins as much as we used to, they still account for almost half of all payments in Britain. Cash may not be quite the king it was but it has not yet been dethroned.

Rogoff, however, makes a persuasive case. “There is little question that case plays a starring role in a broad range of criminal activities, including drug trafficking, racketeering, extortion, corruption of public officials, human trafficking and, of course, money laundering,” he writes.

It is also central to illegal immigration, and the exploitation of both legal and illegal immigrants. Cash allows unscrupulous employers to bring in illegals and to pay them, and other workers, on a cash-in-hand basis, often well below the minimum wage.

Those two arguments have been around a long time. Rogoff’s third is particularly topical, which is why there is a renewed interest in the abolition of cash. While some central banks have moved to marginally negative interest rates to boost their economies – the European Central Bank and Bank of Japan most notably – they are constrained from moving more aggressively into negative territory by cash. Who would hold Treasury bills or other financial instruments with a negative interest rate of, say, 3% or 5% - losing money by doing so – when the interest rate on cash cannot fall below zero?

As he puts it: “The main obstacle to introducing negative interest rates on a larger scale is legacy paper currency, particularly the large-denomination notes that would be at the epicentre of any full-scale run from Treasury bills into cash.”

At this point some will be shaking their heads in disbelief. Zero or near-zero interest rates are bad enough. Surely seriously negative rates – paying the banks to hold your deposits - would be a disaster? His response, which will persuade some but not all, is that it is better to have a short burst of negative rates to lift economies onto stronger growth paths than a decade stuck at zero.

Governments, of course, make money from printing and coining cash, so-called seigniorage. It is not to be sneezed at, averaging around 0.4% of gross domestic product (GDP) in America and about half that in Britain. Even this is small beer, however, compared with the potential benefits of clamping down on illegal activities and aggressive tax avoidance.

What about the practicalities? Technology has moved on. I still take innocent pleasure in making a contactless payment with a debit card, only partly tempered by the fear that somebody else could be doing so just as well if they got hold of it. The technology exists for many, probably most, cash payments to be made electronic.

How about the unbanked? According to the Financial Inclusion Commission, 1.5m adults in Britain do not have a bank account and about half of people with a basic bank account choose to manage their money in cash. Rogoff says governments should take the lead in getting everybody into a bank account and a debit card. Indeed, there are sound public policy reasons for doing so. Financial exclusion often goes hand in hand with economic and social exclusion.

So is it case proven? Not quite. Negative interest rates still make me very uneasy and, as we have seen in recent years, emergency monetary policy moves have a habit of becoming permanent. If the existence of cash acts as a constraint on central banks cutting interest rates well below zero that is no bad thing.

This may also be a very bad time to advocate the abolition of cash. While cash’s role in payments is in decline, demand for notes and coin is accelerating. It rose sharply during the worst of the crisis and is rising again now. The 12-month growth rate of notes and coin, 8.2% in July, was the strongest since August 2009. Some of that is because people still do not trust the banks, especially when zero rates give them little incentive to keep money in them. Telling people they have to throw their lot in with the banks at this time would risk a popular uprising.

Where Rogoff is on very solid ground is when he says the process of weaning us further off cash should begin with the abolition of high-denomination notes. These are used disproportionately in illegal activities and money laundering and serve no useful social purpose. Already the European Central Bank has said it will not supply any more 500-euro notes and the Bank has hinted that the switch to polymer could be an opportunity to phase out the £50 note. Cash is not going to disappear, but we can do more to prevent its misuse.

Finally, before leaving money, I shall throw an intriguing thought your way. There appears to have been a post-referendum acceleration in the growth of the money supply, more broadly defined than just cash.

One measure, which brings together all the different ways of calculating the money supply, known in the jargon as Divisia money, accelerated in July to 10.2%, its fastest growth rate since current records began in 1999. Costas Milas, an economist at Liverpool University, who spotted it, points out that strong growth in this measure is normally associated with robust rises in GDP, and it should get a further boost from the Bank’s relaunching of quantitative easing. Interesting.

Sunday, August 28, 2016
Hammond faces a steeper climb up debt mountain
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

It is back to work, in my case after escaping to the Outer Hebrides, where the people were a lot friendlier than the weather and where I discovered that Breakfast means Breakfast.

On the return-to-work theme, much has been made of Theresa May’s challenging in-tray, and the fact that the new prime minister has a lot on her plate. But do not underestimate the tricky terrain faced by Philip Hammond, the new chancellor, and the Office for Budget Responsibility (OBR), which will help frame his decisions this autumn.

Hammond, who has been described as “swashbuckling” by the Financial Times, perhaps for the first time in his life, has been helped by the fact that the immediate post-referendum shock has been contained. The actions and assurances of the Bank of England and the swift transition to a new government helped a lot; do not forget that we could now have still been in the middle of a Tory leadership contest.

So did the plunge in the pound, probably not mainly by boosting exports but by encouraging more foreign visits to bargain-basement Britain, as predicted here. Selling Swiss watches to tourists has been good business, while retailers in general have done better than they feared. For a fuller reading of the economy’s performance this summer, we will this week get the first of the purchasing managers’ surveys for August, following their plunge in July.

The welcome absence of an immediate crisis only partly eases the pressure on the chancellor, however, and barely makes the OBR’s task any easier. It, remember, has the job of assessing the outlook for the public finances, not just in the short-term, but also in the medium and long-term. It will have to make assumptions about Britain’s post-Brexit future, including future trading relationships, at a time when the government is only starting to grapple with these questions.

Hammond’s autumn statement, drawing on the OBR’s work, has become the key focus for the government’s economic policy approach in this parliament. As Paul Johnson, director of the Institute for Fiscal Studies, has pointed out, we thought George Osborne’s autumn statement last year had performed that role, but things have moved on. The king is dead, long live the king.

An expectation has built up that the chancellor’s promised autumn “reset” of policy will include a sizeable fiscal stimulus, a growth-boosting “giveaway” in the form of additional infrastructure spending, tax cuts, or both.

This is despite the fact that, according to most economists, the prospect is for bigger budget deficits and more government debt even if he chose to do nothing. The latest Treasury compilation of independent forecasts has growth of 0.7% next year, down from 0.8% last month and 2.1% in June. 2017 was always expected to be the year of greatest weakness, with business investment and employment subdued and households suffering an income squeeze as a result of the rise in inflation resulting from sterling’s fall.

Slower growth, in turn, feeds through to higher borrowing, and thus more debt. In June, the average forecast was that borrowing this year (2016-17) would be £61.7bn, falling to £46.7bn next year, 2017-18. Now the predictions are for £66.9bn and £59.8bn respectively.

Should Hammond, knowing that Osborne’s old target for a budget surplus by the end of the decade had been dumped by May even before she appointed him chancellor, throw caution to the wind? Should he go for a package of big personal and business tax cuts, as well as a significant infrastructure boost, to show that Britain is determined not to succumb to gloom? After all, those once-cherished AAA sovereign debt ratings have now all gone.

Well he could, but there will be plenty of voices, including in the Treasury, who will advise him not to. The situation we are in now is in no way comparable to the global financial crisis but there are lessons to be learned from that period. Back then, Alistair Darling unveiled a modest fiscal stimulus to offset the so-called demand effects of the downturn, mainly in the form of a temporary cut in VAT from 17.5% to 15%.

What was not fully realised was that the crisis also inflicted damage on the supply-side of the economy, hence subsequent very weak productivity growth and progress in reducing the budget deficit being slower than hoped.
The OBR, in framing the outlook for the economy and the public finances will be required to take into account both the demand and supply-side effects of leaving the EU. Assessing the latter, as noted, could be the trickiest of tasks.

For those urging a cautious approach on the chancellor, however, there is likely to be plenty of ammunition. These demand and supply-side effects imply significantly higher government borrowing for the rest of this decade, after which demographic factors in the form of an ageing population kick in and, as the OBR has previously warned, put further upward pressure on borrowing and debt.

Allan Monks, an economist with J.P. Morgan, has tried to pull all this together. Even assuming that the OBR is not as gloomy as the Bank on the hit the economy, and its supply potential, and assuming Hammond unveils a modest fiscal stimulus in the autumn, he comes up with numbers in which borrowing stays close to 4% of gross domestic product until 2018-19, before dropping to just under 3% of GDP in 2019-20 (which was intended to be the first of Osborne’s surplus years).

The cumulative addition to borrowing over the next five years, including this year, is more than £200bn, at today’s prices. For those concerned about government debt, there could be quite a bit more of it.

For this reason, we may see a more cautious approach from the chancellor this autumn than some hope. Yes there will be more infrastructure spending, but perhaps with the government as the enabler of private sector spending – permitting new airport runways for example – than spending itself. Given that the challenge is not just a short-term one, temporary tax cuts do not seem like an obvious thing to do. But it is early days. Guidance at the moment is that the autumn statement might not be until the last week of November. That is a long time in politics - and in economics.

Sunday, August 07, 2016
The Bank's big guns won't stop us taking a hit from Brexit
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

You will forgive me, I hope, for being in a state of excitement since Thursday lunchtime. I cannot remember exactly what I was doing in March 2009, the previous time interest rates were cut. I can confirm I had fewer grey hairs back then. But, having sometimes despaired about whether I would ever see another interest rate change, the Bank of England duly delivered.

True, until June 23rd it seemed much more likely that the next rate rise would be up rather than down, though not yet. And true, we thought we had seen the last of quantitative easing (QE) from the Bank. Its invention of a new term funding scheme (TFS), intended to ensure that the rate cut from 0.5% to 0.25% gets fully passed on by the banks and other lenders, is another initiative that owes its life to the referendum result.

I’ll come on in a moment to the Bank’s measures, and whether they will work. Even without the additional QE and the launch of the TFS, however, it was clear that this rate cut was more controversial than most. Before it was announced, some former members of the Bank’s monetary policy committee (MPC) joined other pundits in arguing against it.

One tabloid newspaper which had supported Brexit aggressively bemoaned the fact that its elderly readers were about to be hit with a double whammy of lower interest rates on their savings and higher inflation. To which the answer is, they got what they voted for. Unless, of course, those older readers backed Brexit because they believed George Osborne’s warning that it would mean higher interest rates.

What were the arguments against cutting rates? One was that it is still early days, and that we do not yet know how big a negative hit to the economy the Brexit vote has caused, a question I put to Mark Carney at Thursday’s press conference. The answer, from his colleague, the deputy governor Ben Broadbent, was that the plunge in the composite purchasing managers’ index – the biggest monthly fall on record – provided the Bank with a pretty clear steer.

It would have been unthinkable in the past for the MPC not to respond to such a plunge in the PMI. Even aiming off slightly from it, as the Bank has done in its forecasts, produces an abrupt slowdown. Other evidence, from property and other sectors, pointed to the clear need for a stimulus. Bank insiders say a report from the Bank’s own agents was misreported as suggesting there was no negative Brexit effect on the economy.

The agents, as reported in Thursday’s inflation report, have found that the decision to leave will have a measurably negative impact on investment, hiring and turnover over the next 12 months. Above all, the Bank has to anticipate as well as respond to events. It anticipates a very sharp slowdown in the economy, so action was required. The referendum “regime change” described by Carney – hopefully a bit more successful than the one which got rid of Saddam Hussein – needs some heavy nurturing.

What about another argument, that this is a time, not for the Bank to squeeze the last drop out of what it can do on interest rates, but for the government to take up the baton with fiscal policy? Why not a big increase in infrastructure spending – taking advantage of already very low government borrowing costs – or tax cuts?

There may be a place for both of these things. Increasing infrastructure spending is easier to defend at a time of high levels of government borrowing than cutting taxes, because the so-called multiplier effects – the beneficial impact on growth and therefore government revenues – are larger. But infrastructure is the slow-moving tortoise of economic policy, while monetary policy is the hare. Over time, higher levels of infrastructure spending will be more beneficial to the economy than sustained near-zero interest rates. But as a short-term response to an immediate downturn it is pretty near hopeless.

The third objection to a rate cut was that it would squeeze margins at the banks and other lenders which, if not posing the kind of problems they encountered in 2008-9, might make them less willing to lend, and would make them reluctant to pass the rate cut on to households and businesses.

Though the Bank said 18 months ago that the “effective lower bound” for rates was no longer 0.5% but lower, the banks seem to have been slow to wake up to this. Fortunately for them, the Bank’s £100bn new funding scheme, the TFS, should deal with the problem. Banks that maintain or increase their borrowing will be able to borrow at close to Bank rate, implying funding costs well below those available in wholesale markets. It is the most imaginative aspect of the package of measures announced on Thursday.

Will it, the quarter-point rate cut, £60bn more of quantitative easing (taking the total to £435bn) and £10bn of corporate bond purchases, work? The Bank used its big guns because it thinks the economy needed it and also to show it has not run out ammunition. Another rate cut, to 0.1% or 0.05% (though not negative rates), is assumed by most MPC members before the end of the year. There could be additional QE. We have embarked on another leg of a monetary easing cycle that first began almost a decade ago.

Even with the Bank’s package, growth will slow to a crawl for the rest of this year and be very weak at 0.8% next year. Unemployment will rise by around a quarter of a million. Without it, the Bank thinks unemployment would have increased by half a million or more, with very little economic growth over the next 18 months.

Could the Bank’s actions backfire, by reducing rather than boosting confidence? Is there a danger that by drawing attention to the post-referendum weakness of the economy, it could add to uncertainty?

That danger has been greatly overstated. The downward revision to the Bank’s growth forecast for next year (from 2.3% to 0.8%) was the largest since it became independent in 1997. But importantly, the Bank offered reassurance that, with the right policies, the economy can be guided through these short-term difficulties without falling in to outright recession. That will still leave some substantial long-term difficulties, of course.

The Bank’s big guns will not fire up the economy but they will prevent a sharper slowdown than would otherwise have happened. The Bank has done its bit. It could not have done much more.

Sunday, July 31, 2016
Confidence has crumbled - but it can be rebuilt
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

We are at an interesting moment, something which will be of intense interest to future economic historians. Business and consumer confidence have taken a battering since the Brexit vote on June 23. Is the slump in confidence an inevitable harbinger of very tough times ahead for the economy, a recession, or can it be turned around?

That confidence has fallen sharply is not in doubt. One of the longest running measures of business confidence, dating back to the 1950s, is the CBI’s industrial trends survey. Its latest reading, published a few days ago, was a bit of a shocker.

Optimism over the business situation fell at its fastest pace since January 2009, which was in the depths of the global financial crisis. The drop in confidence was similar to previous periods in the survey’s history when the economy has been in recession.

It is not just businesses which are feeling downbeat. In the immediate aftermath of the referendum GfK, which has been monitoring consumer confidence in Britain since the 1970s, released a “snap” survey showing a sharp fall.

Some suggested that this was a knee-jerk reaction which overstated the true picture, and that confidence would soon settle down. Well on Friday GfK released final figures for July, which showed that the drop was even more dramatic than it had first thought. Instead of falling by eight points, confidence this month was down by 11 points compared with the pre-referendum period.

This, to put it in perspective, was the biggest fall in confidence for 26 years – bigger even than during the financial crisis. Consumers are particularly gloomy about the general economic outlook though they are also worried about prospects for their personal finances.

This downbeat mood among consumers has not been without real consequences. As well as its industrial trends survey, the CBI released its distributive trades survey last week. It showed that retail sales have fallen this month at the fastest pace for more than four years.

We are, as I have noted before, still in the dark when it comes to hard data. In some of the sillier corners of Fleet Street, the second quarter gross domestic product figures, which showed a rise of 0.6%, were greeted as a post-Brexit triumph.

In fact the figures contained virtually no information collected since the referendum and were boosted by an unexpected and slightly odd looking leap in industrial production way back in April. Service sector growth slowed compared with the first quarter and the construction industry, in figures which are admittedly volatile, is officially in recession, shrinking for a second successive quarter.

It would be wrong to deny, however, that on the available evidence we have, the picture in recent weeks has been mixed. At the gloomy end of the spectrum, apart from the confidence readings, was that “flash” purchasing managers’ index, touched on last week. Its drop from 52.4 to 47.7 reflected not just a fall in business expectations, but also in output and new orders, particularly in the service sector.

It was enough to persuade Martin Weale, the outgoing “hawk” on the Bank of England’s monetary policy committee (MPC) to sound the alarm. The figures, which he described as “the best short-term indicator we have”, were “a lot worse than I had thought” he said.

Other evidence has been a little less scary. The CBI’s industrial trends survey, despite the plunge in confidence reported by participants, was relatively upbeat on output and new orders. Some companies too have chosen to emphasise their confidence in Britain since the referendum, such as GlaxoSmithKline’s pledge to invest £275m in its UK manufacturing and McDonald’s promise of 5,000 new jobs by the end of next year. Lloyds Bank announced job losses but its own business barometer survey was surprisingly upbeat.
My informal soundings suggest that for many firms it is indeed business as usual, with no discernible impact on activity in the past few weeks, while for others the uncertainty has hit home, and quite hard. Most of the gloomier ones will, however, take stock after the summer holidays rather than acting precipitately.

That suggests there is time to turn things around. The good news about consumer confidence is that, while it has fallen a lot, it has done so from very high levels, so much so that even after its drop this month it is well above where it was during the crisis, or even as recently as 2013. This is not surprising, given the recent experience of strong employment growth and rising real wages. Households are downbeat but they have not thrown in the towel.

As for business confidence, there have been times when its plunge has either been a harbinger of recession, or has occurred in a recession. Most, it should be said, have been when the global economy has also been in trouble. And, while the world economy is not in great shape now, the clouds hanging over it have lifted a little since the start of the year. America’s Federal Reserve hints at a rate rise in the autumn because the risks to US growth have diminished, notwithstanding Friday's weak second quarter GDP figures.

There have been a couple of occasions in the past quarter of a century when business confidence has fallen very sharply without signalling impending recession. One was in the autumn of 1998 when the simultaneous Asian financial crisis, Russian bond default and the failure of the Long Term Capital Management hedge fund spooked markets and central banks. The other was in the aftermath of the 9/11 attacks on New York and Washington.

In both cases the Bank responded with aggressive cuts in interest rates and the danger passed. There was no recession. The Bank will respond again this week. It does not have a huge amount of room to cut rates but it has other weapons in its armoury, including quantitative easing, which we did not even think about a decade and a half ago.

The Bank, of course, cannot do everything. What the politicians do also matters. At the moment, having found themselves in jobs they did not expect to be doing, including the new prime minister, they are mainly treading water. There will come a time, however, when bland words of reassurance will have to be followed by action. We face what could be one of the most interesting autumn statements for many years, yet without much clue about what the “reset” of fiscal policy hinted at by Philip Hammond might mean.

In the meantime, the small group of headbangers in the Tory party who talk of an early “hard Brexit” and distancing Britain from the single market as quickly as possible would do well to shut up. If anything is like to further undermine business confidence and turn the existing fall in optimism into something more concretely negative for the economy that is it.

Sunday, July 24, 2016
Bank will fight the economic downturn, not the upturn in inflation
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

2015 was an unusual year, though not as extraordinary as 2016 is turning out to be. Last year was strange because for the first time in more than half a century there was no inflation at all. Inflation, which in one way or another has dogged most of our lives, disappeared.

Indeed, there were three months last year when Britain experienced technical deflation; consumer prices lower than a year earlier. Before anybody writes in, not all inflation disappeared; there was still plenty of it in the housing market. But the overall price level stabilised.

That brought direct benefits to households. Even modestly rising average earnings of 2% to 3% looked good when set against zero inflation, delivering solid gains in real incomes and boosting consumer confidence.

Inflation remains very low now. The latest figures, for June, showed a rate of just 0.5%, up from 0.3% in May. We have, however, said farewell to the days of zero inflation, and of flirting with deflation. From here, the direction is up.

Some of this was going to happen anyway, as a result of the recovery in oil and commodity prices, and their earlier falls dropping out of the year-on-year comparisons. It has been given an additional boost, of course, by the pound’s post-referendum fall.

The extent of that inflation boost is a matter of some debate. The consensus in the new independent forecasts assembled by the Treasury since June 23 is that the economy will experience mild stagflation next year, with growth of just 0.5% and inflation by year-end of 2.5%.

Mild, however, is the operative word. After all, 2.5% inflation is only a smidgeon above the official 2% target. Some forecasters, it should be said, see a much bigger pass-through from the lower pound, and predict 4% inflation next year, but that is not the majority view.

Even so, the coming rise in inflation has two important implications. One is that, unless there is an accompanying increase in the pace of pay rises, there will be a return to at best stagnant growth in household real incomes, at worst falling living standards. In the latest official figures, for May, total pay was only up by 2.1% on a year earlier. A squeeze on real incomes will have implications for consumer spending and consumer confidence.

The second, which is as interesting, is what it implies for monetary policy and, in particular, interest rates. Not for the first time in recent weeks I have felt a lot of sympathy for Mark Carney. In contrast to the dithering and confusion that marked the response to the onset of the global financial crisis nine years ago, his has been a textbook central banker reaction.

He offered reassurance – and a promise of £250bn of additional liquidity – in the early morning of June 24. Six days later, in a speech at the Bank, he pledged that the Bank would do its utmost to “support growth, jobs and wages” during this time of uncertainty.

Carney was not the only one to offer reassurance. So, once he got over the shock of the referendum result, did George Osborne, the former chancellor. The rapid coronation of Theresa May as prime minister, also helped to settle nerves.

One response to Carney’s success in helping to calm market nerves, which is that he was wrong to warn of the economic dangers, can be easily dismissed. He has done exactly what everybody is supposed to do: accept the result, deal with the consequences, and move on.

What is also clear, however, that the calming of nerves has revived a debate within the Bank of England. In May, when the Bank published its last inflation report, it talked of a “challenging trade-off” between the inflation and growth impacts of a vote to leave the EU. Should the Bank, in other words, respond to the threat of high inflation or the risks of a prolonged period of weak growth?

We know now that different members of the monetary policy committee (MPC) have different views on this. One, Jan Vlieghe, had already seen enough by July 14 to vote for a rate cut. Carney, in his June 30 speech, said “some monetary policy easing will likely be required over the summer”.

Andy Haldane, the Bank’s chief economist, said just over a week ago that he would “rather run the risk of taking a sledgehammer to crack a nut” and said “a package of mutually-complementary monetary policy easing measures is likely to be necessary”.

But not everybody agrees. Martin Weale, whose final MPC meeting will be next month, struck a cautious note, saying he would need to be sure that weakness in the economy will be large enough to “more than to compensate for any overshoot in inflation”.

Kristin Forbes, another MPC member, wrote in the Daily Telegraph that until there was more hard evidence, her instincts were to “keep calm and carry on”. She also pointed out that there are costs as well as benefits to cutting rates, and not just for savers.

So what does all this mean? Will the Bank cut on August 4, or not? One thing the current debate has done is kill the idea that the Bank is Carney’s fiefdom, and that the rest of the MPC is just there to carry out his instructions. That was said a lot, including by former Bank insiders, in the run-up to the July 14 meeting at which the MPC surprised the markets by holding rates. We should hear less of it now.

I still think, however, that there will be a cut on August 4, probably of 0.25 points, along with other measures, including more quantitative easing and a rebooting of the funding for lending scheme. The justification will come from a sharp downgrading of the Bank’s growth forecast and the argument that it is right to “look through” the temporary effects on inflation of the pound’s fall.

Will it be the right thing to do? Until Friday, and the release of an alarming new purchasing managers' survey, there was a debate to be had. The Bank's own agents had found little evidence of a sharp post-referendum slowdown. The composite purchasing managers' index plunged from 52.4 to 47.7, however, with its services component recording its sharpest reversal in its 21-year history. How long this very deep gloom lasts can be debated. For the moment, however, the MPC has little choice but to respond aggressively.

Sunday, July 17, 2016
Osborne: much better than his critics said, but plenty of unfinished business
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

So no more George Osborne. Hello Philip Hammond. But 0.5% Bank rate, the record low rate that lasted for the whole of Osborne’s chancellorship, lives to fight another day. I’ll come on in a moment to the question of whether the Bank’s decision not to cut on Thursday was the right thing to do.

On Osborne, the game was up for him in the early hours of Friday June 24, though he made a spirited effort to demonstrate he was irreplaceable in the days that followed. Sadly, none of us are.

I’d like to say I’ll miss my fireside chats with the former chancellor at No.11. I’d like to say it but I can’t. They never happened, and they won’t now.

I do, however, feel quite a lot of sympathy for him. The referendum was David Cameron’s idea, not his. No chancellor, and certainly not Osborne, would have taken the risk. As it is, Cameron left office with the cheers of the House of Commons ringing in his ears, while Osborne left by the back door of 10 Downing Street.

Now it is over, how should we view the Osborne supremacy? Was he a good chancellor? There have been few recent chancellors who have divided opinion more. My view is that he was not as bad as his critics alleged, nor quite as good as he and his supporters thought.

His own parting shot, that he hoped he had left the economy in a better state than he found it, can be answered in the affirmative. The recovery got stronger – latterly becoming the strongest in the G7 – and the employment rate rose to record levels. Never before has a higher percentage of the 16-64 workforce (74.2%) been in work. In 2010 Labour said the private sector would never replace the public sector jobs being cut. It did, several times over.

The strength of employment was in contrast to the weakness of wages, damagingly so during the bouts of high inflation, notably in 2011, during his chancellorship. Collectively, people priced themselves into jobs. Osborne’s last big announcement, the introduction of the national living wage, was an attempt to break that low-wage cycle.

Despite weak wages, Osborne presided over a post-crisis decline in inequality – not that you would notice from the debate – and an increase in the share of income tax paid by those at the top of the scale.

His big ambitions have, however, mainly been unachieved. The budget deficit, public sector net borrowing, was £75bn, 4% of gross domestic product, in 2015-16, his last full year as chancellor. That is better than the level of borrowing he inherited, which was more than 10% of GDP, but is a long way from job done. The budget surplus he coveted will not even be a target any more.

His “march of the makers” – a recovery built on manufacturing – did not happen; industry remains below pre-crisis levels. His ambition of doubling exports by 2020 will not happen; it will be missed by a huge margin. The Northern Powerhouse is still a work in progress. Pension reform is incomplete.

But Osborne was more pragmatic than his critics allow; some of his missed deficit targets were unintended, but some of it was because, as an austerity chancellor, he also prioritised cuts in personal and corporate taxes. It would have been possible to eliminate the deficit but the past few years would have been far grimmer. As it was, he managed to maintain the confidence of the markets while presiding over a slower pace of deficit reduction than he intended.

Reducing the deficit was, however, important, and lesser chancellors would have been diverted from the task much more than he was. A deficit of 4% of GDP is still too high, but entering this period of post-Brexit economic uncertainty with it much higher would have increased Britain’s vulnerability. Even so, Britain’s sovereign debt rating has been downgraded since the referendum.

His was, however, a very messy chancellorship. His last budget, in March, contained more individual measures than anybody can remember, and was followed by the forced abandonment of its two headline announcements; disability cuts and turning all schools into academies. His own joke about the 5:2 diet, that in two out of every five budgets he had to eat his own words, was a little too close to the truth. Having mocked Gordon Brown for making the tax system much more complex, he leaves it even more so. History will remember him as a chancellor who took over in a crisis and helped steer the country out of it. It is unlikely to remember him as a great reformer.

How will history judge Mark Carney’s period as Bank governor? Thursday’s decision to leave rates on hold, albeit with what looks like a pretty clear promise to make a move next month, was a sensible one. The monetary policy committee (MPC) fears that that the problems in commercial property and what looks like a sharp slowdown in the housing market presage a wider slowdown in the economy.

But it wants to have a new, fully-worked forecast before deciding on its course of action, and it will have that in three weeks’ time. MPC members have discussed “various possible packages of measures”, which they are ready to unleash next month. It will be surprising if that does not include a cut in rates.

And what about Philip Hammond? Had the Tories won an outright majority in 2010 he would have been Treasury chief secretary, the post he had shadowed in opposition. He would have been responsible for controlling/cutting public spending.

As it is, his route to the Treasury has been a circuitous one, via transport secretary, defence secretary and foreign secretary. In all those roles he has been quietly competent, never making too much of a fuss; the archetypal safe pair of hands.

That is not a bad quality for a chancellor, though the same was said of Alistair Darling when he was appointed in June 2007, and his stint at the Treasury over the following three years was anything but quiet; it was one of the scariest for decades, though Darling did well with the hand he was dealt.

The challenges faced by Hammond will be different ones. And, while most people I have come across have greeted his appointment without a huge amount of enthusiasm, an important part of any chancellor’s duties is to offer reassurance. He will probably be quite good at that.

It may also be that, partly as a result of Brexit and the need to negotiate new arrangements for Britain, and partly because of the new prime minister’s declared intent to pursue a wider economic agenda, run from Downing Street, that the Treasury is less powerful than in the recent past.

In the days of Gordon Brown, and more recently in the case of Osborne, the Treasury has called all the shots. It will still be one of the biggest beasts in the Whitehall jungle but it may have to get used to a slightly more truncated role. That may be no bad thing.

Sunday, July 10, 2016
Why we should all mind Britain's very large gap
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

This continues to be a record-breaking time, though the records being broken are not necessarily those you would want. So, the pound’s peso-style two-day fall in the wake of the referendum was the biggest in the post-Bretton Woods era, in other words for four and a half decades.

Consumer confidence has also taken a tumble, according to a snap assessment published by GfK on Friday. Having been very high – last year was the best year for confidence in the more than 40 years GfK has been surveying it – the post-referendum dive was the sharpest for over 20 years. People may be more worried about their jobs. Another firm, CEB, which monitors online job postings, says they almost halved in the week after June 23.

These things will, as I noted last week, take time to fully reveal themselves. The problems in commercial property which have led to the suspension of withdrawals in several property funds may be the isolated difficulties of an overextended sector or the canary in the coalmine. It is reassuring, I hope, that banks have been stress-tested against a 30% fall in commercial property values.

This week I want to concentrate on what is potentially both a short-term and long-term problem for Britain. I had planned to look at the current account deficit regardless of the referendum outcome. It is timely to do so now.

Just to be clear on terminology, because I know some people get confused, I am talking here of the current account of the balance of payments, which comprises the trade deficit/surplus on goods and services, primary income (mainly investment income) and secondary income (including transfers such as payments to and from the EU).

That something unusual has been happening to the current account is not in doubt. In the final quarter of last year the deficit reached £34bn, a record 7.2% of gross domestic product. It narrowed in the first quarter, but only slightly, to £32.6bn, 6.9% of GDP. The last time we really worried about the current account deficit was in the late 1980s, at the end of the Lawson boom. Its peak then was however smaller, at 4.8% of GDP.

Why has the current account deficit widened so dramatically? Five years ago, the deficit was close to being eliminated, if only for a couple of quarters. Its widening to record levels is not mainly due to the usual culprit, the trade deficit. Though bigger than is healthy, at 2.5% of GDP, it is pretty close to its average of the past decade and a half, 2.4% of GDP.

The problem, instead, lies on the income side, mainly investment income. Just over a decade ago, during 2005, Britain had a surplus on primary income of 3.1% of GDP. Now there is a deficit of a similar among; exactly 3.1% of GDP in the first quarter. It is the turnaround on investment income which has put the current account into a parlous state.

Why the turnaround? It mainly reflects a substantial drop in the investment income that British residents, and British businesses, are getting from their investments abroad, while foreigners’ earnings on their investments in Britain have held up.

Some of that – about half – is directly related to weak oil and commodity prices. Energy and mining companies have seen their overseas earnings slump. Some of it reflects the fact that Britain’s economy has been growing more rapidly - generating more investment income – than most other advanced economies.

Does a big current account deficit matter? The balance of payments has to balance, as every student is taught. A current account deficit has to be matched by capital inflows.

The Bank of England’s financial policy committee, in its twice-yearly financial stability report last week, put the current account deficit at the top of its list of concerns. As it put it: “The current account deficit is high by historical and international standards. The financing of the deficit is reliant on continuing material inflows of portfolio and foreign direct investment.

“During a prolonged period of heightened uncertainty, the risk premium on UK assets could rise further and overseas investors could continue to be deterred from investing in the United Kingdom. Persistent falls in capital inflows would be associated with further downward pressure on the exchange rate and tighter funding conditions for UK borrowers.”

Incidentally, there is a strand of bonkers criticism around about the Bank and its governor, Mark Carney. Having warned against the consequences of Brexit, he and his colleagues have been quick to take action to minimise those consequences. The Bank’s actions may extend to a cut in interest rates this week. Yet all this, according to some economic illiterates out there, is merely an extension of pre-referendum scaremongering.

Will the risks from Britain’s gaping current account deficit diminish, or will they crystallize, to use the Bank’s phrase, in an even lower pound than we have seen so far? The balance of payments, as noted, has to balance, the question is at what exchange rate it does so.

On the current account itself, there are reasons to believe that over time the deficit will narrow rather than widen to, say, 10% of GDP. The fall in the pound so far will help, though not in the way most people expect. The drop in sterling has a direct translation effect on Britain’s overseas investment income, boosting receipts on assets denominated in foreign currencies. This is the main mechanism the Bank sees through which the deficit will narrow.

The trade deficit may respond to sterling’s weakness. The usual way this would happen is through the so-called “J-curve”, whereby the deficit initially worsens as imports become more expensive but then improves as Britain’s exports become more competitive. It could happen, though as I noted last month, sterling’s 25% fall in 2007-9 was notable for its disappointing impact on exports. Foreign tourists will find Britain cheaper, while British tourists will see the cost of their foreign holidays rise. The Brexit vote could thus see more foreigners flocking to Britain.

The current account could also improve if there is a further recovery in oil and commodity prices, boosting the overseas earnings of firms in this sector. There has been a recovery in prices from the lows of earlier this year, though so far it has only taken us back to where we were in the final months of last year.

Finally, the deficit could narrow if the hit to growth in Britain both reduces demand for imports – already we have seen the first signs of a weakening in new car registrations – and results in lower investment income for foreigners with British investments. This, of course, would be the least desirable way in which the deficit becomes less of a problem.

Will the current account deficit narrow by enough to take it off the Bank’s list of critical risks for the economy? That is the big question. To do so it probably needs to be no more than half its present level of nearly 7% of GDP. Getting there may take some time.

Sunday, July 03, 2016
Carney in a battle to head off a post-Brexit recession
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

What an extraordinary time it has been. During the worst of the global financial crisis I wrote that we had 10 years of big economic and financial stories crammed into about 10 weeks. Something similar has been happening in the past few days.

Even leaving aside what is going on at the top of British politics, which is completely barking, this is an action-packed time. Remember all that agonising about whether Britain’s AAA sovereign debt rating would be downgraded? On Monday, the last remaining AAA rating, from S & P, vanished with a big downgrade and Fitch, another agency, also took us down another notch.

Sterling has tumbled but not yet collapsed, though has hit a 31-year low, while the stock market has almost been a caricature of itself; despair followed by euphoria. I would like to take some reassurance from the euphoria bit though, thinking back to the crisis, I recall that the FTSE-100 was still surprisingly buoyant in the late spring of 2008 and gave little sign of the horrors to come.

Meanwhile, as if on cue, official figures reminded us of one of Britain’s important sources of vulnerability. The current account deficit in the first quarter – the red ink on the balance of payments - was a worryingly large 6.9% of gross domestic product, only marginally down on the record 7.2% of the final quarter of 2015.

So what is going to happen? We are still in a state of limbo in terms of the economic impact, short and long-term, of the referendum decision. There is some preliminary evidence that consumer confidence has taken a hit and a lot of talk of cancelled investment projects but very little hard evidence.

That will be the case for some time. Even the June purchasing managers’ surveys, normally a good indicator of what is currently happening, are based mainly on data collected before June 23. For most surveys, and even more so for the official statistics, we may have to wait until August for hard evidence, and that will only be for the initial impact.

In the absence of that, however, economists have been busy adjusting their forecasts downwards. A sample assembled by Consensus Economics gives an idea. Before the referendum the expectation was for 1.9% growth this year, 2.1% next. Now the numbers are 1.4% and 0.4% respectively. That does not sound too bad, but it implies a technical recession – two or more quarters of declining gross domestic product – between now and next summer.

And, if the consensus is right then, for those nostalgic for one of the high spots of the referendum campaign, it implies that GDP per household will be about £1,450 lower by the end of next year than it otherwise would have been.

Some are even gloomier. The Economist Intelligence Unit, which topped my annual forecasting league table in 2012, predicts an outright recession, with the economy shrinking by 1% next year on the back of a big fall in investment and weaker growth in consumer spending. GDP by the end of next year will be 4% lower than it otherwise would have been. Unemployment will rise, it says, and the budget deficit go back up to 5.5% of GDP (from about 4%) and public sector debt rise to 100% of GDP in coming years, from 84% now.

Why should we go into recession? Business investment, which was falling earlier this year on pre-referendum uncertainty, seems likely to be very weak for some time to come. Consumers, apart from feeling unsure, will be hit by the rising prices that result from sterling’s fall.

And, if you really want to be depressed, listen to the respected John Llewellyn, former OECD chief economist, and his team at Llewellyn Consulting. In a note to clients the firm said: “We are more worried - for the UK, though importantly not for the world - than we were in 2008 or any other post-WWII crisis. And between us we have been present for every one of them. The scale of all this will start to unfold in coming weeks.”

The challenge for the authorities is to turn this gloom around. And, in the state of political limbo in which we find ourselves, that for the moment means the Bank of England. On Thursday I, along with other journalists and a large invited audience from the City, assembled in the Court Room of the Bank of England to hear Mark Carney. There was a frisson when, talking about jobs, the governor asked: “Will I keep mine?” He was putting into words the concerns ordinary people have when times are uncertain but he also faced questions about whether he would survive in a post-Brexit government. My view is that the worst thing you could do for confidence is get rid of the Bank governor, but anything is possible amid the current madness.

Carney, as you will have read, had one important message. The Bank’s monetary policy committee (MPC) had been expecting to raise interest rates over the next 2-3 years. Now it is likely to cut them, even from the record low of 0.5%, starting on July 14. Before August is out interest rates could be zero, and another round of quantitative easing (QE) is a possibility. I do not see negative interest rates but other policy tweaks are possible, including so-called credit easing, with the Bank buying assets other than gilts, and action on the Funding for Lending scheme.

Such moves will help ease the shock to the economy but we should not overstate their potency. A cut in rates from 0.5% to zero does not take us very far. QE may be of limited use when long-term interest rates are already very low. Carney himself made the point that there are limits to what monetary policy can do, and that – even when it is effective – its impact is not immediate.

The best the Bank can do may be to reassure. When Mario Draghi, the president of the European Central Bank, promised to do “whatever it takes” to hold the eurozone together, it helped do so. Carney’s “all the necessary steps” message is in a similar vein. The Bank, like the rest of us, has to hope it helps stop some of the nastier outcomes now predicted by economists from becoming a reality.

Sunday, June 26, 2016
I'm not going to sulk - we have to make the best of a bad job
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

For many people reading this, Friday morning will have dawned as a moment of triumph, of liberation. That was not how I saw it, as you might have gathered from my series of pre-referendum pieces. But, admittedly after a dishonest campaign, the voters decided otherwise. Democracy does not always throw up the outcomes we would like, or think sensible. We face a poorer and more uncertain future.

Despite his “no regrets” statement in Downing Street on Friday, I doubt if David Cameron now thinks that of the referendum that is bringing an end to his prime ministerial career. You only ask a big question of voters if you are sure of the answer. Downing Street thought it was sure of the answer as late as Thursday evening but it was wrong. As it is, a Tory prime minister Sir Edward Heath is most remembered for taking Britain into Europe 43 years ago, and Cameron will go down in history as the prime minister responsible for taking us out.

The Cameron-George Osborne double act, meanwhile, does not have much further to run. As with the referendum outcome, people will have mixed feelings about this. The chancellor has had more than his fair share of setbacks, particularly since last year’s election. As he joked himself, his version of the 5:2 diet is one in which in two out every five budgets he has to eat his words.

Osborne wanted to be remembered as the chancellor who took over at a time of crisis and, while courting unpopularity, fixed the public finances, alongside some long-term reforms, including pensions. Now, the abiding memory will be of the warnings on the economy that he commissioned or co-ordinated not being enough to persuade voters. Indeed, if the evidence of the polls is anything to go by, those warnings backfired with many voters. It is not hard to think who might succeed Cameron as prime minister. A successor to Osborne is rather harder to think of.

Osborne’s efforts were not enough, and neither were those of the overwhelming majority of economists, including highly respected bodies such as the Institute for Fiscal Studies (IFS). Businesses, big and small, were much less influential than expected, even locally. Nissan’s presence was not enough to prevent a big vote for Brexit in Sunderland, nor Honda in Swindon, nor Airbus in Flintshire.

I noted last week that economic arguments would not be enough to prevent a big vote for leave and a very close outcome on Thursday, and so it proved.

Many have said that those of us inside the “bubble” were unaware of the anger out there from the economic have-nots, some of which pre-dates the global financial crisis. I was well aware of such anger, particularly in Wales, the poorest part of the UK, where most local authority areas voted for Brexit. But the Brexit vote, as I also know, included many usually non-political, comfortably-off middle-class voters in the south-east.

One thing I do not have the slightest regret about is setting out the strong economic case for staying in the EU. I doubt it swung a single vote but I would have felt permanently guilty if I had not done so, particularly towards the young, many of whom feel they have just had part of their future snatched away by leave-supporting older voters. The baby boomers have done it again.

Many divides were thrown up by the referendum, but the inter-generational one is perhaps the most regrettable. Many young people, including those in my family and their friends, were almost inconsolable after the result became known.

The other thing that my series of pieces did was to provide a road map for the kind of post-EU response we should have. The first response to calm the market reaction, from Mark Carney on Friday morning, managed to make a nasty situation somewhat less toxic without saying all that much, other than that the Bank of England is prepared for all eventualities.

There will be important decisions from the Bank in the coming weeks. In one sense, it is good that Carney and his colleagues have the experience of 2007-9 to draw on, a period in which the authorities’ reaction was less than surefooted.

Whether the Bank needs to cut rates (or raise them to support sterling) and whether it needs another round of quantitative easing (QE) will become clearer in the coming weeks. The Bank’s preferred response will be to content itself with supporting financial stability, riding out the storm without adjusting rates or engaging in another round of QE, which was why there was no knee-jerk reaction on Friday.

What about the fiscal policy response? One campaigning line which Osborne was unwise to pursue was the idea of putting up taxes or slashing spending in the wake of a Brexit vote. That was when he departed from economic logic. If your economy takes a hit, as Britain’s will do, the sensible response to it is not to amplify that hit. Deficit-reduction is appropriate, when needed, in a growing economy, not one that has just been hit by a sock.

The public finances will have to take the strain. Osborne’s deficit targets were slipping anyway, partly because of the pre-referendum slowdown in the economy. His successor will have to decide whether to aim for a budget surplus. There will be downgrades of Britain by the ratings agencies, because of Britain’s record current account deficit, as well as the budget deficit, but that is probably one of the least of our worries.

More important than the short-term monetary and fiscal response are the decisions that need to be taken in the coming months to limit the long-term economic damage from Brexit. Despite silly attempts to disparage it by Vote Leave campaigners, the single market is hugely important to Britain’s economy. It is important for goods, and it is important for services, including financial services.

It is too much to hope for a deal in which Britain could be fully part of the single market while being outside the EU but something as close to that as is feasible has to be the aim. The UK, like Norway and Iceland, will need to be in the European Economic Area but with enhanced arrangements for the City. There will be a price to be paid in terms of what will effectively be a contribution to the EU budget but that would be a small price compared with significantly restricted access to our most important market.

What can be achieved on the single market will be key to Britain’s ability to continue to attract foreign direct investment (FDI). This will be the test in the coming years. Will multinationals automatically choose to access the single market from EU locations, or will it be possible to neutralise the impact of exit by replicate as close as possible existing arrangements? FDI does not come without a huge effort, and those trying to attract it to Britain will fear they have one hand behind their back.

The final area is immigration. We have a system for non-EU migration which does not work well, and an apparent plan to apply that to EU migration as well. In all the debate over immigration, and “taking back to control”, it is often forgotten that it is not just doctors and engineers we need but also in many sectors, unskilled workers.

So, this was not a result I wanted but congratulations to those who did and I am not going to sulk. The task now is to make the best of a bad job.

Sunday, June 19, 2016
A hard pounding - and with so very little to show for it
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

The moment is nearly upon us. Like the Scottish referendum in September 2014 but with even more at stake, a nerve-racking few days lie ahead. Either way, we will wake up to a different world on Friday morning , a very different one in case of a vote to leave.

One point is worth making. It is that economic models tend to underestimate the impact of shocks, as we saw in 2008. Some people say leaving the EU will be a little like leaving the European exchange rate mechanism (ERM) in September 1992. Apart from the fact that both narratives involve a plunging pound, the similarities end there. In 1992 we left a currency arrangement after 23 unhappy months having joined, as was said then, at the wrong rate, the wrong time and for the wrong reasons.

Leaving allowed an overvalued pound to come down to earth, and made room for big cuts in interest rates, which are simply not an option this time. As for sterling’s fall providing us with the elixir of export-led growth, it did not happen after the pound’s 25% fall in 2008-9, and there is no reason – with world trade depressed – it would be any different now.

Voting to leave the EU after 43 years in which our economy has become increasingly intertwined with the rest of Europe, and done well out of it, would be a very different proposition to being kicked out of the ERM. Even leaving the ERM made the Tory economic brand toxic for years. Apart from the economic and financial fallout, the political instability that would result from a Brexit vote would be much bigger. Whether this would be helped or hindered by George Osborne’s threatened £30bn emergency austerity budget – and whether it would happen - is one of the many questions that would arise.

It would be foolish to deny that any of this will prevent a big vote for leave and a close outcome on Thursday, and that those expecting “it’s the economy stupid” to have clinched it were wrong. A minority probably believes in the “project fantasy” of a seamless transition to a world waiting for British goods and services if only the EU were not holding us back, and the mythical pot of fiscal gold and bonfire of red tape beyond Brexit.

Rather more believe much more important is to “claim back our country”, which for most means sharply reducing immigration, even if there is an economic sacrifice. For some, where the pressures on local services are acute, and where there has been a sudden increase in the migrant population, such concerns are valid.

But there is also something more visceral happening elsewhere, the fear that hordes of Syrians, Iraqis, Turks, Libyans and those who use Libya as a jumping-off point are about to hit our shores, as well as legitimate economic migrants from the EU. They are not and politicians will regret stoking up the immigration issue. If there is a vote to leave, we will replace one set of politicians who unwisely promised and predictably failed to reduce net migration to the tens of thousands with another, unless the labour market is so badly affected it ceases to be a magnet.

Non-EU net migration from the Commonwealth but also China (mainly students), Russia and America, has averaged more than 200,000 a year this century. As for EU migration, over the long run it might be reduced but it would not stop.

But there are other pro-Brexit views out there, not specifically related to immigration, some of which I received in response to last week’s piece, which should be addressed.

The first is the eurozone. The argument here is straightforward. Why should we stay in the EU when the eurozone, its centrepiece, is heading for disaster? I wrote here on April 24 about the need for further eurozone reform. The much-misinterpreted Five Presidents’ report of last summer (the presidents of the Commission, Council, Central Bank, Eurogroup and Parliament) is about precisely that, rather than creating a “superstate”.

Its aim, to ensure that the single currency works for all its members and avoids being caught out as it was in 2008, is laudable. It wants member states to establish more flexibility in their economies and to build fiscal buffers so they can cope with future downturns. It is an agenda Britain should support. The worry is that, because of other issues, including the migration crisis and, yes, the referendum, it is not being implemented rapidly enough. But it is lazy to assume another eurozone disaster is looming. Lessons have been learned.

The eurozone’s experience demonstrates that, far from being a superstate, its members are not integrated enough. The European Central Bank had less freedom than other central banks to engage in unorthodox monetary policy, which is why it came to quantitative easing so late, because it had to deal with national sensibilities. That was also why its rescues of troubled eurozone countries were so fraught. Is the eurozone clear of the crisis? No, but as I noted last week, Britain is also in a state of convalescence.

The second strand is a familiar one. It is that, even if there is an economic price to be paid for Brexit, it is worth it to be freed from the yoke of the “unelected bureaucrats” in Brussels, restore our sovereignty and stop the EU making all our laws. In short, why should we stay with an imperfect EU? Space is limited, and these are big issues, but briefly.

It would be foolish to deny there is a democratic deficit in the EU, but it is worth digging into. European Commissioners are proposed by democratically elected national governments. The Commission president, chosen by the European Council (leaders of member states) by qualified majority voting, has to be approved by the European Parliament.

In Britain, moreover, we have a curious attitude to European democracy. If we wanted better scrutiny of the European Commission we would take European Parliament elections more seriously. But two-thirds of us do not bother to vote and we do not mind sending Westminster rejects and anti-EU oddballs there.

You could have direct elections for the Commission and its president (last time there were primaries) but that would be seen by critics as a step towards the superstate they fear.

On sovereignty, no country is truly sovereign in the modern world but we have independent economic and monetary policy, independent foreign and defence policy. Talk of an EU army – if Britain stays - should rightly be taken with a large pinch of salt. Steve Peers, professor of EU law at Essex University, pointed out in a recent article that Britain has vetoes in all the important areas, including defence, transfers of power, enlargement, taxation, non-EU immigration, asylum and criminal law, the single currency (including participation in bailouts and Britain’s opt-out) and the EU budget rebate.

Where there is qualified majority voting, future British governments can and should build alliances. People who think Britain can bestride the world, striking deals left, right and centre, strangely fear we are either incapable, or too timid, to stand up for ourselves in Europe.

These issues deserve a lot more space, as does the idea that most of our laws come from the EU; they don’t and most of those that do are the legal detail of single market rules. Old prejudices die hard, however, Since the days of Jacques Delors, some people have chosen to believe that Brussels only exists to do Britain down. It doesn’t. In this mad campaign, however, some people will believe anything.

Sunday, June 05, 2016
Leaving the single market risks a world of pain
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

Judging by the many ideas I have had for post-referendum subjects – keep them coming – I sense that June 23 cannot come too soon for most. Are we nearly there yet? Yes.

Soon there will be no more of the Brexit camp’s bogus £350m figure, or its fantasy pledges of spending £100m a week more on the NHS or cutting Vat on fuel, which are an insult to voters’ intelligence.

Next week I shall pull all this together and the following week I shall clear up some important loose ends, but today’s piece is a reminder of how far we have come.

When, seven months ago – before we even had a date for the referendum – I wrote that if we left the EU we would lose the single market, the reaction from many Outers was that we would do nothing of the sort. The rest of Europe would be so keen to trade with us that they would allow us to leave while staying in the single market.

Time has moved on. Vote Leave’s position is clear on one thing; that a post-Brexit Britain will not be in the single market. What it will be in is not clear. The small group known as Economists for Brexit has suggested no trade deals at all and the unilateral removal of all trade barriers by Britain. I shall come back to that.

It is important in this debate to know what the single market is. It is not just a trade deal. It is one of the most important ways in which Britain has influenced the EU. When Margaret Thatcher took up the idea of the single market in the mid-1980s, and set Britain’s European commissioner Lord Cockfield the task of pushing it through, it was against the protectionist instincts of some other EU countries.

The single market is still a work in progress but it has come a long way. By setting the same regulatory standards, state-aid regulations and other rules across the 28 members, it guards against unfair competition. Those same standards mean that firms do not have to go through the rigmarole of complying with different sets of rules, including product and safety standards, to sell in different European countries.

The single market has created an integrated European economy, taking advantage of the economies of scale of a 508m population grouping of countries. Supply chains operate across borders. Within a business, some components will be made in one country to be combined with others made in another. Dismantling these supply chains, or putting tariff and other barriers up within them, would be both time-consuming, costly and a recipe for inefficiency.

Most importantly, as far as Britain is concerned, progress is being on a single market in services. When EU leaders such as Donald Tusk talk of deepening the single market, it is an agenda we should enthusiastically embrace. British exports of services to the EU have almost doubled in a decade and trebled in 15 years. The passporting regime, as the Bank and England and others have noted is important for Britain’s financial services sector. In its absence, some activity and employment would be relocated to inside the single market.

Much of the debate on the single market is stuck in the world of 40 years ago. When the Brexit camp say a way would be found for Germany to sell its cars or the French to sell their cheese in Britain, they are reflecting that world. Perhaps the strangest recent comment – in a crowded field - was from Steve Hilton, David Cameron’s former “blue sky” thinker, who said: “The US is not a member of the EU, but the last time I checked, General Motors had no problem selling cars there.”

GM, of course, exports very few cars from America to the EU, but is part of the integrated single market, with local manufacture at Vauxhall in Britain, Opel in Germany, and extensive operations in Spain, Hungary, Poland and Austria.

As for a deal to sell German cars in Britain, maybe. But most of the 80% of British cars built for export are sold elsewhere, including elsewhere in the EU, and a deal to maintain access could be difficult. No wonder Britain’s Society of Motor Manufacturers and Traders reports that 77% of its members favour continued EU membership and only 9% want to leave.

The single market, named by 79% of inward investors in Britain as a key driver of location decisions in the latest EY attractiveness survey, clearly matters for both trade and investment.

It is also a dynamic process. When the rules evolve – and in the case of Brexit without any British influence on those changes – firms selling into the EU would have no choice but to abide by them. Without Britain at the table to push for further liberalisation, and with new barriers erected, our strongly-growing services to Europe would languish.

What about the fact that fewer than half of our exports now go to the rest of the EU? This tells me two things. One is that EU membership is not preventing us exploiting other markets. The other is that it is an inevitable consequence of the rise of China and other emerging economies. As the share of the older industrial economies in the global economy has declined, so their share of UK exports has fallen.

But the EU remains crucial. We sell almost as much to the 450m people in the rest of the EU, as to the 6.5bn or so people in the rest of the world. Making it more difficult to do that does not look like an obviously sensible strategy.

What about the idea, associated with Professor Patrick Minford of Economists for Brexit, of no trade deals at all, and a unilateral removal, by Britain, of all trade barriers? I know Minford well, but I think he is onto a loser with this one. He himself has said it would probably mean the elimination of manufacturing industry in Britain.

An assessment of his proposal by the Centre for Economic Performance at the London School of Economics, using up-to-date trade models and empirical evidence, says the negative impact on living standards in Britain would be similar to the so-called WTO (World Trade Organisation) option. The WTO option is, in any case, quite problematical, as its director-general has pointed out. Whatever future Britain had outside the EU, it would involve extensive and painful negotiation to get there, generating significant uncertainty.

But, as I say, one thing is clear. If we were to vote to leave on June 23, it would be a vote to leave the single market. Some will not mind that. Many, including many in business, will be deeply worried.

Sunday, May 29, 2016
Plenty of migrants - but plenty of jobs for UK workers too
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

The economic debate over EU membership rages on, with the heavy weaponry overwhelmingly on one side. I can only hope there will be a ceasefire on June 24 but I cannot promise it.

So in the past few days we have had the Institute for Fiscal Studies confirming the conclusion of this column on May 1st, “There’s no pot of gold at the end of the Brexit rainbow”, and that there will not be the Leave campaign’s dodgy £350m a week figure to spend on the National Health Service or anything else.

Because the public finances will suffer in net terms from Brexit, on all plausible assumptions, there will be less to spend on services, not more. The IFS, for pointing out this simple truth, got accused by the teenagers who run the Vote Leave campaign of being a propaganda arm of the European commission or, even more absurdly, by Nigel Farage – EU-funded for the past 17 years – of being biased because it gets some funding from the EU.

The IFS’s great achievement over decades has been to rise above politics, informing the debate. Its intervention on the likely consequences for the public finances of a Brexit vote maintained that tradition.

What about the Treasury’s prediction of a short-term Brexit shock of between 3.5% and 6% of gross domestic product, and up to 820,000 fewer jobs than under a Remain scenario? Given that it probably did not need to do it, or be asked to do it, did the Treasury lay it on a bit thick?

Perhaps. Confidence effects are hard to measure, and they could be smaller or bigger than the Treasury assumes. In the political chaos that would follow Brexit, a rapid handover to a government composed of prominent Brexiteers would put the wind up many in the markets and in business. And hte direction of travel of the Treasury's assessment is similar to other, independent analyses.

One criticism of the Treasury exercise I would defend it against is that it did not take into account the monetary policy response to a Brexit vote. If interest rates were cut, in other words, it could mitigate some short-term confidence effects. The reason the Treasury was right not to include such a response is that Mark Carney has made clear it could go either way; interest rates could rise or fall. Even if they were cut from 0.5% to zero, I doubt there would be much of an impact on the economy or confidence. It could even be seen as a panic move.

Anyway, all this is grist to my mill. I shall pull together the economics in a couple of weeks’ time. For now, let me focus on a topic of the moment, one on which Vote Leave feels more comfortable, immigration.

Immigration is subject to more deliberate misreporting and scaremongering than any other subject. If there’s Project Fear on one side on the economy, there’s more Project Fear on the other on immigration. Anti-immigrant sentiment is stoked up as aggressively now as at any time I can remember. Partly because of this immigration, as I wrote when last in this territory in February, is economically beneficial but has become politically toxic, even in areas where there is not a large immigrant population.

This was the context in which the Office for National Statistics released its latest migration statistics. They showed net migration of 333,000 in the 12 months to last December – in other words 2015 – up a little, 20,000, though not in a “statistically significant” way, on the figure for 2014. Net migration, which measures the difference between long-term arrivals and departures, rose compared with 2014 because of a drop in emigration.

As before, and as has always been the case since we joined the European Community in 1973, non-EU net migration exceeded EU migration, though only slightly. EU net migration into the UK was 184,000, non-EU migration 188,000. The 333,000 number for overall net migration arises from 39,000 of net emigration by British citizens.

The ONS also provided some useful information on short-term migration. A couple of weeks ago, many newspapers ran stories about “hidden” migrants, people who come to Britain for between one and 12 months. They do, and always have, some for seasonal work, some for study, some for other reasons. But British people travel abroad for these reasons too. In the year to June 2014, there were on average nearly twice as many short-term emigrants – people from Britain leaving for between one and 12 months (420,000) – as short-term immigrants (241,000). The effect of short-term migration was to reduce not add to the population.

When people have a problem with immigrants that is not simply dislike of foreigners it usually arises from two sources. One is the additional pressure they impose on public services. The figures are, however, clear on this. HMRC data show that migrants who arrived in the past four years paid £2.5bn more in taxes in 2013-14 than they received in tax credits and benefits. That money is currently being used, at least in part, to reduce the budget deficit. But it is also as available as anybody else’s taxes to pay for public services.

The other problem people have with immigration is the “they’re taking our jobs” objection. David Davis, the former shadow home secretary, who I normally have a lot of time for, described the EU as “a job transfer machine – switching employment from British workers to those on the continent”. He is not alone. Many people think that the jobs created in Britain in recent years have mainly gone to eastern Europeans.

Leaving aside the fact that this is also an area of regular misreporting – new jobs and a net increase in employment are not the same thing – the true picture is very different. Since January-March 2010, the post-recession low-point for employment, the number of UK-born workers in employment has risen by 1.1m to a new record level of 26.25m. Not only was the number a record, but so, in 2015, was the proportion of UK-born people aged 16-64 in employment, 74.3%. In the six years to the first quarter of this year. there was a rise from 70.7% to 74.6% in the UK-born employment rate.

There was, it should be said, also a net rise of 633,000 in the number of EU migrants from the new eastern European member countries in work - more than 80% of those of working age do so - and one of 309,000 in those from long-standing EU counries in western Europe. But this rise occurred alongside, not instead of, a sustained increase in UK-born employment.

Employment among UK nationals rose even more, by over 1.5m, in the six years to the first quarter accounting for two-thirds of the overall rise in employment It has also never been higher as a percentage of the 16-64 workforce.

Could there have been a bigger increase in UK-born or UK nationals' employment? Maybe a little, but probably not by much. Given that a significant proportion of the 16-64 workforce is in full-time education and not working, or looking after children and other family members, or unable to work for other reasons, the current UK-born employment rate is probably quite close to the maximum.

What about the kind of migrants we have? Would not we do better with the much-vaunted points-based system, based on the Australian model, promoted by Boris Johnson and Michael Gove, as well as Ukip? Well, we have such a system for non-EU immigration, and even its best friends would say it is not working that well.

As for applying such a system to immigration from Europe in the event of Brexit, even Migration Watch criticises it for its extreme complexity and for the fact that it is a system intended to encourage immigration; Australia’s net migration per capita is roughly three times that of the UK. It is, it says, “thoroughly unsuitable” for Britain.

The majority of EU migrants to Britain would still qualify under skilled-labour criteria under a points-based system. But this additional layer of bureaucracy, whether the onus would be on workers or those seeking to recruit them, would make it harder for firms to fill gaps in their workforces. Those who say they would reduce red tape would merely tangle business up in more of it. And Britain’s labour market would become more inflexible.

Sunday, May 22, 2016
We hate EU red tape - but others are tied up more than we are, and there'll be no bonfire of it
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

A few weeks ago I came across a woman who told me that she was voting to leave the European Union because it had stopped her buying traditional light bulbs. She was, pun intended, incandescent.

I suggested that this was not a very sensible basis on which to base a decision but she was having none of it. The EU had gone too far. I tell the story because it illustrates a wider theme, the perception that Brussels is foisting things on us that, were we to leave, we would no longer have to do; that it is strangling us in its unnecessary red tape.

In the case of incandescent light bulbs, the position is clear and entirely the opposite of that perception. Hilary Benn, environment secretary in the Labour government, announced in 2007 an agreement with retailers to phase out the sale of incandescent light bulbs by 2011. Britain, he said, was “leading the way”.

His initiative came two years before an EU agreement to phase out the bulbs. In this, as in many things, the EU was going with the flow. Most countries have plans in place to phase out old-fashioned energy-inefficient bulbs. In Britain, I should say, nearly a decade after Benn led the way in banning them you can still buy them if you know where to go.

It would be unfair to blame my light bulb lady. For years, blaming Brussels for most things has been the default position of a significant proportion of the media and, it should be said, quite a lot of politicians. The EU provides good cover.

Nor will this stop. The Arthur Daleys abound in the referendum debate. I heard one the other day giving a ludicrous figure for the cost of EU regulation, repeat the now discredited £350m a week figure we “send” to Brussels and claim most businesses in Britain favour Brexit. They don’t. Every credible business survey, covering firms from the large to the very small, show a net position in favour of staying in the EU, apparently in spite of all that red tape.

Red tape is an important issue. None of us like it and for some firms it goes beyond being a mere irritation. There is often a sense among firms I talk to that Britain obeys the rules, and even “goldplates” them, while other EU countries adopt a more relaxed attitude.

But it is also important to be realistic. Some red tape simply represents the fact that things that were acceptable on health and safety or other grounds in the past no longer are. Like lower-energy light bulbs, they have would have happened whether or not we were in the EU. Some may yearn for the days when every new electrical appliance was supplied with bare wires, for the householder to fit the plug – not always successfully – but those days are not coming back.

Not only that, but much red tape is home-grown. Her Majesty’s Revenue & Customs has been trying to reduce the administrative burden on business – hard when you have had successive chancellors addicted to tinkering with the tax system – but it is still a work in progress.

It is also the case that, far from EU rules being foisted on an unwilling Britain, successive governments have often initiated them - as we initiated the single market – or been perfectly happy to go along with them. In Facts, a group which seeks to promote accuracy in the referendum debate, points out that of nearly 2,600 EU votes since 1999, Britain has voted no only 56 times and abstained 70 times. On more than 95% of occasions, in other words, we have been quite happy.

Just because ministers are happy does not, of course, mean business is happy but there are two essential points in this debate. The first is that, however bad it may seem, Britain is less regulated than our EU competitors. This is not that surprising; it is one reason why inward investors have favoured Britain as their location of preference within the EU single market. It is confirmed by Britain’s high ratings in the World Economic Forum’s international competitiveness league table and the World Bank’s “ease of doing business” rankings.

It is quantified in successive studies from the Organisation for Economic Co-operation and Development (OECD). These have the virtue of showing, not only that some EU countries are more regulated than others – look at the French, German, Italian, Dutch and Belgian labour markets – but also that Britain is among the least regulated advanced economies, in or out of the EU.

For product market regulation, Britain is the second least regulated of 34 OECD countries, and marginally less regulated than America. For employment legislation, Britain is the fourth least regulated. However bad the red tape burden seems, it could be a lot worse. The think tank Open Europe points out that even at EU level there has been some progress in reducing red tape over the past two years.

In a letter last week organised by Vote Leave, some 300 business people said that “Britain’s competitiveness is being undermined by our membership of a failing EU”. Now, there are many reasons why Britain is not more competitive, ranging from shortcomings in education and skills, low productivity, a failure to invest enough, including in infrastructure, and lack of innovation is some sectors.

Blaming it on the EU, however, seems to me to be the worst kind of bleating, given that our regulatory burden is lower than the vast majority of our competitors. When we look for failings, we should look in the mirror.

This brings me to me second point. Would there be a bonfire of red tape if Britain left the EU? Open Europe, which is strong in this area, estimates the annual cost of EU red tape to be £33bn a year. There is, it should be said, a parallel estimate of the benefits to Britain of EU regulations of £58.6bn a year, also based on official impact assessments.

How can there be benefits of red tape? The Treasury, in its assessment of the costs and benefits of EU membership, lists some of them, such as the fact that a single testing regime for cosmetics reduces costs, that there have been significant gains to both operators and consumers in the transport sector, and so on. The public benefits from measures to protect the environment while, in the field of labour market regulation, one firm’s burden is its employees’ workplace protection. Estimates of the benefits of EU regulation, to be fair, include those from rules not yet fully enacted.

Staying with the costs, however, Open Europe calculates that a politically feasible maximum for the amount of red tape that could be reduced is £12.8bn out of £33bn, most coming from scrapping some labour market and environmental regulation, some from easier regulation of financial services.

It is a reasonable stab, but I think it is likely to be a significant overestimate. Think of the climate that we have been in, in which a majority Conservative government has had to backtrack on plans to cut tax credits and disability benefits. Think too of the continued debate over zero hours contracts and claimed exploitation of workers, or of the row over diesel emissions, where EU regulations have been attacked for being too lax, rather than too tight.

The idea that a post-Brexit Tory government, facing significant opposition from within its own side as well as from Labour and the Scottish Nationalists, could push through a programme of scrapping workers’ rights, reducing environmental legislation and adopting a softer-touch regulatory regime for the City, seems to me entirely unrealistic.

There is v ery unlikely to be any bonfire of red tape. Given that that has been a significant plank in the case for leaving the EU, this is a big flaw in that case.

Sunday, May 15, 2016
Amid all the referendum excitement, the long wait for a rate hike goes on
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

Thursday’s Bank of England inflation report press conference was, by my calculation, the 29th since interest rates last changed. I may have missed one or two but sat though most.

If you think that’s a burden, think of the members of the monetary policy committee (MPC) itself. The latest “no change” verdict from their May monthly meeting was the 86th in a row. The personnel have changed along the way, and MPC members would not doubt say there was nothing they would rather have been doing. But no wonder, perhaps, the Bank is reducing the number of MPC meetings from 12 to eight a year.

There was a time when the Bank was expected to be the first of the big central banks to hike rates. Then, when it became clear that America’s Federal Reserve would be the first-mover, which it was last December, that the MPC would follow soon after. Now, it is fair to say that there is more speculation about a cut than a rise.

Part of that, of course, arises from the part of the Bank’s inflation report that Mark Carney, its governor, described as “the elephant in the room”. Its view that a decision to leave would have “material economic effects”, including weaker growth, higher inflation and rise in unemployment, was explicit.

Sterling would fall, “perhaps sharply”, and: “Aggregate demand would also likely fall, relative to our forecast, in the face of tighter financial conditions, lower asset prices, and greater uncertainty about the UK’s trading relationships. Households could defer consumption, and firms could delay investment. Global financial conditions could also tighten, generating potential negative spillovers to foreign activity that, in turn, could dampen demand for UK exports.”

The Bank’s frankness has provoked predictable fury from the Leave camp. My tip for them would be not to challenge the Bank’s independence or its governor’s integrity – these verdicts were unanimously agreed by all nine members of the MPC and the 10 members of the financial policy committee – but to argue that a bit of short-term pain would be worth it for what they see as the long-term gain. I doubt if they will take that advice.

The referendum is the latest obstacle to a return to some kind of normality for interest rates, adding to a very long list. The Bank held rates at their record low to help the economy cope with George Osborne’s fiscal tightening, and kept them there and unleashed another round of quantitative easing when the eurozone was mired in its deepest crisis. It passed up an opportunity to raise them in 2014 when growth was strong and unemployment falling far faster than it expected, and well below the 7% rate cited by Carney in his forward guidance the previous summer.

When rates were first reduced to 0.5%, in March 2009, MPC members did not think they would stay there long, probably less than a year. Now, according to the markets, it will be touch and go whether they go up before the 10th anniversary of that cut, in 2019.

Andrew Sentance, the former MPC member and long-time hawk has promised to assemble a live band outside the Bank to celebrate the first hike. I think it will take more than that, maybe a streak down Threadneedle Street. Either way, according to the markets, it looks a long way off.

Is that a reasonable expectation? Let me take two scenarios, Brexit and non-Brexit. The Bank’s response to big events usually has the virtue of being clear-cut. In the global financial crisis cutting rates was a no-brainer.

In the case of Brexit, as Carney and his colleagues made clear, the decision would be more balanced. The slump in sterling and the consequent rise in inflation would argue for higher rates, while the hit to growth would make the case for a cut. A cut would not do much – I am pretty sure the Bank will not want to follow other central banks and opt for negative rates, so from 0.5% to zero would be as far as it goes. A half-point cut in interest rates would not do much to offset a growth shock. As the governor said, there is only so much that monetary policy can do.

Which way would it go? The Bank is not saying. If it thought the rise in inflation resulting from Brexit was temporary, then it could “look through” it, as it has done before, and cut to try and keep growth going. If, on the other hand, a post-Brexit slump in sterling turned into a rout, the Bank might have no option but to raise rates to prop it up. After two decades in which sterling has not been a driver of interest rate hikes in Britain, it could make an unwelcome return. This is the kind of nostalgia we can do without.

The other point about interest rates post-Brexit is that even if policy rates were cut, actual rates in the economy might well rise, because of the increase in bank funding costs. Carney told me that the Bank would do its best to mitigate such effects by providing liquidity, but even that might not do the trick.

What about interest rates under a Remain scenario? That is easier to address, because it is the assumption on which the Bank has based its new forecasts. There is a view that, once the referendum uncertainty is out of the way, the Bank will feel liberated enough to give serious thought to raising rates. Not immediately – August would be too soon – but perhaps as early as November.

A post-referendum bounce in economic activity would provide the context, while the Bank’s forecast that inflation in two years will be back above 2% would give the justification. Quite a few economists in the City subscribe to this view. Add in one or two more rate rises between now and November from the Federal Reserve and the Bank could see itself as going with the flow.

On the other hand, as noted above, there have bene plenty of opportunities to grasp the nettle on rates in the past few years, and it has gone ungrasped. In its inflation report, the Bank devoted a large panel to the effects of uncertainty, and how they can linger even after the event that has caused the uncertainty has come and gone. The post-referendum bounce in the economy would have to be big and very obvious for the Bank to move. And 2016, for all its other excitements, would go down as another year in which nothing happened on interest rates. In which case, maybe next year?

Sunday, May 08, 2016
Housing: a simple story of supply and demand?
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

Let me take a break from the heat of the Breferendum debate this week and enter the calmer but only slightly less contentious waters of the housing market. Another set of elections have passed, amid ambitious promises to sort out the problems of housing. I think I can guarantee that when these elections are next held in a few years’ time those problems will still not have been sorted out.

Britain’s housing problem is easily described. There is plenty of housing demand but not enough supply. And, while it has been possible to comfort ourselves in recent years with the fact that supply, while inadequate, was moving in the right direction, it now appears that it no longer the case.

In such a situation there is only one outcome, prices will rise and housing will become more unaffordable. It is not unaffordable to the vast majority of existing home owners, most of have substantial equity in their properties and continue to benefit from very low mortgage rates. If housing was unaffordable to the majority, prices would fall.

But the problem of unaffordability impacts particularly on new entrants, the first-time buyers faced with a dauntingly large first step to get on the housing ladder. Hence the renewed interest in the leg-up role of the Bank of Mum and Dad, which according to Legal & General is part-funding at least a quarter of mortgages this year. And hence the return of the 100% mortgage from Barclays, an idea which had apparently perished in the ashes of the banking crisis, though this one comes with more strings attached (in the form of parental support) than was the case then.

Let me start with housing supply. One of the best indicators of supply is provided by NHBC, the old National House Building Council. It provides building guarantees, and all but a fraction of new homes being built are registered with it.

Its latest numbers show that in the first quarter of the year, 36.566 new homes were registered, which sounds reasonable enough but represented a drop of 9% compared with the first quarter of 2015, when 40,144 new homes were registered. There were declines in both private registrations, down 7% on a year earlier and in social housing, down 15%.

That first quarter fall was enough to bring an end, for now at least, in the upward trend of housing supply. For the 2015-16 financial year, a total of 152,329 new homes were registered, virtually unchanged on the 2014-15 figure of 152,262. Mike Quinton, NHBC’s chief executive, said the supply of new homes was “consolidating”, though also pointed to an 80% rise in registrations compared with the lows of 2008-9. It is consolidating in spite of continued support from, for example, the government’s Help to Buy equity loan scheme for new homes. We should, remember, be building around 250,000 new homes each year.

In London, where the housing shortage is most acute, and where the mayoral candidates battled among other things over the provision of 50,000 new homes a year, separate figures from Stirling Ackroyd, estate agents, showed that London boroughs approved just 4,320 new homes in the first quarter, down 64% on a year earlier. Those who are quick at mental arithmetic will have noticed that 4,320 new homes in a quarter represents barely a third of an annual target of 50,000.

New housing is not the only source of supply, as I often point out. What existing homeowners do is also very important. The cycle of trading up as families expand and downsizing when they have flow the nest is part of the essential ebb and flow of a properly functioning housing market. But that cycle, if not broken, is severely damaged.

According to Rics, the Royal Institution of Chartered Surveyors, “lack of supply is still an overriding feature of the market”. While the number of people putting homes on the market is better than it was a few months ago, it remains well below normal. I put a lot of that down to high transaction costs – stamp duty and other fees provide a significant deterrent to move – but there are other factors. Older people wanting to downsize also complain of a shortage of suitable properties.

What about demand? Latest Bank of England figures show that mortgage lending is strengthening. In March lending was up by 3.4% on a year earlier, while its annualised growth in the latest tree months was a robust (by recent standards) 4.7%. A year ago mortgage lending was trundling along at less than 2%.

Some of its recent strength, it should be said, reflects a buy-to-let and second home rush ahead of George Osborne’s imposition of a 3% stamp duty premium on such purchases, which took effect last month. But part of it reflects the underlying growth in demand you would expect in a rising population, and the gradual normalization of the mortgage market. Housing supply, in all its forms, is inadequate to meet housing demand.

We see the consequences of that, of course, in prices. The Halifax, part of Lloyds Banking Group, will provide an update on prices tomorrow but its last bulletin had prices rising at an annual rate of 10.1%.

The official house price index, from the Office for National Statistics, has prices growing at a 7.6% annual rate, but that is still more than three times the growth in average earnings. A glance at the ONS’s long-run chart shows that prices are currently more than 120% higher than in 2002, the base-date for the index, and 20% above their pre-crisis peak. As time goes by the crisis will come to look like barely a blip on the house-price radar.

I said this was a non referendum piece but it would be wrong to ignore the impact of the forthcoming vote on housing. Brexit uncertainties are weighing on the economy, and thus on the housing market. Rics, to quote them again, says that we should look to commercial property for the biggest effects, but that housing will also be affected, with prices pushed lower “in the immediate to short term”.

In the long run, however, it is the fundamentals that will determine what happens to housing. The problem of inadequate new housing supply pushing up prices was, after all, quantified by Kate Barker in her review for the Labour government in 2004. This was before the surge in migration from the rest of the EU and it is a verdict that will survive the end of that surge. Leaving the EU might moderate the long-term upward pressure on house prices but would not remove it.

The problem of unaffordability for those wanting to get on the ladder – and the difficulty of saving for a deposit while renting – will remain. Many people say the housing market is not working. In one key respect, however, it is. When supply is weak and demand strong, prices will tend to rise. That’s what happens in all markets.

Sunday, May 01, 2016
There's no magic money tree if we leave the EU
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

There are two things that even the most casual observer of the EU referendum debate will have heard. One is that we “send” £350m a week to Europe. The other is, in a pattern familiar in politics, those who favour Brexit have come up with various ways in which this money could be better spent, the latest being to settle the junior doctors’ dispute.

If there is one thing I can impress on you as we approach our date with destiny on June 23, it is to expunge that £350m figure from your mind, because it is wrong. That is not an easy thing to do because it is so often said. But ignore any politician who says we send £350m a week to the EU. Tear up any leaflet that makes that claim.

A second thing I would urge is to reject what I would call the crude accountancy approach to Britain’s contribution to the EU budget, or others might term a reductio ad absurdum about this debate. In other words, the effect on Britain’s public finances, or for that matter the balance of payments, will be dwarfed by the wider effects of a decision to leave the EU. The analogy is not perfect, but it is a bit like deciding whether or not to buy a prestigious car on the basis of the cost of replacing the wiper blades. There is a lot more to it than that.

Let me start with the contribution itself. The odd thing about the £350m figure is that it is widely used by many Brexit campaigners who profess admiration for Margaret Thatcher, while conveniently ignoring the EU rebate she successfully negotiated at Fontainebleu in 1984 and which for three decades has reduced Britain’s budget contribution before anything is “sent” to Brussels.

The rebate has outlasted her, and it will outlast the current generation of politicians should Britain remain in the EU. The rebate was worth £4.4bn a year in 2014, the latest full year for which data is available, and averaged of £3.5bn over the period 2010-14. It is deducted from the £17.4bn annual gross contribution over that period.

That is not the only necessary deduction. An average of £5bn a year flowed back to Britain’s public sector during 2010-14, reducing the net contribution to £8.9bn, or £170m a week. Roughly £2bn a year comes from the EU to the private sector in Britain. On this basis, the net contribution over the latest five years averaged £7.1bn a year, £135m a week. In 2014 alone, it averaged £110m a week; less than a third of the claimed £350m.

These figures, I should say, come from correspondence between Sir Andrew Dilnot, the head of the Statistics Commission, the independent statistical watchdog and Norman Lamb, the Liberal Democrat MP who had complained about the use of the £350m figure. Sir Andrew agreed that it was “potentially misleading”, which means it should not be used.

The method in the Brexiteers’ madness may be that, even though they know £350m is misleading, any figure which runs at more than £100m a week is still a very large number. They, in other words, do not mind a debate about it. £110m or £135m a week is a lot of money to most people.

It is, however, small in relation to government spending; well under 1%. Could that money, small though it is in terms of the public finances, be used instead for domestic priorities? The answer to that comes in two parts.

The first is that any post-Brexit trade deal with the EU comes with a bill attached. Both Norway and Switzerland have deals which give them less favourable access to the single market than Britain has now, and no influence over the way single market rules are made. Norway pays only a slightly smaller per capita contribution as Britain.

Switzerland pays less, but misses out on, amongst other things, the financial passporting scheme that Mark Carney, the Bank of England governor, has said is very important for London’s role as a global financial centre. Switzerland would dearly love to have it. Nobody can say what the bill to access the single market would be but it is not impossible that it would be larger than now. The budget rebate would, after all, die with the end of Britain’s EU membership.

Even more important than this is the second key point, which is that any savings on the budget contribution would be dwarfed by the wider economic effects. As foreshadowed here last week, the Organisation for Economic Co-operation and Development (OECD) added its voice to the many warning of the economic costs of Brexit.

Angel Gurria, its secretary general, said Britons would pay a “Brexit tax”, equivalent to a month’s salary by 2020, adding that it would be “a pure deadweight loss, a cost incurred with no economic benefit”. It was an odd way of putting it but I think we know what he meant. Gross domestic product would be 3% lower than under a remain scenario by 2020 and between 2.7% and 7.5% lower by 2030.

As he put it: “While no one knows precisely what the costs would be, what is striking about our estimates and those produced by most others is that all the numbers under a Brexit case are negative. The best outcome under Brexit is still worse than remaining an EU member, while the worst outcomes are very bad indeed.”

On the budget contribution, the OECD’s assessment noted that “net transfers to the EU budget are relatively small, at 0.3% - 0.4% of GDP per annum in the years ahead, and the saving from a reduction in these transfers would be more than offset by the impact of slower GDP growth on the fiscal position”.

Like the assessments of the International Monetary Fund, the Treasury and the London School of Economics, the assumptions used in coming to such verdicts can be challenged. But all are remarkably similar and, in the case of the Treasury like the OECD, imply that far from Brexit helping the public finances by reducing budget contributions, the net effect would be “higher government borrowing and debt, large tax rises or major cuts in public spending”. Tax receipts by 2030 would be between £20bn and £45bn lower.

Some economists are attempting a fightback against what is becoming the prevailing wisdom. Three I know very well – Patrick Minford, a long-term “better off out” campaigner, Roger Bootle of Capital Economics and Gerard Lyons, economic adviser to Boris Johnson – are part of Economists for Brexit, which launched on Thursday. They are in a small minority against the economic mainstream but I shall take their views into account in my overall assessment.

Oxford Economics, which has no axe to grind in the debate, says that even the most benign Brexit outcome - one that does not harm the economy over the medium to long-term - would produce a “negligible” dividend for the public finances.

So the Brexiteers should stop pretending that leaving the EU would suddenly free huge sums to spend on what we like. There is no magic money tree. It is an insult to voters’ intelligence to suggest there is.

Sunday, April 24, 2016
In or out of the EU, we need a euro with stronger foundations
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

There are now just two months to go (two months!) to the referendum and as promised another instalment in my series on the economic issues. So this week, the euro. Do the single currency’s flaws mean we would be better off leaving the EU?

A few days ago the Treasury produced a comprehensive and rather impressive 200-page assessment of the impact of EU membership and the alternatives, taking the economic debate to a new level. I suspect most of its critics either have not read it or did not understand it. This week the Paris-based Organisation for Economic Co-operation and Development (OECD) will be the latest heavy-hitter to warn of the consequences of Brexit.

Even the most sophisticated economic modelling cannot, however, either product or sufficiently allow for disaster and crisis, as we saw in 2008. What if the subsequent near break-up of the euro was just one of a series of damaging convulsions that will be the norm for the eurozone in coming decades?

The euro and I go back a long way. Two decades ago, with my former colleague Andrew Grice, we had the world exclusive on the single currency’s name. Like all great stories, it did not make it onto the front page.

In 1999, my book Will Europe Work? was published, which concluded that the euro, as it had been set up, could not. The euro lacked the conditions of a so-called optimal currency area and would struggle. When it was published I encountered a small army of enthusiasts for early UK membership of the euro. They included Adair Turner, now Lord Turner, when he was director-general of the CBI. He has since admitted that he was wrong to advocate membership. Most of the others have airbrushed it from their memories.

Perhaps the euro advocates were not as out of step as it looks now. In the early 2000s, we started regular polling on the issue with the new (at the time) firm of YouGov. Throughout 2002, the year euro notes and coins were introduced, a majority of British people thought we should either join immediately or when conditions were right.

It is intriguing that, a decade or so after a time when joining the euro, or not, was the hottest topic in British politics – 2003 was the year of the Treasury’s famous five tests exercise – voters should be deciding on whether to leave the EU, something few thought was even the remotest of possibilities back then.

So what of the euro and its flaws and dangers? It is fair to say that the eurozone has been held together, sometimes against the odds, by the extraordinary actions of the European Central Bank. Since Mario Draghi, its president, said in 2012 he would do “whatever it takes” to save the euro, the ECB has run through its armoury of weapons, including most recently negative interest rates and quantitative easing. It has resulted in a return to modest growth and falling - though still very high - unemployment. The euro has held together.

Lessons have been learned. I would be surprised if a crisis of the kind that hit the eurozone in a series of waves between 2010 and 2015 were to repeat itself exactly. That was the time when its banking, sovereign debt and competitiveness crises came together. These were special and unusual circumstances. Glib forecasts of another big impending crisis should be taken with a large pinch of salt.

Even the euro’s best friends would admit, however, that much more needs to be done to make the eurozone secure, and turn it into a monetary union in which more than modest growth is possible.

Some things have been done since the crisis, of which the move towards banking union is the most impressive. But some initiatives, such as the so-called euro plus pact agreed at the height of the crisis, have foundered. Last summer’s “five presidents” report, Completing Europe’s Economic and Monetary Union, set out an ambitious programme, including fiscal union (one of the conditions for an optimal currency area).

But the attention of Europe’s leaders has wandered, to the migration crisis and even Britain’s referendum. Reform of the eurozone still has a very long way to go.

What does that mean for Britain? Both sides of the EU debate would agree on one thing; this country cannot be moved to another part of the world. Proximity is important. When the eurozone slid into a second recession in the 2011-13 period, Britain was affected, despite the attempt of some to portray the slowdown in that period as entirely home-grown.

But Britain’s growth over that period, 2%, 1.2% and 2.2% (2011, 2012 and 2013) was better than the achieved by Switzerland, a non-EU country, and Sweden, like Britain in the EU but not in the euro. I have mentioned before that being inside the EU but sensibly outside the euro has been good for Britain’s relative growth performance. Since January 1999, Britain’s economy has grown by twice as much as Germany and France and 10 times as much as Italy.

Are there enough safeguards to prevent Britain being dragged into future eurozone crises, as and when they occur? As a European country, Britain would be affected, but one key element of David Cameron’s now largely forgotten renegotiation is that the rights of non-euro countries have been given enhanced protection. Britain will never have to participate in eurozone rescues, except as a member of the International Monetary Fund (which would continue to be the case outside the EU).

And, according to last week’s Treasury assessment: “The new settlement provides the basis for stable and sustainable economic governance arrangements. It puts in place a set of legally-binding principles, supported by a new safeguard mechanism, that will ensure the UK is not penalised, excluded or discriminated against by EU rules because it is not part of the euro area. The new settlement recognises that not all member states have the euro as their currency and that the UK should not be forced to participate in measures designed for euro area countries. “

It would be better, of course, if Europe’s leaders were able to move on from the migration crisis and focus on strengthening the euro. Its existence makes life easier for British businesses, while Britain’s non-euro status provides us with the most important freedom in this debate; freedom to pursue an independent monetary policy. And we should not be too gloomy. The euro is here to stay. One way or another, we have to live with it.

Saturday, April 16, 2016
Let's hope it's just fear of Brexit hitting growth
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

The sun has been shining, the birds singing and the days getting longer. But if the economy has a spring in its step it is keeping it well hidden. That squelch you hear underfoot is a soft patch.

The National Institute of Economic and Social Research, which uses official data and other information to calculate gross domestic product a monthly basis, reckons growth slowed to just 0.3% in the first quarter, half its rate in the final three months of last year, and its slowest since late 2012.

The British Chambers of Commerce, in its latest quarterly survey a few days ago, reported that growth had softened in the first quarter, “with most key survey indicators either static or decreasing”.

A similar message has been emerging from the monthly purchasing managers’ surveys compiled by Markit, the information services provider. As Chris Williamson, its chief economist, put it: “Survey data indicate a slowing in UK economic growth in the first quarter, with the suggestion that the pace is more likely to ease further rather than recover in coming months as business confidence remains unsettled by worries at home and abroad.”

In fact, though these things can change, it has been hard to find very much of cheer in the recent numbers. Even consumers appear to have been letting the side down. The British Retail Consortium reported that the value of retail sales in March was flat compared with a year earlier, with so-called like-for-like sales down by 0.7%. It ascribed this “relatively disappointing” picture to the timing of Easter, though in the past Easter has often provided a spending boost.

In some ways, weaker growth is not a surprise. Though the storm has now passed, the first few weeks of the year were characterised by a mood of deep gloom, and some deeply gloomy reporting of it, with markets plunging, the oil price apparently tumbling towards $10 a barrel (it is now in the mid-$40s) and George Osborne warning of a dangerous cocktail of risks. I am not suggesting your average Primark shopper keeps a close eye on the daily gyrations of the FTSE 100 but these things do percolate through to the mood.

Fortunately, too, we have another ready explanation for this period of weaker growth. I am not sure how wise it was for the International Monetary Fund to enter the Brexit debate a few days ago. At a time when at least some British voters are fed up with unelected supranational institutions throwing their weight around, another one sticking its oar in was not necessarily very deft.

I am not sure either that the chancellor should have celebrated that intervention so enthusiastically. The IMF is saying “heightened uncertainty” about the referendum is already hitting the economy and that Brexit itself would be a significant economic shock, with the potential for “severe regional and global damage”, according to Maurice Obstfeld, its chief economist.

But this apparently growth-damaging, risk-enhancing event has been created by the prime minister, with the full support of a chancellor whose long-term economic plan was supposed to take Britain away from danger. In this respect at least, you might argue, the economy would have been safer with Ed Miliband and Ed Balls.

The idea that Brexit uncertainty is to blame for the current period of weaker growth is not confined to the IMF. The Bank of England’s monetary policy committee (MPC) left interest rates unchanged at 0.5% for the 86th month in a row on Thursday.

In detailing that decision the MPC both outlined its view that “a substantial proportion of the recent fall” in the pound reflected referendum uncertainty, and that nervousness about the vote was weighing on growth.

As it put it: "There had been signs that uncertainty relating to the EU referendum had begun to weigh on certain areas of activity. Media references to uncertainty had jumped, though the impact of this on household spending was unclear. The likelihood that some business decisions would be delayed pending the outcome of the vote was consistent with the easing in survey measures of investment intentions, reports of the postponement of IPOs and private equity deals and a softening in corporate credit demand. The fall in commercial property transactions in Q1 had been particularly striking. Thus, there might be some softening in growth during the first half of 2016.”

It will surprise nobody that the Bank will be doing nothing between now and June 23. Whether it has to do anything afterwards, and particularly in the event of a vote to leave, it says it will “use its tools” to respond to what might be “an extended period of uncertainty about the economic outlook”. Osborne has talked about rate hikes but it could include interest rate cuts, even from 0.5%, reluctant though the Bank is to do that, and more quantitative easing, as well as emergency liquidity and other measures.

The EY Item Club, in its latest forecast out tomorrow, is also strong on the Brexit uncertainty point. As its chief economist Peter Spencer discussed here last week, it expects consumer spending to be less buoyant next year. Fortunately – on its assumption of continued EU membership – the cavalry will arrive in the form of stronger business investment.

“With the recent drag from uncertainty assumed to fade, companies are likely to resume their investment drive, putting their healthy balance sheets and high profits to good use,” he says. “This bounce back in business investment should more than offset the slowdown in the consumer sector.”

So we have a story here. The economy has slowed but a large part of that slowdown is due to pre-referendum uncertainty. Once that uncertainty is out of the way with a vote to remain, there will be other things to worry about, including the US presidential election, but growth should rebound.

It is a decent story, but it is not one we can be certain about. There is plenty of anecdotal and survey evidence that referendum uncertainty is having an impact but very little hard data. Recent weakness in manufacturing, exemplified by the problems in the steel industry, reflects fundamental rather than temporary factors, and is not just affecting Britain. Britain, as the IMF reminded us, is still in the process of fiscal consolidation – deficit reduction – with Osborne still hoping for that budget surplus. Global growth prospects, as the IMF also reminded us, have deteriorated a little in recent months.

We should not be too gloomy, but we should also not assume that with one bound we will be free to grow more strongly if there is a vote to remain. Ahead of the Scottish referendum in September 2014 there was a lot of talk of referendum uncertainty weighing on growth. But if there was a post-referendum bounce it was short-lived. In a picture admittedly complicated by oil weakness, the Scottish economy grew by just 0.9% between the fourth quarters of 2014 and 2015. All I can say is it would have been a lot worse with a vote for independence.

Is there a bigger uncertainty effect weighing on UK growth now than there was in Scotland then? We have to hope so, but it is by no means guaranteed.

Sunday, April 03, 2016
Britain would struggle to maintain inward investor appeal after Brexit
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

The referendum on Britain’s membership of the EU is still more than two months away, though the campaign seems to have been going on forever. Given that most election campaigns do not get properly in their stride until the final weeks, I cannot offer any early relief.

Instead, as promised, I will continue my series on the economic aspects of Leave and Remain. Shortly before the referendum, all these will be pulled together in a single piece and a verdict.

So far I have done five pieces. I began last November with trade, pointing out if you leave the EU then, unless you replicate the conditions of membership (including free movement of people and a budget contribution) you lose the single market. There is a lot of misunderstanding about that, mainly because many do not appreciate the difference between a trade agreement and the single market.

At the start of the year I warned, even when talk was of global risks to the recovery, that the referendum represented the biggest threat to Britain, a theme that has since been widely taken up. In February I looked at migration, under the heading economically beneficial, politically toxic.

I also examined in February at how Britain’s relative economic performance had improved since we joined the European Economic Community (EEC), the EU’s forerunner, in 1973. Mark Carney, the Bank of England governor, got into trouble with some Tory MPs for making a similar point. Finally, ahead of the budget, I wrote about how the chancellor would be seeking to emphasise the economic dangers of Brexit, while presenting a safety-first budget to minimise referendum risks. Whether or not he succeeded with the first, he failed with the second.

Today, let me examine another aspect of the economic debate, inward investment into Britain. The starting point, overwhelmingly supported by the evidence, is that EU membership has been good for inward investment, particularly foreign direct investment (FDI), for entirely logical reasons. The question is whether Britain’s attractions for inward investors could be maintained outside the EU.

Foreign companies have been attracted to invest in Britain, over decades, because of the combination of a less regulated and taxed economy and access to the European market. The phenomenon goes back at least as far as the 1970s, and decisions by American multinationals to increase investment when this country joined the EEC.

It accelerated in the 1980s with Japanese car manufacturers – starting with Nissan in Sunderland - establishing operations in this country. It has increased further since the single market began in 1993.

Over this period Britain has regularly been the biggest European recipient of foreign direct investment from outside the EU, though often vying with Germany for top slot. A process that began with America, then shifted to Japan and Korea, has moved more recently to the new economic giants of China and India.

The ‘voice of Indian business and industry’, the Federation of Indian Chambers of Commerce & Industry (Ficci), put it straightforwardly last month. “Britain is considered an entry point and a gateway for the EU by many Indian companies,” its secretary-general said.

Inward investment from distant nations like India creates a lot of attention, and in examples like Tata and Jaguar Land Rover, and much more challengingly in recent days in steel and Port Talbot, deservedly so. But, importantly, about half of the stock of foreign direct investment in Britain is from closer to home: the rest of the EU. Britain is integrated with the EU economy via investment as well as trade.

Let me make one thing clear. EU membership is not the only reason why there is foreign direct investment in Britain. Britain’s attractions include openness, a flexible labour market with pools of particular skills, the English language and the English legal system.

In many cases, such as much-needed foreign investment in Britain’s energy or transport infrastructure, it is hard to see that there would be very much difference whether we were in or out, except to the extent that Brexit reduces future growth prospects.

But it would also be folly to deny that EU membership is an important determinant of inward investment. EY, the accountancy and professional services firm, provides the most comprehensive annual survey of FDI. In its 2016 survey, to be published next month, it will look specifically at the potential effects of Brexit.

In the meantime, we have last year’s survey to go on. It showed a record 887 inward investment projects in Britain in 2014, up 11% on the previous year, and an increased European market share of 20.4%. It also found that 72% of inward investors cited access to the single market as important in their decision.

The question can be asked why, with the referendum on the horizon, inward investment in 2014 was so strong. The answer is that at that time business put a very low probability on Brexit.

What impact would Brexit have? We will await EY’s verdict next month but its rivals PWC had a stab in its work for the CBI, predicting that there would be an overall negative effect on inward investment even if a free trade agreement for trade in goods were to be swiftly negotiated. Service sector inward investment would still be “negatively affected”. The Bank of England, while stressing the many reasons why there has been foreign investment in financial services in Britain, also highlighted the importance EU’s “passporting” regime for banks.

Do we need inward investment? Yes. It makes for a more successful and dynamic economy and, while we are now in the middle of a period of productivity disappointment, foreign-owned businesses have made an important contribution to Britain’s economic performance over decades.

Could steps be taken to maintain Britain’s appeal to inward investors after Brexit? Yes, though some of them would involve a possibly tortuous renegotiation in order to try to re-establish what we already have, and at a cost. Whatever was negotiated in terms of access to the single market would probably not be as good as now. Impressions count, and the impression from afar – let alone from the rest of the EU – would be that Britain had moved from being semi-detached to being detached from the rest of Europe.

In my younger days I used to enthuse about the idea of Britain as the Hong Kong of Europe, free of eurosclerosis, with low taxes and with the most deregulated economy. As I have grown older I have become more realistic. Britain already has among the most deregulated product and labour markets in the advanced world, according to the OECD. There is red tape but much of it is home-grown. Her Majesty’s Revenue & Customs does not get its instructions from Brussels.

As for tax, George Osborne is already aiming for the lowest corporation tax rate, 17%, in the G20. He could aim to reduce it to 12.5%, matching Ireland, but the public finances are still not fixed, and voters – already pretty fed up with what they see as sweetheart tax deals for multinationals – would look askance at tax cuts intended to make life even easier for them.

As well as this, inward investors know that business tax cuts or supposed bonfires of red tape are prey to shifts in the political wind – the next government could reverse them at the drop of a hat – but EU membership and access to the single market have been regarded as permanent. If it ceases to be so, it seems inevitable inward investment will suffer.

Sunday, March 27, 2016
A big rise for the low paid - will it cost jobs?
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

On Friday this week, the biggest government intervention in wage-setting since the introduction by the Blair government of the minimum wage in 1999 will occur.

The national living wage of £7.20 an hour for the over-25s will come into force. It is, curiously, exactly double the original minimum wage of £3.60 an hour of April 1999. More importantly, it is 50p an hour, or 7.5%, above the existing minimum wage of £6.70 an hour.

It seems a long time since George Osborne announced his version of the living wage in his post-election budget last July. Iain Duncan Smith, who had apparently not been told in advance, celebrated with some energetic fist-pumping on the floor of the House of Commons. It was probably the moment of maximum togetherness between the chancellor and the former work and pensions secretary.

Incidentally, there has been far too much excitement about the supposed “black hole” in the public finances following the abandonment of the disability cuts that supposedly provoked Duncan Smith’s departure. £4.4bn between now and the end of the parliament and £1.3bn in 2019-20 does not constitute even a pale grey hole. There are many much larger challenges on the chancellor’s rocky road to a budget surplus, not least the questions of whether he will ever raise fuel duty and the cost of further raising the personal tax allowance and higher rate threshold.

But back to the living wage. It was, in many ways, a curious policy announcement from a Tory chancellor. At the time I noted that had the election turned out differently, and the living wage had come from Ed Balls in an Ed Miliband government, the response might have been quite different. Many in business, and many commentators, would I suspect have said that it was an intervention that showed how little Labour understood how the economy really worked.

Politically, too, what some saw as Osborne’s masterstroke – seizing the centre ground from a wounded Labour party – can now be seen as jumping the gun. At the time, most thought that Jeremy Corbyn’s candidacy for the Labour leadership was a curiosity and that one of the mainstream candidates would win. It was not, so Labour left the centre-ground of its own volition. The chancellor had no need to muscle in to push it aside.

The other thing about the national living wage announcement, which speaks to some of the recent criticism of Osborne’s approach, is that it was deliberately intended to shock and awe. This was the rabbit out of the budget hat. There was thus little consultation ahead of it. Anybody who has read the Low Pay Commission’s deliberations on the minimum wage will know the careful analysis that goes into them, including detailed assessments of the impact on different sectors of the economy.

No such detailed analysis preceded the living wage announcement. Some sectors, including care homes, domiciliary care, cleaning, and parts of retailing, catering and the hotel trade are exposed. Others, except to the extent that they use the services of some of these exposed sectors, are not much affected. When governments have intervened in pay-setting, way back to the wages councils that were eventually abolished in 1993, they have taken into account these sectoral differences.

Even within the affected sectors some will be more exposed than others. Certain employers have taken steps to trim elements of pay, such as overtime rates, ahead of the introduction of the living wage, in order to control the pay bill. Others have embraced it. Whitbread, for example, says it will pay above the national living wage to all its Costa and Premier Inn employees, even those aged under 25 and apprentices. The British Retail Consortium (BRC), on the other hand, cited the living wage as one of the factors in its prediction of 900,000 retailing job losses by 2025.

The most vulnerable employers (and employees) are probably those in the care sector, caught between rising wage costs and squeezed local authority budgets.

So what will happen? One certain effect is that the living wage will provide a significant boost for the lower-paid. A Resolution Foundation analysis, out today, shows that, in combination with October’s rise in the minimum wage, people on the lowest rung of the pay ladder will have seen a 10.8% rise in pay once the living wage comes in this week. That is four times the increase in pay for workers as a whole, and it is not a one-off.

Resolution expects the lowest-paid to enjoy a 5.7% average annual pay rise between now and 2020, compared with a 3.7% workforce average (which looks optimistic). The living wage will, says Resolution, provide an immediate boost to 4.5m workers and “make significant inroads into tackling Britain’s low pay problem”.

Will it cost jobs as the BRC and others fear? The issue came up at the Royal Economic Society’s annual conference at Sussex University last week. If I were to sum up the position among economists who have researched this, always a tricky thing to do, it would be that the adverse employment consequences of minimum wages have been overestimated in the past – job losses were expected to be bigger – and that the same will probably be true of the living wage. The Bank of England, for example, expects it to add only 0.1 percentage points to overall pay growth; not enough to cost many jobs.

But this is an uncertain area. A new survey of economists carried out by the Centre for Macroeconomics, which I take part in and which encompasses the universities of London and Cambridge as well as the Bank and the National Institute of Economic and Social Research, is on this very subject.

It shows that by two to one, 57% to 33%, economists do not expect the living wage to lead to significantly lower employment. More convincingly, by 76% to 11%, they believe it will have only a muted effect on wages and prices across the economy as a whole.

We should not, however, be too complacent. The fact that many economists do think the living wage will lead to sizeable job losses is a worry. So is the fact that, while researchers agree that introducing a minimum wage at an appropriate level and increasing it gradually does not have a big employment cost, the chancellor may be testing that theory to destruction. A 10.8% pay rise for the lower paid at a time of zero inflation is big in anybody’s book.

So Friday sees the start of an experiment. The hope has to be that employers can absorb the increase in wage costs, or neutralize it by achieving productivity improvements. It will be good for everybody is that is also the reality. But that is not guaranteed.

Sunday, March 20, 2016
Why two Osbornes and one Duncan Smith don't mix
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

My initial reaction to Wednesday's budget was that, apart from being the fiddliest I could recall, it would not stay long in the memory. That was before it exploded on Friday evening with Iain Duncan Smith's resignation.

We are four days on from a budget that included 77 separately costed measures – more in a single budget than anybody can remember – as well as some of most obvious and ungainly fiscal gymnastics.

So, I was fully geared up to hold forth on a chancellor more addicted to unnecessary tax tinkering and more prone to using smoke and mirrors to meet his fiscal rules than that legendary exponent of the art, Gordon Brown.

And I was all ready to weigh in an assault on George Osborne for failing so soon in this parliament on two of his fiscal targets; the so-called welfare cap (breached in November and still breached now) and reducing debt as a percentage of gross domestic product every year, which is breached now according to the Office for Budget Responsibility. If this, his eighth budget, were also to be his last because of a Leave vote in the EU referendum, it would not have been a great swan song. It wasn’t even the safety-first budget the referendum had apparently required.

Then, two things happened. One was that plenty of other people immediately weighed in with a similar critique of the chancellor, so there was no point in repeating what is already out there. The other was the surprise resignation of Duncan Smith as work and pensions secretary on Friday evening, ostensibly about cuts to disability benefits. In leaving, he attacked Osborne’s entire approach.

Before coming on to that, I do not want to add to the unjustified gloom that surrounded much of the budget coverage. True, there is a significant referendum risk to growth, described here last week. Otherwise, however, Britain does not look like an economy in all that much trouble.

On the morning of the budget official figures showed a rise of nearly half a million in the numbers of people in work over the latest 12 months. A record percentage of people are in employment and growth in wages has ticked higher.

The biggest surprise in the OBR’s projections was a downward revision of its prediction for government borrowing this year, 2015-16. Instead of the £73.5bn of borrowing it projected in November, and a near-unanimous view among outside economists that there will be a sizeable overshoot, the OBR expects the number to come in at £72.2bn.

It is quite likely too that Osborne’s debt rule, having been broken in 2015-16 on this occasion, will be subsequently found to have been met. The rule was broken, not because of higher debt – it is a little lower than expected in November - but because of lower nominal, or cash, GDP. As the official statisticians get round to revising the GDP figures, most likely upwards, so this apparent failure could revised away.

Similarly, the almost universally downbeat view on growth and productivity – the biggest single economic change underlying the budget – should be taken with an appropriate quantity of salt The OBR responds to the latest data at its disposal. The productivity numbers in the final quarter of last year were thoroughly gloomy, so the OBR gave up the ghost on its previous productivity expectations.

But these are murky waters. Sir Charlie Bean’s independent review of official statistics, the recommendations of which were fully accepted by Osborne, pointed out the challenges of measuring both output (GDP) and labour input (hours worked) in a changing economy and labour market. Productivity growth has undoubtedly slowed since the crisis but the extent of that slowdown is complicated by measurement challenges.

Why is productivity so important for the public finances? As the OBR says: “Lower productivity growth means lower forecasts for labour income and company profits, and thus also for consumer spending and business investment. In aggregate this reduces tax receipts significantly.” If the OBR is right and, as I wrote a couple of weeks ago we should learn to live with weak productivity, we may also have to learn to live with weaker tax receipts than we would like.

This brings me on to my big point. When Osborne misses his fiscal targets, and has to perform contortions with the timing of corporation tax changes and infrastructure spending to keep his target of a budget surplus alive, some of that is due to factors outside his control, including the performance of the global economy. If Britain’s productivity performance has deteriorated then anything that has been done since 2010 to try to fix it – and there is a legitimate debate about whether it should have been more – will not show through until long after this chancellor has moved to pastures new. Supply-side reforms take time.

Some of the missed targets are, however, entirely deliberate. There are two Osbornes; the Jekyll and Hyde of the Treasury. There is Osborne the deficit cutter, harsh and unbending in his determination to slow and eventually eliminate the rising tide of debt. Osborne the deficit cutter wanted to get rid of most (not all) of the deficit by the end of the parliament.

Then there is Osborne the politician who, like all politicians, wants to be loved. He is not, as we have seen in recent days, necessarily all that good at it. This Osborne developed his economic philosophy in the years of plenty. “Sharing the proceeds of growth” between tax cuts and spending was the Osborne and David Cameron call when Labour was in office. It has survived into the era of austerity and big deficits.

A good example is fuel duty. Wednesday marked the sixth successive year in which fuel duty has been frozen. The chancellor is proud of the fact that pump prices are 18p a litre lower than they would have been if the pre-2010 duty escalator had been maintained, and that the average motorist spending £450 a year less on fuel than five years ago (not just because of duties). The cost of this admittedly popular freeze compared with the alternative is at least £6bn this year and cumulatively several times that, according to the OBR. Assuming the freeze continues, that cost will continue to rise. Deficit-cutting Osborne would have had no truck with this; for politician Osborne it was second nature.

Or look at the details of last week’s budget. Faced with a £56bn underlying deterioration in the public finances, the deficit-cutter would have bent over backwards to squeeze more revenue and cuts out of the system, eschewing any giveaways.

Politician Osborne, in contrast, found room for reducing business rates, corporation tax and capital gains tax, and for generous increases in the personal tax allowance to £11,500 next year and in the higher rate threshold to £45,000. Every tax-raiser, such as the sugar levy, was immediately spent. As I sometimes remind people, in his austerity budget of 1981 Lord (Geoffrey Howe) froze allowances and thresholds at a time of high inflation. Osborne prefers to increase them at a time of no inflation.

Politician Osborne may be right. Most voters do not follow the finer details of the public finances. Many do not know the difference between debt and the deficit. They do know when the cost of filling up the car goes up. Holding out the ambition of a surplus is an important signal, drawing the distinction between the Tories and Labour. Achieving that surplus may be less important.

But the Duncan Smith resignation has also exposed the weakness of the “two Osbornes” approach. Had the chancellor stuck to deficit-cutting, eschewing giveaways, the former work and pensions secretary would not have had much of an argument, leaving aside the obvious differences over Europe. Welfare cuts and deficit cuts need to go hand in hand. Because Osborne did not, preferring to splash some of the welfare savings around, he left himself open. It remains to be seen how quickly he can recover.

Sunday, March 13, 2016
Osborne skates on thinner ice as Brexit fears hit growth
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


When George Osborne started thinking about his eighth budget a few weeks ago he probably knew that by the time March 16 came around the EU referendum battle would be in full swing. That did not, however, stop him pushing ahead with ambitious plans to reform the way pensions are taxed, with his preference for a wholesale switch to a so-called pension ISA (individual savings account).

We know now that this will not happen, or at least not this week. Fear of doing anything potentially unpopular in the run-up to the referendum, as changing the existing system of tax relief would have been, led to the plans being shelved. There had been murmurings from Tory MPs.

Chancellors are supposed to do unpopular things in the interests of the longer-term good of the country. Osborne is finding it difficult to do so, particularly since the election. We may look back on the 2010-15 coalition as a model of stable government, certainly in comparison with what has followed.

Tory MPs have discovered their power. It only takes 30 or so of them, sometimes less, to force a retreat. That, more than the chancellor’s political opponents, forced the U-turn on cuts to tax credits last November. Tory MPs, by voting against the government, helped defeat plans to relax Sunday trading laws. There is a gathering revolt against a fuel duty rise this week, a rise that is counted in the government’s fiscal calculations. With dozens of Tory MPs openly campaigning against the EU stance of the prime minister and chancellor, this is turning out to be a chaotic government.

Osborne is quite good at pulling rabbits out of the hat, even if often on closer examination they turn out to be tiny kittens, so do not discount the possibility of a populist surprise or two this week. Even if there are, however, the chancellor will not want to let the moment pass without issuing stark warnings against the dangers of a vote to leave the EU.

Saying anything that suggests leaving the EU will have negative consequences and that membership has benefited Britain is tricky territory, as Mark Carney discovered a few days ago. The Bank of England governor can look after himself but when faced with attacks by oddball Tory MPs and an out-of-control “big beast”, the former chancellor Lord Lawson, there must have been moments when he wished he was back in Ottawa.

Jacob Rees-Mogg, the Tory MP for North East Somerset, accused him of making “speculative” pro-EU comments that were “beneath the dignity” of the Bank. Peter Bone, his Wellingborough colleague, said Carney should consider his position and drew the contrast between the Bank governor and John Longworth, the “Brexit martyr” who resigned as chief executive of the British Chambers of Commerce (BCC) after speaking out at its annual conference.

MPs have sunk low in recent years but this really was scraping the barrel. Carney was not speculating but accurately reflecting the view of his institution, as set out in its carefully-researched report last October, EU Membership and the Bank of England, which provided extensive evidence that trade openness with the EU, inward investment to access the single market and free movement of labour “reinforces the dynamism of the UK economy”. Longworth, in contrast, deliberately went against the agreed position of the BCC, the organisation he was paid to run.

Lord Lawson was even worse. Suggesting in a BBC interview that Carney was driven by the desire to curry favour with Goldman Sachs, his former employer, and get a good job there when he steps down from the Bank, was beneath the dignity of a former holder of the office of chancellor.

Fortunately for Osborne, one accusation that was levelled at Carney, that he was guilty of wading into politics, cannot be legitimately directed at him. The chancellor is meant to be knee-deep in politics, though sometimes he is up to his neck in it.

The chancellor has promised a full Treasury analysis of the costs and benefits of leaving versus staying in the EU, though the only guidance on timing is that it will be published between now and the referendum. One thing that would help frame the debate, an Office for Budget Responsibility forecast showing the outlook for the economy and the public finances on “In” and “Out” is, officials say, outside the OBR’s terms of reference. It can only forecast on the basis of government policy, which is to stay in the EU.

It is, however, generally accepted that Brexit would be a negative shock for the economy. The long-term consequences or leaving can be debated. In the short-term it would, as the prime minister put it in a speech last week, cost growth and jobs.

As a report last month, London: The Global Powerhouse, commissioned by Boris Johnson, the pro-Brexit mayor of London, put it: “Leaving the EU would be an economic shock. Most, if not all, economic shocks depress economic activity. Thus economic forecasts that focus on, say, a couple of years ahead would tend to show that leaving the EU is always worse than the alternative.”

How big a short-term negative shock might there be? Kevin Daly, UK economist at the aforementioned Goldman Sachs, says that there would be “a damaging uncertainty shock for the UK” which could be prolonged. “Business investment accounts for 10% of UK GDP,” he writes in a special report. “A collective decision to pause a significant share of this spending would be materially negative for UK output.”

ABN-Amro, another investment bank, says Brexit would push Britain’s GDP down by between 1% and 3% next year. An effect at the upper end of that range would push the economy back into recession. Societe Generale, in a new report, says Britain’s growth would be reduced by between 0.5% and 1% for a period of 10 years.

A bigger concern than these effects on GDP, which can never be precisely measured, would be if things really got out of control. That is why Carney announced measures to see the financial system through a Brexit shock, if it occurred. Even that might not be enough. Berenberg Bank warns that a crisis in the second half of the year would follow a vote to leave. Neil Williams, chief economist at Hermes, the investment managers, thinks the Bank of England would be forced into another round of quantitative easing, last undertaken four years ago.

This is where it gets interesting, and where useful anti-leave ammunition for Osborne could turn into something more dangerous. The public finances, as the chancellor often reminds us, are still not fixed. He is likely to announce further action this week to restrain spending over the medium-term.

Even without a Brexit vote he is heading for a £50bn borrowing overshoot over the next five years compared with the OBR’s November forecast, according to a new analysis published today by PWC. It will not be surprising, given the downward revision of so-c alled nominal GDP since November, if the OBR has presented the Treasury with similar numbers.

With Brexit, borrowing could easily shoot up to more than £100bn annually, creating powerful echoes of the crisis of a few years ago, and fatally undermining Osborne’s efforts to restore the country to fiscal health.

The chancellor has been steering a fine line between keeping the markets and international investors happy with deficit reduction and not killing the recovery with excessive austerity. A Brexit vote, or even the heightened fear of it, could mean that he has been skating on very thin ice.

Sunday, March 06, 2016
Let's relax and learn to live with low productivity
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

We all need a break from the referendum this week, so I will provide one here. The only thing I will mention in passing is the question of whether Brexit fears are already weakening the economy as they have weakened the pound.

Brexit uncertainty is one factor cited by Markit, which produces the monthly purchasing managers’ surveys, all three of which (manufacturing, construction, services) weakened last month. If Brexit is indeed a factor in what looks to be a slowdown, it plays both ways.

The Remain camp will say it shows anticipation of how the economy will suffer if we leave. The Leavers will argue that it is not Brexit fears hitting growth but wider worries about the global economy. The rest of us might conclude that a government that says we should not take risks with the economy has itself introduced risk by holding the referendum.

Anyway, it is another area of weakness I want to address this week; productivity. Britain’s poor productivity performance has been one of the stories of the post-crisis period. Productivity – output per hour or output per worker – is the lifeblood of the economy, the source of all our prosperity. In the famous phrase, “productivity isn’t everything but in the long run it is almost everything”.

But if productivity is almost everything, in recent years it has not been very much at all. Output per hour across the whole economy has crept above its pre-crisis level, but only just. In the latest figures last year it was 1.6% higher than in early 2008. That, however, was nothing to celebrate. The Office for National Statistics points out that had it kept up with the pre-crisis trend it would be 13% higher than it is.

I should say at the outset that plenty of business people dispute the extent of the productivity gloom. My colleague Dominic O’Connell encountered such scepticism at a high-level dinner a few days ago. The EEF, the engineering employers, published a major report on productivity recently which found that for many in industry, official measures of productivity are poorly specified and poorly measured. Economists at Legal & General, in a new report, say official statisticians are “failing to capture the revolution in distributed networking and cloud computing”.

But, staying with the official numbers, a large chunk of potential productivity growth has been lost, apparently never to be regained. Even now, while output per hour is rising, it is doing so at barely half the rate that was the norm before the crisis. The picture for output per worker, another productivity measure, is, if anything, even more muted as a result of the strength of employment growth. The latest figures had it just 0.7% up on pre-crisis levels. If it had grown as fast as in the seven years leading up to the crisis it would be 14% up.

If you want to get really depressed about productivity, meanwhile, look at the comparisons with other countries. Official figures last month showed that output per hour in Britain in 2014 was 18 percentage points below the average for the rest of the G7 (America, Germany, Japan, France, Italy and Canada).

Worse, Britain appears to be doing appallingly badly in comparison with our near neighbours. French output per hour is 31% higher than Britain’s. In the case of Germany, the gap is a whopping 38%. The British disease, once characterised by too many strikes and tea breaks, appears to be back. How worried should we be?

In terms of the international comparisons, there is not a lot to the proud of, but the picture is not as black as it first appears. German and French workers have much shorter average working weeks than their British counterparts, 26.4 and 28.3 hours respectively, compared with a British average of 32.3.

Some of that is explained by legislation, some by the part-time, full-time split. But it means that if we take an alternative measure, output per worker, then Germany is a more manageable 11% higher than Britain, and France 15%.

There is another comparisons produced by the Office for National Statistics. This, a constant price productivity measure, suggests that Britain achieved significantly stronger growth in output per hour in the 10 years leading up to the crisis, and somewhat weaker since. Britain is behind, but on this measure by only a few percentage points.

The bigger question is how worried we should be about the weakness of productivity which, in the post-crisis period, has not been just a British affliction. The point has often been made in recent years, including by me, that strong employment growth has been a price worth paying for weak productivity but that it cannot go on forever.

Now I wonder, both whether lower productivity is temporary and also whether we should be that worried about it, a suggestion that is almost sacrilege in economic circles.

Many years ago, in the 1980s, when the world was looking to Japan, both as a tough competitor and a model economy, international productivity comparisons showed up something very curious. Despite its fearsome reputation Japan’s productivity was lower than the other big industrial countries, including Britain.

Japan, in those days and indeed now, combined high levels of productivity in the export-facing sectors it needed to compete, including manufacturing, with low productivity across large swathes of the rest of the economy, including much of the service sector and agriculture. Japan combined a high degree of competitiveness with a high employment, indeed virtually full employment and a lifetime system of job security.

Japan is no longer a model to follow in a general sense, but its productivity approach has a lot to be said for it. Combine high productivity in export-facing sectors such as manufacturing and internationally-traded services with low productivity across a whole range of domestic service industries and you end up with something that, if not ideal, is not bad. Having the most productive hairdressers in the world will not necessarily help Britain compete.

Low-productivity services, of course, imply low wages, or else there would be an inflationary threat. But they also imply high employment.

What about the sectors in which we need to compete? The EEF notes that manufacturing productivity has grown at twice the rate of the rest of the economy, and of services, over the past 20 years. Its chief economist Lee Hopley, noting that good data is hard to come by, cites figures showing that Britain’s manufacturing productivity grew faster than Germany, France, Italy and the Netherlands in the five years straddling the crisis. But there is work to be done – a lot of it – to make manufacturing more productive.

As for internationally-trade services, the picture is mixed. Productivity growth in financial services has gone into reverse since the crisis, while business services continue to perform pretty well. Across the services where Britain is strongest, there is no reason for complacency but none for deep gloom either.

Productivity matters, but it matters more in some sectors than others. It is those sectors in which government should direct its efforts. And it is in those sectors – not everything – we should worry when we fall behind.

Sunday, February 28, 2016
Inside the EU, we whistled a happier tune
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

History does not necessarily repeat itself, but it is a long way from being “more or less bunk” as Henry Ford famously put it. History looms large in the politics of the EU referendum. Now, as 40 years ago, we have a prime minister trying to sell his renegotiation to voters, while presiding over a divided cabinet. For David Cameron, read Harold Wilson.

There is also useful history in the economics of Britain’s relationship with Europe. Campaigners for Brexit look to a future in which Britain is disentangled from the constraints of the EU and free to forge new and stronger economic relationships with the rest of the world. I shall have a look in more detail what this might mean between now and June 23rd.

Before that it is worth reminding ourselves of that tangle-free world, because Britain has been there before. In the 1950s and 1960s, while the original six members of the EU were forging ever closer economic relationships, beginning with the coal and steel community and then the European Economic Community (EEC), Britain ploughed a very different furrow.

By staying out of the talks leading to the establishment of the coal and steel community in the early 1950s because, in the words of Herbert Morrison, Labour’s deputy prime minister (and Peter Mandelson’s grandfather), “the Durham miners won’t wear it”, Britain had already demonstrated a hostility to European integration. It was no great surprise when the EEC, created as a result of the Treaty of Rome of 1957, and starting in 1958, did not include Britain among its original members (Germany, France, Italy, Belgium, the Netherlands and Luxembourg).

While Europe was busy integrating, the world was Britain’s oyster. Where there had once been the Empire, on which the sun never set, now there was the Commonwealth. There was the special relationship with America. There were opportunities well beyond the narrow confines of the EEC.

The world, however, was not enough. Commonwealth countries such as Australia and South Africa, far from being happy to be easy markets for British exports, wanted to develop their own industries and imposed tariff barriers against the mother country. India was heavily protectionist from the time of independence in 1947.

As a result of this and other factors, Europe’s grass started to look a lot greener. Britain’s economic performance in the 1950s and 1960s, while reasonable in comparison with later decades, was poor in relation to the EEC pioneers. Germany and France had a lot more catching up to do after the devastation of the war but, even allowing for this, achieved growth well in excess of Britain.

In the period 1950-73, sometimes known as the golden age, gross domestic product per head rose by an average of 2.4% a year in Britain, 4% in France and 5% in Germany. By 1960, Germany was once again producing more cars than Britain and had secured a bigger share of world trade.

Having sampled life outside, successive British governments wanted in, and desperately. Having tried a smaller alternative to the EEC, the European Free Trade Association (EFTA), established in 1960, Britain applied, and was rejected for EEC membership, in 1963 and 1967, before being finally admitted at the start of 1973. Envy of Europe went deep. The 1964-70 Labour government, under Wilson, consciously and unsuccessfully tried to imitate France’s successful experiment with economic planning.

The politicians of the 1960s and early 1970s were not daft. Having lagged behind growth in the EEC prior to membership, Britain caught up and then overhauled the original six. Their growth became no longer a cause for envy. Growth rates slowed everywhere after the golden age, but Britain’s relative performance improved. Plainly not all of this was due to being in the EEC. Clearly, some of it was.

Joining the EEC was a considerable economic success, according to a new paper The Growth Effects of EU Membership for the UK: A Review of the Evidence, by the noted economic historian Professor Nick Crafts of Warwick University.

“Membership has raised UK income levels appreciably and by much more than 1970s’ proponents of EU entry predicted,” he writes. “Joining the EU raised the level of real GDP per person in the UK compared with the alternative of staying in EFTA. The deeper economic integration EU membership entailed increased trade substantially and this had positive effects on income.” His calculations suggest that the positive economic effects of membership have outweighed the cost of Britain’s EU contributions and red tape by a factor of about seven to one.

The world was different in 1973 when Britain joined the EEC, and 1975, when we had a referendum, comfortably won, on whether to remain in. Many people who did have a vote in 1975, and some who did not, claim that the country was conned, that we voted to join a common market and ended up with ever closer union, migration and a single currency on our doorstep.

It is true that at the time of the 1975 referendum the government chose to emphasise the trade aspects of membership to the exclusion of almost everything else. But freedom of movement and equal treatment of people were part of the Treaty of Rome, though in the 1970s most people expected the flows to be from Britain to Europe, not the other way around. The subsequent TV series Auf Wiedersehn Pet was about British migrant workers in Germany.

As for the single currency, when Ted Heath began his successful entry negotiations, the EEC was still officially on course for monetary union, the Werner Report of October 1970 having set the target of achieving it by 1980. It took a further two decades but Europe’s intentions were pretty clear.

A stronger point is that Europe has changed in 40 years. No longer do we envy our European partners their growth, although I find that many people I talk to still have a lot of envy for Germany, and even France. The world has changed too, with the rise of China and other emerging economies. Trade is freer, for goods, if not yet enough for services, though Britain is making great strides: service-sector exports doubled between 2006 and 2014.

The question which I will address in the coming weeks is whether things have changed enough for life to be better outside. Does our EU membership prevent us taking full advantage of the wider world, or is that an escapist fantasy? Germany has been a notable success, from within the EU, in selling to the world. Only China and America, with much larger populations, export more. A few decades ago we found that life outside Europe was cold. The question is whether it would be any warmer now.

Sunday, February 21, 2016
EU migration: economically beneficial, politically toxic
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

It is the biggest and most toxic issue in the referendum debate, central to the deal concluded by David Cameron late on Friday. It is the one in which emotions run highest. I am talking about immigration, safe in the knowledge that whatever I write today plenty of people will disagree with me.

Immigration from the rest of the European Union to Britain has got caught up in the public mind, wrongly, with the EU migrant crisis; the flood of asylum-seekers from Syria and elsewhere making their way across Europe and threatening the EU’s open borders, the Schengen agreement. Britain, of course, is not part of that agreement and never likely to be.

But figures this week will confirm that “normal” net migration into Britain – the number of immigrants minus the number of emigrants – is at or close to all-time highs. Thursday’s figures, covering the period to September last year, are set to show a rolling total similar to the 336,000 for the 12 months to June 2015, which was a record.

The figures will provoke a row, again making a mockery of David Cameron’s always unachievable 2011 “no ifs, no buts” pledge to reduce net migration to the tens of thousands. Before getting into the arguments, let me provide a little more detail on the previous set of numbers.

The 12-month total to June last year comprised 636,000 immigrants and 300,000 emigrants (many previous immigrants). Of the 636,000, 294,000 came to work, 192,000 to study, and 80,000 accompanied or joined other family members.

Just as there is confusion over migration and the asylum crisis, so there is a widespread assumption that immigration into Britain is overwhelmingly from the rest of the EU. That is not the case now, nor has been true at any time in the 43 years of Britain’s EU/EEC (European Economic Community) membership.

In the 12 months to June 2015, EU net migration to Britain was 180,000, non-EU migration 201,000. If you think that does not add up to the 336,000 net migration total you would be right. The circle was squared by 45,000 of net emigration by British citizens (much of it to the rest of the EU). That continued a long-term trend. In only one year in the past 40, 1985, has there been no net emigration by British citizens.

Immigrants from the EU tend to come to Britain to work. They accounted for at least 162,000 of the 294,000 migrants coming for work reasons. Non-EU migrants, in contrast, are more likely to come to study – 131,000 out of 192,000 – or for family reasons; at least 45,000 out of 80,000.

What about the impact of EU migrants on the job market? Separate labour market figures released last week showed there are now 2.04m non-UK nationals from the rest of the EU working in Britain, about double the number from the rest of the world. In the latest 12 months (between the final quarters of 2014 and 2015) there was a 215,000 rise in employment for EU migrants – two-fifths of the total rise in numbers in work. These were the figures that caused apoplexy on some front pages on Thursday.

Is immigration from the rest of the EU good or bad from the economy? As a thought experiment imagine what the impact would be of waving a magic wand and increasing the working population by hundreds of thousands of mainly young, mainly skilled and mainly educated people. You would expect the economic effects to be beneficial and you would be right.

Studies have consistently found that EU migration provides a fiscal boost, not a fiscal drain, including a much-quoted November 2014 University College London study. EU migrants, on average, pay more tax than they receive in public services or benefits. Notwithstanding a central aspect of the prime minister’s EU renegotiation, migrants mainly come to Britain to work, not to claim benefit. If there is a problem with in-work benefits, including tax credits, the fault lies with the design of the system.

A Home Office review of the evidence two years ago found that EU immigration does not adversely affect native employment during normal times. Only when the job market is weak, such as in 2008-9, is there an adverse effect.

What about pay? A Bank of England working paper last year by Steve Nickell and Jumana Saleheen found that immigration has a small negative impact on average wages, though there was no difference in the impact on earnings of EU and non-EU migrants.

Though other studies have suggested no impact on wages, that conclusion does not seem logical. The effect of immigration is to provide an ongoing boost to labour supply. That means more slack in the job market and at the margin less upward pressure on wages.

But such effects should not be overstated. The overlap between the jobs EU migrants do and those British workers want to do is much less than commonly thought. As Jonathan Wadsworth of the London School of Economics put it in a recent paper, new migrants are much more likely to be close job market substitutes for existing migrants than native-born workers.

I wouldn’t want to use the Pret A Manger close to our offices as typical of the labour market as a whole, but it appears be entirely staffed by young, largely EU, migrants. The availability of migrants for work almost certainly increases employment, currently a record 74.1% of the workforce.

We do not know is what might happen in the long-term if EU migrants stay permanently rather than returning home. Younger workers who stay eventually get old, and the positive contribution they make to the public finances evens out over time. One indicator of that would be if EU migrants were choosing to apply for UK citizenship in large numbers. So far that does not appear to be happening. Poles are remaining Poles: there are 853,000 people of Polish nationality in Britain.

There are swings and roundabouts in EU migration but the evidence points to the economic benefits comfortably outweighing the costs. Why then is migration such a politically toxic issue, the big potential swing factor in the referendum?

One factor, plainly, is the speed of change. Until the mid-1990s there was virtually no net migration from the rest of the EU. Since then there has been lots. In 10 years from 2004 to 2014 the number of EU nationals in Britain rose from just over 1m to nearly 3m. From 1997 to 2015, the proportion of employment accounted for by non-UK nationals rose from 3.8% to 10.2%, driven by EU migration.

Another factor is the uneven concentration of EU migrants. In some areas migrants put intense pressure on schools and public services. Across much of the country migrant-driven population growth exacerbates the housing shortage. Add to that the fact that the losers from migration, perhaps from being squeezed out of housing provision or low-skilled job opportunities, feel those losses much more keenly than those who benefit from economic gains spread across the population.

But those who oppose immigration should not be played for fools. If we left the EU tomorrow there would still be large-scale net migration to Britain. Non-EU migration, which is substantial, would be unaffected. Some EU migration would continue. But business would find it harder to recruit the skilled and productive workers it needs, and gaps in the job market would go unfilled. EU migration both reflects and contributes to Britain’s flexible and successful labour market. Economically, we would lose out.

Sunday, February 14, 2016
Osborne's budget surplus starts to look like a distant dream
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

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

Every recording artist is familiar with the idea of the difficult second album – the tricky follow-up to a successful debut – as is every author of a bestselling first novel. Now George Osborne is experiencing the equivalent, in what so far is proving to be a difficult second term.

To be fair, not all of the chancellor’s first term ran smoothly. The low point was 2012 and the “omnishambles” budget, and there were others. But, as he prepares for next month’s budget, his fourth big set-piece event in 12 months (three budgets and an autumn statement/spending review), even his best friends would admit that things are not going that well. What might have been his golden age – a Tory chancellor in a Tory-only government – is proving a bit of a headache.

Osborne’s U-turn on cuts to tax credits in his autumn statement may have been politically necessary, but it was embarrassing. Another U-turn may be looming over planned reductions in the amount of public money, so-called Short money, opposition parties receive.

Tumbling stock markets, which have taken on a slightly more sinister turn with the sell-off in banking shares, have forced the postponement of the sale of the government’s remaining stake in Lloyds Banking Group, a sale once intended to recapture some of the privatization spirit of the 1980s.

Growth forecasts are being revised down. Both the CBI (down from 2.6% to 2.3% for this year) and the Bank of England (down from 2.5% to 2.2%) predict continued recovery, but at a slower pace. A 1.1% drop in industrial production in December, announced last week, owed much to the effect of exceptionally mild weather on electricity and gas demand but added to the softer growth tone. The chancellor’s “dangerous cocktail” of risks he referred to last month is having an impact. There is also a tricky EU referendum to negotiate.


The biggest question, perhaps, arises over what is central to Osborne’s chancellorship, his aim of eliminating the budget deficit and leaving a legacy of permanent surpluses. Having planned to eliminate most of the deficit in the last parliament and not succeeded, he moved on to the more demanding target of achieving a budget surplus by the end of this one, and keeping it there.

Recent days have seen one of the biggest events in the fiscal calendar that does not involve the chancellor, the Institute for Fiscal Studies’ annual green budget. The IFS, which is always fair, warned that Osborne is “boxed in by his own rule” (that of achieving a surplus) and “has to pull off a precarious balancing act”.

The all-party House of Commons Treasury committee, which will shortly publish its assessment of the autumn statement and spending review, is also set to criticise Osborne’s fiscal rule, while pointing out that the tax burden in rising as a result of measures such as the apprenticeship levy and the tax attack on buy-to-let landlords. Ahead of the election the chancellor had promised to finish the job of deficit reduction by restraining spending, not raising taxes.

The IFS is right to say that budget surpluses are rare – there have only been eight in Britain over the past 60 years – but wrong to point to a £7bn “black hole” in forecasts for the public finances over the next five years, caused by weaker project growth in earnings and the recent stock market fall.

Its economists know as well as I do, that £7bn in the context of the public finances at the end of the decade is the equivalent of loose change. The path of the budget deficit over the next few years will not be determined by what has happened to the stock market over the past few weeks.

Where the IFS is right is to point to the difficulties of achieving a budget surplus while simultaneously reducing some significant taxes. Osborne aims to increase the personal income tax allowance to £12,500 (from £10,600 now), while also increasing the higher rate threshold. These pledges are so far unfunded. The sums on which the official public finance projections are based assume fuel duties will rise in line with the retail prices index – not the more gently rising consumer prices index – something that the chancellor last did five years ago. Our business-friendly chancellor is bent on cutting the main rate of corporation tax to 18%, the lowest in the G20, even though the main challenge with this tax is getting companies to actually pay it.

This, perhaps, is the nub of the problem. There is nothing wrong with setting a target of achieving a budget surplus in normal times, rare while that might have been in the past. It does not mean starving the country of necessary infrastructure spending: that depends on how much you raise in tax and how you divide up public spending. It does mean you reduce the public sector debt burden more quickly, which after the huge budget deficits of recent years is no bad thing.

Where there is a problem, particularly if you have a chancellor with a populist eye on succeeding David Cameron as prime minister, is trying to combine expensive and supposedly popular pledges, including raising the inheritance tax threshold on family homes to £1m, with the hard job of eliminating the budget deficit. The two may be incompatible.

A few days ago we had a rare speech from Sir Nick Macpherson, the outgoing Treasury permanent secretary, its top official. Normally those in his position adopt a Sir Humphrey-like vow of silence.

He was responding to criticism that the Treasury should have been more Keynesian in its approach in recent years, and less obsessed with getting the deficit down. I agreed with most of his speech, particularly what he described as the “asymmetry” of policy by governments, which find it much easier to relax fiscal policy than tighten it, and to run budget deficits rather than surpluses. I also agree that most economists underestimated what a tightrope Britain was running with the very large budget deficits of a few years ago, and how close the country was to a full-blown fiscal crisis. Sir Nick was weaker on the absence of “shovel ready” infrastructure projects which the government could have spent money on. A government determined to spend more on infrastructure should by now have overcome planning and bureaucratic delays.

In 2009 and 2010, some of Sir Nick’s Treasury colleagues were worried that Gordon Brown, if re-elected, would not have the stomach or the desire to push through the necessary measures to get the deficit down.

Now, they are entitled to wonder whether the same is true of Osborne, or whether populism will win out over eliminating the deficit. A test will come next month. With oil prices hitting new lows, there has never been a better time to start increasing excise duties on petrol again, albeit in the knowledge that it would certainly generate negative headlines for him. Osborne should forget popularity, which may in any case be a lost cause, and do the right thing.

Sunday, February 07, 2016
Britain should never join this negative interest rate club
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

Negative interest rates are in vogue. The Bank of Japan a few days ago joined a club which includes Switzerland, Denmark, Sweden and the European Central Bank (for one of its key rates) in pushing the interest rate dial below zero. Three of the world’s biggest central banks have negative rates. I shall come on to the Bank of England in a moment.

After a long period in which interest rates have been close to zero and central banks have engaged – and in some cases are still engaging – in large-scale quantitative easing, it appears that it is still not enough. At least five central banks think negative interest rates are now necessary. Could they ever become the norm?

Negative interest rates are still a strange phenomenon. The idea that anybody should pay for the privilege of depositing funds runs counter to the normal rule of “time preference”, that any rational person, or business, would rather spend now than later. The usual way of dissuading them from doing so, in other words encouraging them to save rather than spend, is an interest rate incentive. We will defer consumption if it is worth our while. That is how it works.

Central banks are different. The interest rate they typically set is on the reserves commercial banks hold with them. In most cases, commercial banks have to hold at least some of those reserves, for prudential and other reasons. They are, in that sense, a captive audience – up to a point.

As Paul Sheard, chief economist at Standard & Poor’s puts it: "Central banks can do this because they get to determine the total amount of liabilities they issue, giving them the unique ability to set both quantity and price. In the real economy, borrowers can't usually force lenders to lend to them.”

So, even in countries which have adopted negative interest rates, ordinary savers are unlikely to have to pay for the privilege of putting their money in the bank, though that may be of small comfort to those who have been enduring near-zero returns for years.

What is the point, then, of negative rates? When the Bank of Japan, or another central bank reduces rates below zero, it is trying to do two things. It is sending out a signal to the markets that whatever expectations they may have of future interest rate rises, they can revise them down. And, by penalising commercial banks – effectively taxing them on their deposits at the central bank – it is hoping that they will use any excess reserves (those above what are required by the regulators) will be used more productively; lending them into the real economy.

Negative rates are, as I say, still a strange idea. In the crisis, and in the post-crisis period, we have, to paraphrase Lewis Carroll, got used to believing many impossible things. This is just the latest.

It is perhaps not so strange when we think about the “real” interest rate; the interest rate adjusted for inflation. A negative “real” rate has been the norm for many years. Rates set by central banks have been well below inflation since the crisis hit.

In Britain in the period since Bank rate was reduced to 0.5% in March 2009, consumer price inflation has averaged 2.4%, implying an average negative real interest rate of almost 2%; -1.9% to be precise. At its worst, during 2011, real interest rates were negative by almost 5%.

Logic would suggest that if a negative real interest rate averaging nearly -2% has been needed to generate recovery over the past seven years then, at a time when inflation is close to zero – and set to remain so for some time – real interest rates might currently be too high.

So, while inflation of 2% or so allowed the Bank to pursue a negative real interest rate strategy by stealth, zero inflation could mean it has to do so in an upfront way. Actual, or what economists would call nominal interest rates, might also need to be negative, perhaps significantly so.

Logic can only take us so far in this, however. There are important practical and symbolic differences between a negative real interest rate achieved when both rates and inflation are positive, and a negative real rate that can only be achieved by cutting below zero. Even then, as noted above, a reduction in general rates throughout the economy would provide a powerful incentive for everybody to keep everything in cash. This was the conundrum addressed by Andy Haldane, the Bank’s chief economist, when he mused a few months ago that negative rates might require the abolition of cash.

So what of the Bank? It, and its governor Mark Carney, tried to be both dovish and hawkish on Thursday, with the publication of the quarterly inflation report. The dovish signal was that the only member of its monetary policy committee (MPC) to have been voting in recent months for a rate rise, Ian McCafferty, has thrown in the towel, for now at least.

The hawkish signal was that the MPC think markets have got ahead of themselves. Ahead of Thursday they were pricing in a 30% chance of a cut in rates, with no increase until 2018. The MPC, Carney said, has not even discussed the possibility of negative interest rates, and believes rates will need to rise to hit and maintain inflation at the 2% target. Not yet, but they will go up. Pressed repeatedly on rate cuts, the governor batted the suggestions away.
This is, as Bank-watchers know, no guarantee but it looks to be a pretty firm stance. The Bank is not even flirting with joining the negative interest rate club. It does not intend to turn Japanese.

That is good news. Britain’s economy is strong enough not to need further monetary help, even with the Bank’s modest trimming of its growth forecast. And, having argued a couple of weeks ago of the dangers of leaving rates too low for too long, I am not now going to argue that they should be cut, let alone go negative. To reprise one of the arguments then, a good way or persuading people and businesses that something must be badly wrong, thereby hitting confidence, would be a negative interest rate. This a club to which we do not want to belong.

Sunday, January 31, 2016
Confidence and a brighter eurozone argue against a Brexit vote
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

We do not yet have a date, and we do not yet have much of a campaign, but the referendum on Britain’s membership of the European Union is slowly looming into view. Moreover, it is already starting to affect the markets.

An opinion poll a few days ago which appeared to offer a greater probability of “Brexit” weighed on the pound. City economists, responding to requests from clients, are busy penning notes both on the effects of referendum uncertainty on the economy and the consequences of a vote to leave if it were to happen.

There will be time to consider these things in the coming weeks. Today, however, to continue my planned programme of pre-referendum pieces, let me address another aspect to the European question.

The euro is the pinnacle, so far, of European integration, and it is the fault-line on which many of the continent’s problems rest. Badly designed, open to too many countries too soon, it brought Europe to the brink of a crisis a few years ago that could have been at least as big in its impact as the banking crisis of 2008-9.

That should have been a wake-up call for Europe’s leaders. So far, however, they have been content mainly to kick the can down the road rather than pick it up and redesign it. The fundamental problem of the eurozone remains. It is not what economists call an optimal currency area. There is no central Treasury, or properly co-ordinated fiscal policy, to offset the power of the European Central Bank. Eurozone labour markets, and wages, are inflexible. And, contrary to what you might think from your TV screens, there is not enough mobility of labour within Europe.

There is a second issue about the eurozone, and it is one that troubles George Osborne, when he can drag his thoughts away from Google. There are 19 members of the euro, out of the EU’s 28 members. 337m people, two-thirds of the EU’s population, live in euro member countries. More countries are likely to join, despite its flaws, in the next few years, though Britain never will.

The danger is that the euro “outs”, comprising a diminishing minority within the EU, gets outvoted and outmanoeuvred by the rest. Ensuring this does not happen, which will be difficult, is arguably the most important aspect of the government’s renegotiation.

For some people, the flawed euro and the risks of being repeatedly turned over by the euro majority in the EU are sufficient grounds for a “leave” vote. As I have said before, I will hold fire on my verdict until nearer the time of the referendum.

In terms of how the economics of the referendum vote will play out, however, and trying to cut through the noise from other issues, let me offer a view of how voters may see things.

Most people do not think too deeply about the euro. They certainly do not trouble themselves over whether the eurozone is an optimal currency area or not. A perhaps disturbingly large number of people in Britain thought – and may still think – that euro membership would be good for us because it would cut out the inconvenience of having to exchange currencies when holidaying elsewhere in Europe.

But people do know when things are going badly. Three years ago, when all the talk was of a double-dip recession in Britain (it never happened), the eurozone had a proper one. It lasted for over a year and it coincided with talk, not just of Greece leaving but of a complete dismantling of the single currency. Eurozone unemployment stood at more than 12% and in Spain and Greece was more than 25%.

This, to not quite paraphrase Groucho Marx, was a European club that we wanted nothing to do with. Polls at the time showed a lead of 20 points or more for the exit camp.

How we feel about Europe matters. How we feel about ourselves also matters. 2012-13 was the time of the squeezed middle, the squeezed bottom, and the squeezed just about everything else. Growth was tentative and the rise in employment, while happening, was weaker than subsequently became the case. Prices were rising faster than wages. Consumer confidence was very depressed. We felt miserable. We probably blamed the eurozone crisis for some of that misery.

There has been a turnaround. The euro’s fundamental flaws have not disappeared but the eurozone has come through its crisis. You would not rule it out indefinitely but Grexit, the departure of Greece from the euro, has ceased to be an imminent threat. It was a close-run thing, but the eurozone has held together.

It has also returned to modest growth. The eurozone started growing again in the spring of 2013 and has continued to grow since. Its current growth rate of 0.3% or 0.4% a quarter is nothing to write home about but it is better than the alternative. The unemployment rate has come down to 10.5%. No longer does Europe appear to be in economic crisis.

As for consumer confidence in Britain, figures on Friday showed it has maintained its strength of last year this month, in spite of tumbling stock markets. Last year was the best for consumer confidence in Britain in the more than 40 years GfK, which surveys the public on behalf of the EU, has been assembling the data. This month has seen a two-point rise in its overall measure of consumer confidence, on the back of continued strong employment growth and rising real incomes. Britain’s consumers are “resiliently bullish” says GfK. They are no longer feeling miserable and they are no longer looking for somebody else to blame.

If these two things persist – a crisis-free and modestly growing eurozone and heightened levels of consumer confidence in Britain – the leave campaign will have its work cut out in trying to persuade voters that change is either necessary or desirable.

That does not, of course, preclude non-economic factors coming to the fore, though people tend to vote with their wallets and purses. The economic backdrop to the referendum is more favourable for a “remain” vote than David Cameron could have imagined when he pledged an in-out vote three years ago this month.

Sunday, January 24, 2016
The dangers of leaving rates too low for too long
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

Mark Carney has spoken, in a speech to celebrate 50 years as a professor of economics at London’s Queen Mary University of Lord Peston (Robert’s dad). I don’t think he will have the gall to pop up again this summer and warn us be on the alert for a hike in interest rates at the end of this year.

For the Bank of England governor, who has the ability to generate headlines, being twice-bitten (he gave such warnings in both 2014 and 2015) should mean that this year he will choose to be a little shy.

He could, of course, generate plenty of headlines by starting to drop hints of interest-rate cuts. The Bank’s chief economist, Andy Haldane, appears to be genuinely agnostic about whether the next move in interest rates should be up or down. The Bank has said there are no technical barriers to cutting even from a record low 0.5% rate. Haldane has even talked about the possibility of a negative interest rate.

Carney and most of the other members of the Bank’s monetary policy committee (MPC) continue to insist that they fully expect the next move in rates to be up. Looked at logically and in the context of the governor’s speech, however, it is clear that there are circumstances in which a rate cut could occur.

His three conditions for raising rates were: growth being above its long-run trend, which in practice means quarterly growth of at least 0.5%-0.6%; evidence of a firming of cost (particularly wage) pressures, and a rise in core inflation consistent with getting back to the 2% target.

It is a reasonable set of conditions, but it also opens the way to a possible rate cut. What if quarterly growth were to slow to 0.1% or 0.2%, alongside a further weakening of wage growth and a few more months of inflation being stuck at close to zero, or even going significantly negative on the back of a new round of energy price cuts?

I do not expect it to happen, and I don’t think it would be a good idea, but it is not impossible. There is perhaps a 10% chance of a cut. Earlier this month George Osborne said that a rise in rates would be a sign of strength in the economy. If there were to be a cut he would need another script.

The remaining probabilities I would say are for no change at all this year, maybe 50% (some would put it a lot higher), with a 40% probability still clinging to a very late move this year, though not until November.

The governor’s speech, which was preceded by the MPC’s 82nd consecutive monthly decision to leave interest rates on hold, was unremarkable in its conclusions. With global markets plunging and the oil price slumping, the dust needed to settle. Most of those 82 decisions have been unremarkable.

If you were looking for an ideal time to raise interest rates, with every duck lined up in a row, such times have been in short supply. And, to the extent the MPC is waiting until a decision to raise rates is incontrovertible, a “no-brainer”, the longer we will have to wait for a move.

But, just because each decision to hold rates is defensible, is there a bigger picture danger, which is that ultra-low rates for too long, apart from depriving savers of returns, become dangerous?

Some would see those dangers in the housing market, where the latest Rics (Royal Institution of Chartered Surveyors) survey points to a further acceleration in house prices. For much of the period of very low interest rates, limited mortgage availability has offset the boon provided by low rates, though low rates have also encouraged investors to move into buy-to-let property. Now mortgage availability is improving fast there is a danger that low rates are stimulating the housing market – and pushing up prices – too much.

This is part of a wider point. Early last week I attended and spoke at a conference organised by the Spinoza Foundation in Geneva. One of the other speakers was Bill White, the Canadian former chief economist of the Bank for International Settlements, the central bankers’ bank.

White, who genuinely warned of the crisis before it happened (unlike many who claimed to do so) says central bankers made the mistake of pursuing excessively easy money policies before the crisis, and are making the same mistake again, supplemented by policies such as quantitative easing. Very low rates have had only a limited (and I would say diminishing) effect in boosting growth, while storing up other problems.

Indeed, as he put it in another recent speech, easy money policies may have had the opposite effect of that intended. “Much of what has been done recently smells of panic,” he said. “Arguably, by increasing uncertainty, it might even have encouraged people, both companies and households to hunker down and spend less rather than more.”

The BIS, which presciently warned of the “uneasy calm” in markets last month, thinks central bankers – including the Bank – are collectively making a big mistake. As it put it in its annual report last year: “Low rates are the most remarkable symptom of a broader malaise in the global economy: the economic expansion is unbalanced, debt burdens and financial risks are still too high, productivity growth too low, and the room for manoeuvre in macroeconomic policy too limited. The unthinkable risks becoming routine and being perceived as the new normal.”

The fact that there is even a possibility of a rate cut in Britain from 0.5% would meet the BIS’s definition of “unthinkable”. So would the fact that we are fast approaching the seventh anniversary of a cut to 0.5% in March 2009 that at the time was regarded as emergency and short-term.

The common theme between the pre-crisis period and now is inflation. Before the crisis, central banks focused too much on inflation and missed the dangerous credit bubble that was building. Since the crisis, the Bank ignored above-target inflation for some years, but now sees itself as constrained from raising rates by very low inflation.

Whether these post-crisis easy money policies will ultimately prove to have been dangerous and damaging is hard to say. But there is at least a risk that we will come to regret having near-zero interest rates for so long.

Sunday, January 17, 2016
When world trade struggles. so do Britain's manufacturers
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

Another year is now in full swing. Alongside all the other things sent to try us, including weak and volatile stock markets, a plunging oil price and worries about global growth, manufacturing is in the doldrums.

Official figures last week confirmed the gloomy message of industry surveys. Manufacturing output fell by 0.4% in November and was down by 1.2% on a year earlier. Whatever things happened last year, a rise in factory output was not amongst them. And there is, sadly, nothing very new in this.

In the past four years there have been up years like 2014, when manufacturing output rose by a healthy 2.7%, and there have been down years like 2012 and 2013, when it fell by 1.4% and 1.1% respectively.

Broadly speaking, however, and allowing for the fact that there have been winners and losers within the overall numbers, Britain’s manufacturers are now producing what they were in 2011.

That was the year, of course, when George Osborne, in his March budget, talked about “A Britain carried aloft by the march of the makers”, for which he has been much lampooned, the latest in a series of politicians to see a bright future in manufacturing, only to see a grimmer reality kick in.

To be fair to Osborne, he thought in March 2011 that he was simply riding the tide. With parts of the service sector, most notably financial services, reducing activity, there did appear to be a genuine shift back to making things. Manufacturing output rose by a very healthy 4.5% in 2010 and Britain’s factories looked to be set fair.

That, unfortunately, was that. If every part of manufacturing had done as well as transport equipment (including cars), output up 38% since 2010, the chancellor would be hailed as a great sage. Well, he might. But other parts of manufacturing have either not prospered or fallen back sharply, for example in the case of sectors such as basic pharmaceuticals and textiles. Overall, the makers have not marched.

Why is this? Every time we get a disappointing set of manufacturing numbers, industry experts come up with a range of explanations, from skill shortages and high energy costs, through to lack of investment and Britain’s anti-industrial culture. All have a part to play in the long-run story of British manufacturing.

The manufacturing disappointment of recent years has a simpler and more straightforward explanation, however. When world trade does well, British manufacturing does well too. When world trade struggles, so will Britain’s factories.

In 2010, on the back of which Osborne chose to highlight industry, world trade boomed. Having dropped by more than 10% in 2009, the annus horribilis for the global economy, world trade volumes bounced back even more strongly in 2010. For a while it seemed as if normal service was being resumed for the global economy after the crisis, with Britain’s manufacturers playing their full part.

It was a false dawn. One of the missing ingredients of the post-crisis recovery has been world trade. 2011 saw a slowdown, 2012 and 2013 the equivalent of trade being becalmed in the Sargasso Sea. 2014 was better, hence a relatively good performance for manufacturers that year. That last 12 months have, though, seen trade growth fall back.

The CPB Netherland Bureau for economic policy analysis, which records world trade growth, says that it dropped back to just 1.4% in the autumn. As it put it: “Export momentum was down in both advanced and emerging economies.”

I have written before about the post-crisis weakness of world trade, suggesting a combination of lack of availability of export credit, some re-arranging of global supply chains and subtle protectionism.

Trade weakness is plainly not just affecting British manufacturers. The CPB Bureau also produces data for global industrial production, which shows a remarkably similar pattern to that of Britain. In Europe, Germany stands out as the only major economy which has increased its manufacturing output in this period of weak, post-crisis trade growth, with a rise of around 8% since mid-2010.

France, like Britain, is becalmed, while Spain and Italy are down. It is a tough world for manufacturers, and particularly tough in Europe. Maybe, also, something more profound is happening.

I don’t get invited to the Davos World Economic Forum these days but I notice that its theme for this week’s gathering in the mountains is the “fourth industrial revolution”, what it describes as the “ongoing transformation of our society and economy” by various technologies, ranging from robotics to artificial intelligence.

It is easy to mock Davos and its pretensions. Its themes have sometimes been spectacularly mistimed. But technology does change the nature of trade. This may seem an odd point to make when car sales in Britain have just had a record year of more than 2.6m new vehicles registered. We still eat and drink.

But the rise of a new kind of consumer intangible, the most obvious example of which is electronic downloads, is having an effect on trade. It means that, in the case of Britain, exports of services are fast closing on those of goods. As recently as 2010, service-sector exports were less than 70% of the value of exports of goods. In November last year, the figure was just under 90%. Soon Britain will be exporting more services than goods.

Even that may not fully capture the effect of intangibles but the net result will be that there will be a smaller increase in the output of manufacturers, and probably measured trade, for a given increase in gross domestic product and consumer spending in Britain and other advanced economies.

Does that mean we will never see a “march of the makers”? One would hope, despite some of the structural shifts that we are seeing in world trade, that it is not permanently in the doldrums. Some exporters will take comfort from the fact that sterling has come down from last year’s highs, particularly against the euro. At the margin, that will provide a boost for manufacturers.

But it would be unwise to expect too much. Some of Britain’s manufacturers are indeed marching, and long may they do so. Some, equally, are only going backwards.

Sunday, January 10, 2016
Don't drink too deeply of Osborne's dangerous cocktail
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

Such is George Osborne’s reputation for political cunning, the natural reaction to anything he does is to look for the true meaning behind the message. Prince Metternich’s observation on the death of Talleyrand – “What did he mean by that?” – springs to mind.

The chancellor is in good health but his warning three days ago, that Britain’s recovery faces “a dangerous cocktail of new threats”, provoked similar thoughts.

When, in November 2014, David Cameron talked of the “red warning lights … flashing on the dashboard of the global economy”, and was quickly backed up by Osborne, it was pretty obvious what they were up to. With the election less than six months away, they wanted to remind people not to risk handing over the economy back to Labour.

As I put it back then, the world was not about to go pop but they wanted voters to think it might, and that only they could be trusted to shield voters from the damage.

This time, some of the chancellor’s motivations are fairly clear. The government has faced criticism over cuts to flood defence spending, as Osborne did last year over his planned – and eventually abandoned – cuts to tax credits. Hence his emphasis on the work still to be done on the budget deficit.

There are two things to say about spending on flood defences. One is that given the scale of the rainfall in recent weeks, the overwhelming majority of the flooding problems we have seen would have occurred with or without the spending reductions of the coalition government’s early years. Spending was cut by 16.5% in real terms in 2011-12 and maintained at the new lower level (which was roughly what was being spent in 2007-8) for two more years.

But we are not talking about billions of pounds here – the 2011-12 cut was less than £100m in cash terms – and even some defences that were considered state of the art proved inadequate. If extreme weather events are becoming the norm, spending on flood defences by all recent governments has been significantly too low.

The second point is that the benefits of good flood defences and related infrastructure improvements far exceed the costs. The fact that those benefits may be intangible – when flooding does not occur it is a non-event – should not matter. Preventative medicine also brings large benefits. That rethink everybody is now talking about on flood defences is necessary. A government that goes on a lot about security must be aware of the insecurity of having your home or business flooded out, or being under threat of it.

But, and this was one of the aims of Osborne’s speech, the public finances are a long way from being fixed. Splashing out on flood defences, no pun intended, will require compensating cuts elsewhere if the chancellor still intends an eventual budget surplus. Six years after it peaked at more than £150bn, public sector borrowing is officially predicted to be more than £70bn this year, and there are pressures on that forecast after a couple of disappointing recent monthly figures.

Was Osborne responding to disappointing pre-Christmas growth figures and getting his retaliation in first ahead of a sharp slowdown this year? As I said at the time, previous experience suggests we should take the late-December data revisions from the Office for National Statistics with a pinch of salt. Most economists expect similar growth this year to last and they are not known for viewing the world through rose-coloured spectacles.

That said, a few things have changed for the worse in the past few weeks. There have been downward revisions to global growth forecasts, particularly for emerging market economies. The World Bank, for example, has just revised down its prediction of global growth this year from 3.3% to 2.9%, and for next year from 3.2% to 3.1%. Both would be better than last year’s estimated growth of 2.4%, which is important to bear in mind, but weaker than hoped.

The World Bank still thinks Chinese growth, at 6.7% this year after 6.9% last, will be with within touching distance of 7%. Investors who have been panicking about China’s prospects in recent days would be more than pleased with that.

It is hard to say whether the Chinese stock market panic reflects genuine concern about the country’s growth prospects or whether it is mainly a response to cackhanded interventions by the authorities. But it has ensured a dreadful start to the year for world markets, including our own FTSE-100, and it has been accompanied by a further plunge in the oil price to a 12-year low of under $35 a barrel.

That further fall in oil prices, when in the past an escalation of tension between Iran and Saudi Arabia might have been expected to push them higher, shows what a changed world we are in. Traders have decided that this oil glut is not going away, and that Iran-Saudi tension means co-operation within the Organisation of Petroleum Exporting Countries to make it do so is even less likely than it was.

So how worried should we be by these recent developments? The stock market’s grim start to the year is not good news but the correlation between what happens in the markets and the real economy is weak, and even more so in China than Britain.

The fall in oil prices is in danger of turning from a helpful boost to growth to a damaging rout which could set back energy investment for years. It looks as if we are now firmly in overshoot territory for oil prices, but without any indications of when prices might start to bounce. The predicted cold snap should help retailers still trying to offload winter clothing lines, and it could help the oil price.

There is nothing wrong, of course, with a chancellor keeping people apprised of the risks that face the economy. But there is a danger, coming after a year in which consumer confidence in Britain has had its best run for more than four decades, that people and businesses overreact to such warnings and they become a self-fulfilling prophecy. The hope has to be that they do not drink too deeply his dangerous cocktail. If they do, 2016 will be “mission critical” for the economy, to use the chancellor’s words, for the wrong reasons.

One thing that should be knocked on the head is the idea, which emerged from some interpretations of Osborne’s speech, that an early rise in interest rates from the Bank of England is inevitable, and that he was preparing the ground for it.

As noted last week, a rise in rates this year is marginally more likely than not but could still very easily not happen. The Recruitment and Employment Confederation said on Friday that pay growth for permanent jobs, crucial to the Bank’s thinking, has slowed to a 26-month low.

More than that, the more that Osborne’s fears about the global economy come to fruition, the significantly less likely a rate rise. If the backdrop remains one of volatile stock markets, weakening global growth and a plunging oil price, the Bank will not be raising rates.

Sunday, January 03, 2016
EU referendum is the biggest cloud on the horizon
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


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

The easiest thing to do when looking ahead is to assume more of the same. That, to let you into a dirty little secret, is how economic forecasting generally works and it is why economists are not bad at identifying trends but not good at predicting turning points.

It also keeps forecasts within realistic limits. Having ended the year at close to zero, you would put a very low probability on inflation rebounding to 10% over the next 12 months. Britain’s twin deficits – the red ink on the budget and current account – are not going to turn to surplus between now and the end of 2016.

The Bank of England’s monetary policy committee (MPC), similarly, will continue to adopt an ultra- cautious approach. After nearly seven years pondering whether the time was right for a quarter-point rise in interest rates, it will not suddenly start jacking them up as if there was no tomorrow.

Things do change in unexpected ways, however, even when they are flagged in advance. Britain’s continued membership, or not, of the European Union will come into focus this year. Even that, of course, is subject to some uncertainty.

We do not know for sure whether the EU referendum will be held in 2016, even though a summer vote appears to be David Cameron’s clear preference.

Assuming the referendum is held this year, we do not know whether it will be an economic non-event or the biggest challenge for Britain’s economy since the global financial crisis. Swap opportunity for challenge and you have both sides of the debate encapsulated. More on that in a moment.

As for the world beyond Britain, the world’s two biggest economies will, unsurprisingly, have the biggest influence. It may be that America’s presidential election is just a bunch of unelectable Republicans providing entertainment before Hillary Clinton’s stately passage into the White House but it cannot be ignored.

The Federal Reserve will raise interest rates further, perhaps as many as four times this year. Markets celebrated last month’s first Fed hike for nine years.

They might not do that every time, though if the Fed feels confident enough to continue the process of “normalizing” rates, it shows it is reasonably sanguine about the US and global economies.

As for China, its landing was hard enough last year to hit commodity and stock markets but in recent weeks the numbers have looked rather better. If you believe the official figures of growth of slightly below 7%, Chinese growth should stabilise around that level this year. That will provide a little support for oil prices. I cannot see a sustained drop in oil to $20 a barrel though I would be surprised to see a recovery to much more than $50.

America and China are not the whole of the world economy but they suggest a picture of reasonable growth; not as good as strong as the 4% trend rate of global expansion but 3.5% is achievable.

What about Britain? Before returning to the EU and the referendum, two things. The first is the argument that this recovery is so long in the tooth that we should be ready for the next downturn. We are now into the seventh year of a recovery that began in the middle of 2009. It sounds like a long time but the recovery that preceded it, from the early 1990s to 2000, ran for more than 16 years. The one before that, in the 1980s, lasted for over nine years. Given how far the economy fell in 2008-9, it is far too early to be calling time on the recovery.

The second thing is to deal with the end of year flurry of nonsense about Britain being in the middle of some kind of debt-fuelled consumer boom. In the national accounts released just before Christmas, the Office for National Statistics reported that aggregate wages and salaries in the third quarter were 4.6% up on a year earlier, pushed higher by both pay rises and employment growth, at a time of zero inflation. Real household disposable incomes were up by 4%. Consumer spending growth of 3% over the same period looks modest by comparison.

And, while household borrowing has picked up a little, it remains remarkably restrained. Overall borrowing has risen by less than 5% over the past seven years, and is significantly lower in real terms and relative to income than it was before the crisis. Unsecured borrowing is 15% lower in cash terms than before the crisis.

So what is in prospect? The big question about the EU referendum is not just the result but whether the uncertainty leading up to it has a significant impact, for example postponed or cancelled investment projects. My judgment is that there will be a little of this, but not too much. Despite the closeness of some polls, most businesses are assuming that the status quo will continue, and that voters will not choose Brexit. If that assumption, which I tend to agree with, turns out to be wrong, then the EU will be the big story for Britain’s economy in 2016. And, whatever your view of the long-term consequences of EU exit, the short-term effects would be significant, and negative.

In the absence of that, what is the outlook? If you took the pre-Christmas gross domestic product figures at face value, which suggested a slowdown, you would expect even slower growth in 2016. But, as I said last week, I did not, so growth of around 2.5% is on the cards for this year.

Inflation, having surprised everybody on the downside last year, should rise very slowly, as some of the helpful “base” effects drop out. But We may still be below 1% at the end of the year. I shall go for 0.75%.

Does that mean the Bank of England will leave interest rates unchanged? I am tempted to say so, conscious of the fact that for the past six years at this time the Bank has been expected to raise rates over the course of the following 12 months, only to do nothing of the sort. But, while fearing another error, there is a limit to the extent to which the Bank can ignore rate hikes by America’s Federal Reserve without at least a token move. So, with trepidation, I will say one move, to 0.75%.

Unemployment should continue to fall, to 0.7m on the claimant count, and just under 5% on the wider Labour Force Survey measure. The current account deficit will still be with us, as noted, but should drop to around £60bn, from nearly £80bn last year.

All that assumes that the economy in 2016 will not be hugely different from the economy in 2015. Meanwhile, the big issues, including productivity, the budge