David Smith's other articles Archives
Sunday, December 01, 2019
More Stoke-on-Trent than Singapore-on-Thames
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.

General elections are occasions when political parties can set out their visions for the country, allowing voters to choose between their wares. Labour has done so emphatically, as discussed here last week. We can say, beyond any doubt, that the country would look very different after five years of a Jeremy Corbyn government.

But what about the Tories? They have come out with a manifesto so devoid of content and vision that they might as well have not bothered. If it was intended to be instantly forgettable, it was a great success. Otherwise, instead of the roar of a lion, we had the squeak of a mouse.

Now I know what the politics behind this was. The Tories were desperate to avoid anything that would get in the way of the central message of “getting Brexit done”. The ghost of Theresa May’s 2017 manifesto, and a social care plan hastily put together and presented to voters, and most of an unconsulted cabinet, hangs heavy over Conservative Campaign Headquarters.

Even so, the omens are not good. Readers will remember a time when enthusiastic Tory Brexiteers talked about creating a “Singapore-on-Thames”, a super-competitive, low-tax, de-regulated, enterprise economy after Brexit.

It was the kind of message that provoked concern elsewhere in Europe, and a bit of a pushback from some Singapore people, who protested that it was not the freebooting entrepreneurs’ paradise it was portrayed as. Even Philip Hammond, the former chancellor, talked of adopting a different model for the UK economy. In the immediate aftermath of the referendum three years ago, this newspaper advocated cutting the main rate of corporation tax to 10% to ensure that Britain remained a magnet for foreign direct investment.

Well, looking at what the Tories have in mind for the next five years, it looks like more of a case of Stoke-on-Trent or Stockton-on-Tees than Singapore-on-Thames. Both are estimable places. Stoke was the pottery capital of the world and Arnold Bennett, one of my favourite authors, is one of the city’s most famous sons. Stockton can lay claim to the railway heritage of George Stephenson and the inventor of the friction match. People in both places would also accept, however, that a successful past is no guarantee of a glorious present; far from it.

Under the Tories’ modest proposals, the main rate of corporation tax will stay at 19%, rather than being cut to 17%, as previously planned, so a lot higher than 10%. Beyond the announced rise in the National Insurance threshold to £9,500 next April, there is no obvious room for tax cuts if the party is serious about meeting its fiscal rules.

The starting position on tax is what the Institute for Fiscal Studies (IFS), describes as the “highest sustained level” for the tax burden since the late 1940s, when the economy was being brought down from a wartime footing. Most other European economies have a higher tax burden than Britain, it should be said, and under Labour it would be higher still. But the Tories under Boris Johnson appear to have shed their ambitions to be a low-tax party.

It may be that this reflects the political and economic reality. After the austerity years, tax cuts no longer win votes. Johnson’s idea of increasing the higher rate tax threshold from £50,000 to £80,000, left out of the manifesto, went down like a bit of a lead balloon in polls. The Tory proposition, apart from delivering Brexit, is that it can deliver affordable and fiscally manageable increases in public spending.

The idea of a post-Brexit bonfire of red tape also appears to have slipped down the list of political priorities. The scope for product or labour market deregulation is, in any case, limited. Britain is already among the lightest regulated advanced economies in the world in these areas, according to the Organisation for Economic Co-operation and Development. Where there is scope for de-regulation, in our absurdly complex tax system and in planning, the red tape is home-grown, and setting fire to it has been within the gift of successive governments.

The Institute of Economic Affairs, indeed, warns that the Tory “tax triple lock” of pledging not to raise income tax, VAT or National Insurance, “is a recipe for further complicating the tax code, as government officials desperately look to find cunning ways to increase state revenue without breaching the specific terms of this catchy, but ill-judged, manifesto commitment”. Quite a lot of the increase in the complexity of the tax system in recent years has been due to parties avoiding breaking manifesto pledges on headline tax rates.

It is not all about low taxes and deregulation. Good governments enthuse, and create a climate in which businesses want to invest and expand. They bring out the “animal spirits” of entrepreneurs. All this government does is promise a post-Brexit investment boom, without doing anything to help bring it about.

The Tories in even wanting to change the state aid rules so they can prop up failing industries, and adopt a "buy British" policy for government procurement, sound as though they are playing a game of anti free market, protectionist Bingo.

So on the face of it, all we can look forward to in the next few years is that, after a modest boost to growth next year as a result of Sajid Javid’s one-year spending boost. The economy settles down at a lacklustre pace of about 1.5% growth a year, well below its long-run rate. Or worse, we get over the Brexit line and collapse in in an exhausted heap.

It would be good to be more optimistic, and some of the investment banks are trying to push a bullish view of the UK. Do not carried away, however. What Goldman Sachs describes as a “post-election pick-up”, may only lift growth temporarily to a little over 2%. Businesses will remain very cautious about investing until they know what Britain’s future relationship with the EU looks like.

Inspiration is definitely lacking. The Tories are giving the impression that achieving Brexit is a bit like the dog chasing a car. Once it has caught it, it does not know what to do with it.

Sunday, November 24, 2019
Labour's four-day week is just a terrible waste of time
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 you are just spoiled for choice and, suspend your disbelief for a second, on this occasion it is the politicians who are spoiling us. The Tories will be revealing all in their manifesto today, an odd day for a launch, but they will have to go some to match the cornucopia unveiled by the Labour party on Thursday.

There is enough in Labour’s manifesto for not one, but a dozen columns. Fortunately there is a cut-off date, December 12, to stop me doing that.

At its heart is a simple message. The Tories, with their cruel austerity, have been the party of food banks, rough sleeping and “communities blighted by lack of investment, endless cuts to vital services and millions struggling to make ends meet, while tax cuts are handed to the richest”. Labour had a go at an austerity-based campaign in 2017, and it worked quite well.

This one goes further in its ambitions for public spending, including higher public sector pay, raising the increase in NHS spending from 3.4% to 4.3% a year, abolishing tuition fees, the £500m-plus annual running costs of British Broadband and £10.8bn a year for free social care for the over-65s.

That will add more than £80bn a year to day-to-day government spending by 2023-24, on top of which there will be a £400bn National Transformation Fund. The latter will be funded by borrowing, the former by a very precise £82.9bn of additional taxes, equivalent to 4% of gross domestic product.

The 45% income tax rate applicable at £80,000 and the new “super rich” 50% rate at £123,000 will raise £5bn a year, putting corporation tax back up to 26% and a new unitary tax on multinationals £30bn. Higher taxes on capital gains and dividends will be worth £14bn a year, a financial transactions tax £8.8bn. And so on, Labour says it has taken into account behavioural changes in calculating its £82.9bn tax hike, which others will dispute, as they will dispute the idea that 95% of taxpayers will be unaffected by these changes, a claim that Paul Johnson, the saintly director of the Institute for Fiscal Studies, has described as “simply not credible”.

There is also, of course the biggest programme of nationalisation since the Attlee government of 1945-51. Private landlords will not be forced to sell to tenants at a discount but they will face rent controls. There will be a pilot programme to test whether a universal basic income works. I can save them the time and money. It doesn’t.
I could go on. But I need to pin something down and I choose Labour’s policy of promising a four-day, 32-hour week within a decade. It says more about how Labour thinks the economy works, even than all of the above.

It is an odd policy, intended to be populist but regarded with scepticism and even amusement among those it is intended to persuade to vote Labour. Boris Johnson was laughed at in last week’s ITV leaders’ debate when he said that telling the truth was important – he has been hauled up for telling porky pies even about pork pies -and Jeremy Corbyn was when pressed on the 32-hour week.

John McDonnell, the policy’s architect, commissioned a sympathetic academic expert, the eminent economic historian Lord Skidelsky, to examine the policy, which he did in a paper published earlier this year by the Progressive Economy Forum, called to How to achieve shorter working hours. But he declared that “capping working hours nationwide, on the lines of France’s 35-hour working week, is not realistic or even desirable, because any cap needs to be adapted to the needs of different sectors”.

Labour, according to the argument set out by Corbyn in the debate, and repeated in the manifesto, would square the circle of a four-day week, ensuring workers do not suffer pay cuts or firms big increases in costs, by raising productivity. As the manifesto put it: “Labour will tackle excessive working hours. Within a decade we will reduce average full-time weekly working hours to 32 across the economy, with no loss of pay, funded by productivity increases.”

Let us think about that for a second. The absence of productivity growth is the problem that has bedevilled economists and policymakers for a decade. Labour thinks productivity can be revived by dictating a maximum working week of 32 hours. Would firms invest in such circumstances to bring about the necessary productivity revival? I think not.

Let us think about it a little more. Suppose that productivity does revive over the next few years, as we would hope it does. Workers would expect that to be reflected in higher pay, and rising real wages. Most would not be happy for pay to stand still just so they could achieve a reduction in working hours.

Clearly, as discussed here before, if people are overworked or overstressed, there is the possibility of productivity gains from making them happier. Some isolated experiments with four-day weeks have suggests this is the case. But the progress towards a four-day week has been backwards, rather than forwards recently.

There was a fanfare when the Wellcome Trust announced that it was examining whether to put its employees on a four-day week. But the plan was shelved as “too operationally complex to implement” and unfair on those employees it would be difficult to switch. There were suggestions, supported by some academic research, that stress caused to employees of trying to cram five days of normal work into four actually reduced productivity.

Above all, this idea is a throwback to a different age, when governments courted the unions, not business. The Trades Union Congress (TUC) likes it, and has called for it because it speaks to a time when powerful unions sat down with big employers and arm-wrestled, often interspersed with industrial action, over pay and conditions.

The world has changed. The great reduction in working hours as a result of factory automation are over. The unions are still influential and have solid membership in industry and in the public sector but are close to being irrelevant in private sector services; which accounts for the bulk of employment. Only 23% of all employees are union members; 13.5% in the private sector and 52% in the public sector.
The nature of employment has changed. Clocking in and clocking off is now a rarity. Many people, in offices and elsewhere, work as long as the task requires.

For those on the edges who have to maintain several toeholds in the job market, discussed here last week, the 32-hour week is either an irrelevance or an unattainable goal; they would love to have a job which gave them so many hours.

It should be thrown back into the pond of unworkable ideas. This election is bringing out quite a few of those.

Sunday, November 17, 2019
Wages up, jobless down, but confidence is lacking
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.

Students of British election history will know that official figures can often scupper the best-laid plans of political parties. Bad trade figures, by legend inflated by a couple if jumbo jets, famously helped cost Harold Wilson, the Labour prime minister, a general election in 1970 he was expected to win. The release in May 2016 of official figures showing a record figure for net migration the previous year changed the nature of the referendum debate and helped swing a leave vote the following month.

So it is with some trepidation that ministers, who no longer see the figures in advance, will have awaited the latest batch of economic numbers. But it is, for then, a case of so far, so good, for the economic figures, if not the latest NHS performance data. Third quarter gross domestic product was softer than expected, up just 0.3% and the 12-month rate of growth was the weakest since 2010.
Importantly, however, the economy escaped the political elephant trap of a recession.

There were also dangers for the government in the latest labour market statistics. But, despite some softening, including a 58,000 fall in employment in the latest three months, the news was good enough to provide, in normal circumstances, an election-winning platform.

The unemployment rate dropped back to 3.8%, its lowest since the mid-1970s. Real wages are rising, with the growth in money wages, 3.6%, running at twice the relevant inflation comparison. 1.8%. The day after those figures were released, other official data showed a further drop in the inflation rate, to just 1.5%.

The job market is not perfect. Vacancies have been falling since the turn of the year and the drop in employment in the latest three-month period told us that for some workers, particularly women, the job market is softening. All the fall and more was, however, accounted for by a drop in part-time work while full-time employment rose.

So a sigh of relief for the Conservatives. And, if you believe, as pollsters used to tell us, that all elections are “pocketbook”, or wallet and purse, elections, these figures should support what the polls are telling us, that the Tories will certainly emerge as the largest party on December 12, and could easily secure a comfortable majority.

These things are not perfect. I remember telling Michael, now Lord, Heseltine in the run-up to the 1997 election that a strong labour market and rising real wages did not guarantee victory. Labour lost in 1979 in spite of this, probably because of the “winter of discontent” of strike disruption, while the Tories succumbed to a Labour landslide in 1997 because of divisions on Europe, sleaze and memories of the 1992 “Black Wednesday” European exchange rate mechanism humiliation.

Is there anything to hold the Tories back this time? Boris Johnson does not offer voters huge reassurance and lacks a grasp of detail, or that may just be his style, but there are more public doubts over Jeremy Corbyn than there are about him. Johnson’s simple pitch of getting Brexit done may be inaccurate but will be effective with many voters.

The question is whether there is anything in the performance of the labour market to prevent it delivering for the Tories. Those of us who have lauded the job market’s performance in recent years – 3.5m net new jobs created since 2010 – have always had to contend with the criticism that, not only has this occurred against the backdrop of stagnant productivity, which continues, but that wages have been weak and many of the jobs created insecure.

A related strand of criticism of the labour market’s performance is the focus of a new Resolution Foundation report. The report, Feel Poor, Work More, takes a different approach to the employment “miracle” of recent years, with more jobs created than anybody thought possible.

Traditional explanations for the strength of the labour market do not work, argue the authors. Torsten Bell and Laura Gardiner. If it was all about Britain’s labour market flexibility, then nothing has really changed on that score since before the financial crisis. If it was all about demand from employers for labour, perhaps in lieu of investment, then you would have expected this to show through in a faster pace of wage increases than we have seen.

Some attribute the improvement to welfare reforms but the paper points out that this does not square with the slow, at times glacial, roll-out of universal credit, although welfare cuts may have made people more willing, and needing, to work.
Instead, they argue, the jobs boom is very significantly a labour supply boom. One aspect of this is well known. Changes in their state pension age have meant that many older women have had to work longer than they planned, and this is acknowledged by official statisticians as a contributory factor in the rise in the female employment rate.

The Resolution Foundation report goes further. It thinks that households have responded to the changed economic circumstances since the financial crisis by having to work more. This includes both partners in a couple now working, where previously only one did.

As the report puts it: “A deep recession in which wages fell dramatically, followed by an unprecedentedly sluggish earnings recovery, meant household incomes dropped far further than expected, and stayed lower. A rational response from households has been to shield family finances from the depth of such earnings reductions by increasing the number of workers or working more hours.”

The downward trend in working hours stopped a decade ago and collectively we are working 65m more hours a week than we would have done if we still had the 2008 employment rate today and the decline in the average working-week had continued.

What does this mean? People like me are always inclined to regard work as a good thing, and the more people that are in it, the better. But there is another way of looking at it, as the Resolution Foundation report highlights. Many people have been forced into work by circumstance, sometimes into multiple employment – holding down several insecure jobs at once – just as some older woman have been forced to work longer because of changes in their state pension age

For people in this situation, a near-record employment rate and the job market “miracle” of jobs created in recently years is not something to celebrate. It is reflection of their need, and in some cases their desperation.

There is other evidence that a low unemployment rate and rising real wages will not translate as smoothly in support for the government as it might have done in the past.

Consumers are not confident. Private new cars sales last month were down by 13.2% on a year earlier. The latest GfK consumer confidence barometer, for October, showed a drop of two points to -14. People are gloomier than they were in the immediate aftermath of the referendum, when confidence slumped, though not yet as gloomy as they were in 2012-13, when the economy was battered by the eurozone crisis, or during the crisis itself.

Confidence was riding much higher than this, however, when David Cameron secured a small majority for the Tories in 2015, and it was higher in 2017 when Theresa May failed to get the bigger majority she craved, or indeed any at all, in 2017. Something to ponder

Sunday, November 10, 2019
Spend, spend, spend, but beware the bond 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.

This is turning into an autumn of cancellations, not of trains because of leaves on the line, though no doubt there have been some of those, but of economic events. Last Wednesday was supposed to be Sajid Javid’s first budget but it was cancelled because of the election, the day after the chancellor insisted it would go ahead.

On Thursday, the Office for Budget Responsibility (OBR) intended to produce a “forecast restatement”, taking into account changes since its last assessment in March, notably the different treatment by official statisticians of student loans; which has added to borrowing. But this was cancelled too on the advice of the cabinet secretary, Sir Mark Sedwill, who said it would be in breach of the cabinet office’s election guidance.

Similar considerations led Sedwill to intervene in another cancelled event, the costing by Treasury officials of Labour’s spending plans, due to be published by Javid in a flourish, though as you may have seen elsewhere in the paper, they have found their way into the public domain.

When so much is being cancelled, what is a chap to do? Fortunately, there is plenty to fill the vacuum. The Institute for Fiscal Studies, which provided the OBR with its chairman, Robert Chote, stepped in on “the budget that never was” day the declare that the era of deficit reduction is at an end, and that the combination of statistical changes and the extra spending announced so far, will see the budget deficit – public sector net borrowing – rise above £50bn this year and next, from just over £40bn in 2018-19.

The increases will mean a budget deficit of more than 2% of gross domestic product, the old fiscal target, albeit one which was dropped by the chancellor in his speech on Tory spending priorities on Thursday.

What are voters to make of it? This election means that the end of austerity has come with a bang not a whimper. To adapt the old phrase, £100bn here, £100bn there, and soon you are talking about real money.

You will be pleased to hear that I am not going to go through every jot and tittle of the parties’ spending plans. The Green Party can, I think, claim an early victory in the spending-fit-to-bust stakes, with its plans for £1 trillion of extra spending over the next 10 years to deliver a greener economy. After taxes, that would add a gloriously precise £91bn a year to the budget deficit.

Both Labour, in the form of the shadow chancellor John McDonnell, and the Tories, through Javid, have ambitious plans for infrastructure spending. Under the Tories, it would be around £20bn a year higher than at present, averaging about £70bn a year in today’s prices over the next few years, according to the IFS. His aim is £100bn of extra infrastructure spending over five years.

McDonnell, promising “investment on a scale never before seen in this country” would, according to the IFS and Resolution Foundation, pledge to deliver £55bn a year of extra infrastructure spending, more than doubling it from current levels to roughly £100bn a year, approaching 5% of gross domestic product. There is a serious question about whether this amount can be spent wisely or, given capacity constraints, spent at all.

Both parties are, then, committed to a lot more infrastructure spending, borrowing to invest. Javid has constrained himself more than McDonnell, by adopting new fiscal rules that will prevent too much of a splurge and to try to constrain Boris Johnson, who does not come over a s fiscal conservative.

Those rules are for a balanced budget defined by current, or day-to-day, spending, a rule that already looks quite tight; the National Institute of Economic and Social Research suggests that it is already on course to be broken. There would also be a limit of 3% of GDP on infrastructure spending and a commitment to change tack if borrowing costs rise. McDonnell would target public sector net worth, an acknowledgement of the fact that infrastructure spending creates assets, and set a higher limit on any rise in borrowing costs. Whatever the rules are, recent experience would suggest that they are there to be broken.

What does it all mean? Is it, as the free market think tank the Institute of Economic Affairs says, that both parties have “abandoned fiscal restraint” in favour of more borrowing? Lord Macpherson, former permanent secretary to the Treasury, its senior civil servant, asks whether the fiscal proposals of the two main parties have ever been “so incontinent”.

Well, while Labour and Tories will always go out of their way to emphasise their differences, some things unite them. Both have seen the opportunity, in current very low borrowing costs, to push the boat out on infrastructure spending. The scale may vary but the logic is identical.

Without wanting to rain too much on their parade, there are two things to be concerned about, beyond the question of whether the extra spending can be sensibly delivered.

The first is that the main parties have embarked on relaxation with public spending, relative to GDP, at a much higher level than in past cycles. It was a notable achievement of the coalition and then the Tories from 2010 to bring down spending from a crisis peak of 46.6% of GDP to 40% last year 2018-19. Austerity may not have been popular but in this respect it worked.

If 40% is the low point, however, or close to it, it compares with a low point of 35.2% of GDP in 1999-2000 and 34.6% in 1988-89. Some of those comparisons were helped by strong growth in the economy but the point still stands. Leaving aside the impact of the crisis, if we ere to see the same rate of spending relaxation in coming years as during the Blair-Brown years of the 2000s, you could easily see spending rising to 50% of GDP.

The second cause for concern arises from the cross-party logic of borrowing to invest. Yes, it looks like a no-brainer to borrow cheaply, at current low rates, to invest. Javid, with direct experience of working in financial markets, knows this.
The logic, however, only goes so far. The circumstances that have given us ultra-low and in some cases negative interest rates on government bonds may not last. History would suggest that they will not. It is not good enough simply to commit to pulling back on borrowing if bond yields rise. By then it may be too late. The bond markets are powerful, as governments have often discovered.

Not for nothing did the US political adviser James Carville say in the 1990s: “I used to think that if there was reincarnation, I wanted to come back as the bond market.”

Debt is debt, and it has to be rolled over when the bonds issued to finance it mature. When the government borrows more to fund its extra spending, the fact that it can do so now on the basis of lower borrowing costs offers no guarantees for the future. The extra borrowing, the additional debt, may still end up as a very considerable burden on future generations. When politicians are splashing the cash, as they are now, remember that.

Sunday, November 03, 2019
Beyond Punch & Judy, some good ideas for 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.

It is hard to feel much enthusiasm for a general election nobody really deserves to win, and which seems certain to be dominated by Brexit. Financial markets, taking their cue from betting markets, are seeking reassurance in the prospect of a Tory majority. I would warn them that the betting markets have not covered themselves in glory in recent elections and referendums, and that Theresa May was a hotter favourite in 2017 than Boris Johnson is now, and achieved a bigger share of the vote then (43%) than the Tories are polling now.

The last Tory leader to win a comfortable majority was Margaret Thatcher in 1987, more than three decades ago, the majorities achieved by John Major in 1992 and David Cameron in 2015 being uncomfortably small.

As for the outcome and Brexit, a Tory majority would probably not deliver Brexit by Christmas, as ministers are suggesting, but should do so by January 31. The Tories as the largest party in a hung parliament would have to make concessions on labour rights and possibly customs union membership to secure support for its withdrawal agreement.

Labour, say in power with the support of the Scottish National Party, would negotiate a softer Brexit and put it to a second referendum, opening up the prospect of a very long goodbye. In all cases, of course, we are not talking about “getting Brexit done” but merely bringing an end to the first phase. It is not a happy thought but there are years to come of this.

The question is what we should be hearing from the parties apart from Brexit. How do we prepare for a successful post-election and, eventually, a post-Brexit economy?

I commend, in this regard, the efforts of the newly-formed Policy Reform Group (PRG), whose recommendations are published under the auspices of the National Institute of Economic and Social Research (NIESR). The group includes John Llewellyn, Jeremy Greenstock, Russell Jones, Andrew Gowers, Preston Llewellyn, Nick Greenstock, Gerald Holtham, Terry Scuoler and Rhys Bidder. A range of other authors has contributed to its policy ideas.

John Llewellyn, a former chief economist at the Organisation for Economic Co-operation and Development (OECD), who now runs his own consultancy, says that nobody else has attempted such a comprehensive review of UK policy-making, which includes recommendations not in the economic sphere. He is also aware that most people will not agree with all of the PRG’s ideas, called Beyond Brexit: A Programme for UK Reform but that the aim is to stimulate debate.

Let me take five of the proposals. Readers wanting more can find them in the latest National Institute review, published last week. The first proposal is, I think, uncontroversial, which is that Britain, still operating with 20th or even 19th century infrastructure, needs an urgent renewal of energy, water, transport and communications infrastructure. Sajid Javid, the chancellor, planned to announce a big rise in infrastructure spending in the “budget that never was” on November 6.

Historically, the UK has invested too little in infrastructure. The remedy is to set a target of 3.5% of GDP, which the OECD regards as the norm for developed economies, for public and private sector infrastructure spending. Currently the UK spends just over 2% of GDP. The National Infrastructure Commission could, the report says, evolve into a National Investment Bank, with infrastructure bonds used as source of funding.

Housing is infrastructure and another set of suggestions from Kate Barker in the report, is for redesigning housing policy. Barker, who undertook reports on housing supply for the last Labour government, when she was a member of the Bank of England’s monetary policy committee, advocates an increase of 100,000 a year in the number of social homes being built, to alleviate the “real and acute” crisis, particularly at the bottom of the market.

Though she is on the board of Taylor Wimpey, the housebuilder, she also advocates the winding down of the “much-criticised” Help to Buy scheme, to be replaced by a capital sum for young people which could be used towards the purchase of existing as well as new homes.

More radically, recognising that neither of these proposals would be a panacea, Barker also advocates a change in the tax treatment of owner-occupied housing, to include a wealth tax or capital gains tax on the profits made from rising house prices. Nothing, it should be said, is more guaranteed to produce a wailing and gnashing of teeth among homeowners.

Another strand of ideas which caught my eye was what to do when monetary policy has lost its potency. The authors do not favour raising the inflation target, discussed here recently. They do think that fiscal policy needs to take on more of a role. Older readers may recall that fiscal fine-tuning used to be in vogue, varying taxes and public spending to smooth the economy’s path. The “regulator” allowed chancellors to vary indirect taxes by up to 10% for this purpose. It fell into disuse with the rise of monetarism in the 1970s and 1980s.

There may be a case for it to make a comeback, in an era of very low interest rates. There may also be a case for more dramatic measures. The authors touch on the idea of “helicopter money”; electronically created money handed out to boost demand in a downturn rather than used to purchased gilts as under quantitative easing. More interesting, perhaps, is the idea of keeping markets onside by creating a special emergency fund, used only in downturns. The very good idea underpinning this is that governments should have their weapons ready in advance, not improvise when trouble hits.

If we are going to make the best of the future, improving skills, a long-term Achilles’ heel for Achilles heel for Britain will be vital. Skill levels, particularly basic and intermediate skills, compare badly with other countries. The government’s experiment with technical A-levels, T-levels, is not going well.
The report calls for” the enhancement of active labour market policies, especially for 16–24 year-olds and low-educated/low-skilled job seekers, closer to best practice in OECD countries. They should be buttressed by substantial investment in lifelong learning, with a focus on upskilling workers.”

I have left one idea until last, because I know it will provoke a response from people who, irrationally, have come to regard the EU’s single market, a proud legacy for Margaret Thatcher, as something to be avoided at all cost.
That is not so, or it should not be. “The EU single market is the world’s largest free trade area, and the UK’s closest,” the authors say. “Staying closely integrated with it is the most important measure that the UK can take to ensure that trade continues to be a positive force for its living standards.

“There are new and rapidly growing markets beyond Europe, but most are small. And the UK already has, by virtue of agreements concluded on its behalf by the EU, access to all but 17% of the global economy. Meanwhile, international trade is at growing risk from protectionism and attacks on the international institutions.”
Perhaps it is too late for a rapprochement with the single market, or perhaps our future relationship with the EU is more up for grabs than it sometimes seems to be. We shall soon see.

In choosing these ideas, I have left a lot out, including a suggested programme for decarbonising the economy and for spending significantly more than 2% of gross domestic product on defence. But these are the kind of ideas we should be discussing over the next few weeks, not just watching a Brexit Punch and Judy show.

Sunday, October 27, 2019
All dressed up for the budget, but nowhere to go
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 all the years I have been covering budgets, I cannot remember the run-up to one, for that is what until Thursday night we were in, to be quite as odd as this. Maybe that was why the usual full pre-budget speculation mode, my e-mail inbox overflowing with budget demands from everybody from the CBI, Institute of Directors and British Chambers of Commerce to the Federation of Licensed Victuallers Associations, was more muted than normal.

The budget, it seems, has fallen foul of the government’s parliamentary game-playing, cancelled because of the opposition’s expected refusal this week to go along with the prime minister’s plan for a general election on December 12.

Incidentally, I know that many people reading this are thoroughly fed up with what seems like a never-ending process for what, after all, is only the first stage of Brexit, and blame a “Remainer” Parliament for its dithering and delay. In fact, if it is to be a missed deadline, the blame for that lies squarely with Boris Johnson and a gimmicky Downing Street operation, whose gimmicks have all failed.

The prime minister, with very little time on his hands, wasted it with an initial policy of not talking to the EU, an unlawful prorogation of Parliament and then a very late set of proposals which were swiftly amended when unacceptable to Brussels. To expect Parliament to rush his deal through to meet his vanity project of leaving on October 31 was a final push too far.

We should be glad that the courts, and Parliament, have prevented a government from riding roughshod over convention and proper procedure. This not a pro or anti-Brexit point; once this has happened once a future government could use the precedent established for more sinister purposes.

The need for proper Parliamentary scrutiny, by the way, is underlined by the fact that neither the prime minister nor his Brexit secretary appear to understand what they have conceded on Northern Ireland and what it will mean for business. Details matter.

Anyway, back to the non-budget and at times like this, I feel sorry for Sajid Javid, the chancellor. On Wednesday he was reassuring Robert Peston on ITV that there would be a budget on November 6, and that the only circumstances in which there would not be a budget on November 6 would be if Britain left the EU without a deal.

The chancellor, who had a rushed one-year spending review imposed on him by 10 Downing Street last month has now had the budget cancelled from under his feet.
I also feel sorry for Treasury and Office for Budget Responsibility (OBR) officials who were hard towards the expected budget in 10 days’time. Whether we will see the fruits of their labours remains to be seen, though under the Industry Act the government is required to publish two official forecasts a year, and there is not that much time left.

The question is whether this postponed budget is a lucky escape for the public finances. After all, we had one pre-election giveaway in the spending review last month, in the form of a £13bn-plus spending boost for next year.

The backdrop to the Treasury’s preparations, frustrated as they now are, was that, for the first time in many years, the public finances are deteriorating. Borrowing last month was up on a year earlier and, in the first half of the fiscal year, the government borrowed £40.3bn, an increase of £7.2bn, or 22%, on the corresponding period a year earlier. Not for five years has April-September borrowing shown a rise.

The danger is of more of this to come. George Buckley, an economist with Nomura, the Japanese investment bank, warned of a “perfect storm” for the budget deficit. “The chancellor has already announced a significant increase in spending, more loosening could come in the budget – and on top of that the ONS (Office for National Statistics) has changed the way it accounts for student loans,” he wrote last week. “All of these may conspire to raise the 2020-21 deficit substantially from the spring statement forecast of around 1% of GDP, possibly creeping towards 3% of GDP.”

The chancellor had an answer to this, which was that his priority in the budget would be infrastructure spending, which generates long-term gains for the economy, rather than tax cuts to offer a short-term political boost.
Javid’s commitment to more infrastructure spending is genuine and longstanding, and his frustration on being able to deliver on it must be considerable. He sees the combination of very low borrowing costs for government and the need to add to and renew transport, social housing, hospitals and schools in Britain as a no-brainer. When he was in the leadership contest he talked of an additional £100bn over five years. He has talked more recently of an “Infrastructure revolution”

There was also, emerging in Treasury thinking, a way to do this, while remaining true to fiscal rules, and respecting the need to control the budget deficit. The thoughtful and somewhat complex way of doing this, highlighted by Richard Hughes and his colleagues at the Resolution Foundation, will be discussed at an event this week. This one, at least, has not been cancelled.

This approach, that the fiscal rules should target the public sector’s balance sheet, by focusing on its net financial liabilities or the intergenerational balance sheet, which would include the present value of future tax and spending commitments, has a lot to be said for it. Most relevant to a government intending to spend more on infrastructure would be to target public sector net worth; all financial and non-financial assets and liabilities pf the government. This would show the virtue of borrowing to invest.

The main drawback was that a net worth target, while sensible, might be difficult to implement immediatelly, partly because of data shortcomings. Scrapping the fiscal rules would be risky, economically and politically.

More straightforwardly, for a government that had not had too much time to think about these things, Ruth Gregory of Capital Economics suggested that the government could simply focus on balancing the current budget, excluding investment, alongside a secondary commitment to reducing debt relative to GDP.

The current budget was in small surplus last year, 2018-19. Such an approach, she suggests, could allow an immediate infrastructure boost of £32bn, or 1.5% of GDP.

All this was ready to roll, and one would hope that the effort has not been wasted. Brexit has cast its deadly spell again.

Sunday, October 20, 2019
Can the next Bank governor avoid negative interest 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.

Is there a light at the end of the tunnel? Can we, for a time, focus on something else than Brexit? Yesterday’s vote in the House of Commons suggested that we may yet have to wait a while before sounding the all-clear, but the omens are better than they were, though the long-term implications of the prime minister's approach, discussed here last week, will still have to be taken into account.

In an election, which must come soon, the Tories will now be campaigning on their deal, the revised withdrawal agreement and what looks like a permanent “backstop” arrangement for Northern Ireland concluded with the EU last week, rather than a no-deal Brexit. The risk of the most destructive form of Brexit, crashing out without a deal, has diminished further. The government moved quite a lot in the last couple of weeks to avoid a no-deal Brexit and the EU moved a little. That is a good thing.

We analyse all this and the implications of yesterday’s parliamentary business, elsewhere in today’s paper. Let me instead focus on the possibility of other things happening once the Brexit logjam is cleared. Sajid Javid, the chancellor, has announced that should a deal with the EU be concluded, and that Britain leaves on October 31, his first budget will come less than a week later on November 6. We shall see.

The other aspect, which I wanted to concentrate on today, is the Bank of England. The Bank is awaiting the announcement of a new governor to replace Mark Carney, who may yet have a future in Canadian politics, and they should have known by now.

The chancellor has insisted that the process is on track to have a new governor in place by February 1 is “on track”, though that merely repeats the language used by Philip Hammond, his predecessor. He thought it best to leave the task to his successor. The complication for Javid is that, if there is to be an election, appointing the next governor ahead of a potential change of government could handing them a poisoned chalice.

I would love to be able to tell you today who the new governor is going to be. But most of the candidates have been keeping their heads down and, as far as I know, are as much in the dark as any of us. Most of the bookmakers who were taking bets on it appear to have lost interest.

One potential candidate who has raised her head above the parapet, the “superwoman” fund manager Helena Morrissey, wrote in the Spectator that a prerequisite for success is “a willingness to think about old problems in new ways”. I tried that one in an interview once.

She comes over as a bit of a devaluationist in hoping the Bank “will recognise the fantastic opportunity for export-led growth” offered by the pound’s referendum fall. As someone who has ploughed through more of the Bank’s analysis than I care to remember, I can confirm it has been looking very hard for such growth in the past three years.

Morrissey wants the new governor to be convinced that Britain has a bright future. Carney certainly did when he became governor in 2013, though his optimism has been tested more recently.

Perhaps most interestingly of all, Morrissey thinks the next governor should have no truck with negative interest rates. That is a hot topic among central bankers. One of the European Central Bank’s key interest rates, the deposit rate, has gone even more negative, at -0.5%. The Bank of Jpaan has had negative interest rates for some time.

And, while the chances of the Bank being forced into emergency action by a no-deal Brexit have faded, it is still the case that if and when the next recession comes, the Bank will go into it with much lower interest rates than in the past. The IMF has warned of a synchronised global downturn, and that this year's growth will be the weakest since 2009.

At 0.75%, Bank rate compares with 5.25% when the last recession struck, and 15% for the one before that. In both of those previous cases, the response was to cut official interest rates by roughly 5 percentage points. You do not need a calculator to work out that a similar response now would take interest rates into heavily negative territory.

A new collection of essays published by the National Institute of Economic and Social Research (NIESR), Renewing Our Monetary Vows: Open Letters to the Governor of the Bank of England, is therefore timely.

One, from Charlotta Groth, global macroeconomist with Zurich Insurance, sets out a series of actions the Bank could take to avoid being pushed into negative interest rates. They include more aggressive use of unconventional policies such as quantitative easing (QE), before that point is reached.

The Bank gets very exercised about suggestions that QE has increased inequality, which it has not. It as, as Groth points out, more ammunition at its disposal than other central banks; QE in Britain is equivalent to around 20% of gross domestic product (GDP), compared with 40% for the European Central Bank (ECB) and over 100% for the Bank of Japan and Swiss National Bank. But, while QE has focused on purchases of government bonds, gilts, future QE may need to include risk assets.

An even more radical suggestion, which some central bankers are attracted to, is avoiding ultra low and negative rates by targeting a higher rate of inflation. Richard Barwell of BNP Paribas and Tony Yates, a former Bank of England adviser, argue in their essay that “four is the new two” and that serious consideration should be given to raising the inflation target from 2% to 4%.

The original UK target, set in 1992, was 1% to 4%, they remind us, with a long-term aim of 2% or less. It has not been properly reviewed in more than a quarter of a century. Their most pressing argument for change is one that was not even considered in the early 1990s, a time when double-figure interest rates were the norm. This was that the so-called “zero lower bound”, and the question of whether official rates should ever go negative, would become an issue. Nobody believed then, or for that matter until 2008-9, that interest rates could ever go as low as they are now. “Raising the inflation target reduces the probability that the economy will arrive at the lower pound in the first place,” they write.

It would be a big step, and one that would have to be done in co-ordination with other countries. When the original target was introduced few believed the UK could meet it but it has, particulalr in the period since Bank independence in 1997, since which time inflation has averaged exactly 2%. Getting to 4% from current low inflation rate – 1.7% in Britain – would require an effort.

But these and other ideas provide food fro thought for the new governor. Whoever he or she may be.

Saturday, October 12, 2019
The long and the short of Johnson's Brexit deal
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 shift from extreme pessimism to optimism in recent days over an early agreement on the terms of Brexit was as sudden as it was welcome. Sterling, that reliable Brexit barometer, led the celebrations, with tis best two-day performance in a decade, though I note it is only back to where it was when Boris Johnson succeeded Theresa May as prime minister.

A lot has changed. It seems there will be a customs as well as regulatory border in the Irish Sea, though complex arrangements will still allow Northern Ireland to benefit from an tariff reductions negotiated by the UK in trade deals. The Democratic Unionist Party will not have a sole veto on regulatory alignment between Northern Ireland the EU. The Johnson backstop is a variation on May’s but may yet be workable - and indeed is similar to what the EU proposed some time ago - and for the first time the prime minister has shown some statesmanship. We will see this week whether there are further lurches on the rollercoaster.

The government, sensibly, wants to avoid a no-deal Brexit, as do Ireland and the EU, and the Institute for Fiscal Studies reminded us a few days ago why. Its green budget, in conjunction with Citi, showed that no-deal would lead to recession, and an economy 2.5% smaller than otherwise after three years. Add that to the effect on the economy of the referendum itself, and there is a 5%-6% hit to gross domestic product over six years.

Under a no-deal, the government would also borrow a lot more. The IFS has added the extra public spending announced by Sajid Javid to the effects on the public finances of a no-deal, to estimate that by 2021-22 the government will be borrowing around 4.5% of gross domestic product (GDP), or more than £90bn, and government debt will be up to more than 90% of GDP.

The short-term matters; the long-term even more. Amid all the excitement over the cliff-edge, and the need to avoid falling over it, the long-term consequences of the kind of future trade deal with the EU envisaged by the Johnson government, if it is around for long enough to negotiate one.

I am indebted therefore to the think tank, The UK in a Changing Europe, which has filled an important gap in our understanding. Its report, The Economic Impact of Boris Johnson’s Brexit Proposals, will be published this week. It has been written by Hanwei Huang, Jonathan Portes and Thomas Sampson, with contributions from Matt Bevington and Jill Rutter. The think tank is based at King’s College, London, but the report also used the trade model developed by the Centre for Economic Performance (CEP) at the London School of Economics.

The Johnson proposals differ from those envisaged by Theresa May’s government in a number of important ways. While she committed to maintaining similar regulatory standards for agriculture and manufactured goods, and a “level playing field” on labour and environmental standards, the Johnson government has said it wants flexibility. May would have kept the whole of the UK in a customs territory with the EU.

Taking these and other differences into account, the think tank concludes that while the May government could have negotiated a future “Canada-plus” (or even plus-plus) trade agreement, or perhaps something even closer such as Turkey’s deal with the EU, the Johnson red lines will only allow a “bare bones” trade agreement, which they describe as Canada-minus. The UK, in other words, would have a trade agreement which is less comprehensive than that negotiated between the EU and Canada. Tariff would be eliminated but significant non-tariff barriers would be in place. It would be a long way from what business currently enjoys as a result of single market membership.

You do occasionally hear some economically illiterate nonsense which suggests that the EU single market has not been good for Britain. Those who argue this should not be allowed anywhere near statistics. The fact that, for example, trade between China and the EU has grown faster than that between Britain and the rest of the EU since the single market came into being in the early 1990s simply reflects the reality that one (China) started from a very low base while the other (Britain) began from a position in which there was already a high degree of trade and integration.

The single market matters for trade and Britain’s ability to attract inward investment. Losing it will come at a cost. Simulating the effects of Johnson’s proposals is not straightforward, given that there has been a lot of vagueness about them. The economists are keen also to point out, as I always do when reporting these exercises, that they are not conventional forecasts.

They cannot tell you precisely what will happen to the economy over the next 10-15 years, which will depend on many factors. But, just as a doctor can tell you that if you smoke 50 a day and eat a lot of fatty food, you will be less healthy than otherwise, they can tell you that if you take actions which inhibit trade, your economy will be smaller than otherwise. One of the things you might do, negotiate trade deals with other countries, will by the way have a relatively small effect; 0.1% to 0.2% of GDP after 15 years according to the government’s own long-term assessments.

There are three separate elements to this new assessment of the Johnson proposals. The first is the impact on trade of imposing greater barriers on trade with the EU than currently exist. The second is the related effect on productivity, with a clear relationship between reduced trade intensity and productivity. The third, and this is where the Johnson proposals could offset some of the negative effects of the first two, is immigration. Immigration, particularly immigration of skilled workers, boosts productivity. The more that it is restricted, the more that productivity and living standards will suffer.

The overall conclusion is that the future relationship envisaged by Johnson is worse for the economy and the public finances in the long run than the May plan, though not as bad as a no-deal Brexit.

So, the first two factors produce the result that after 10 years, income per head is 6.4%, or £2,000, lower than it would be if we stayed in the EU. That compares with 4.9% under the May plan and 8.1% under a no-deal.

The more liberal immigration regime hinted at by the prime minister would bring that fall in per capita incomes down a little, to 5.8%. But if he was as restrictive as May intended to be, the drop would be bigger, at 7%.

As for the public finances, the IFS has warned of short-term no-deal damage, and the UK in a Changing Europe report calculates that even a deal along the lines Johnson suggests would do some significant damage in the long run. Depending on whether the future immigration regime is liberal or restrictive, annual borrowing in 10 years will be between £40.5bn and £48.8bn higher, compared with £38.8bn under the May plan and £60.7bn under no-deal.

These are significant sums. Brexit is about more than economics, as the think tank says, and some people do not care too much about the long-term. But they should.

Sunday, October 06, 2019
This deal isn't flying, but no-deal still has to be grounded
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.

By now you will be pretty fed up of hearing about the Irish backstop, and I do not intend to prolong the agony for too long today. Boris Johnson promised to get rid of it but, as was always likely, has instead suggested a revised version of it.

The government’s proposals are thoughtful, and in some respects ingenious, and when the inevitable general election comes will be regarded by many voters in the UK as reasonable, and any rejection of them by Ireland and the EU as unreasonable, which is perhaps the intention, but it is also pretty obvious what the flaws in them are.

Voters in Northern Ireland wanted to remain in the EU and a majority was in favour of what the Johnson government called the “undemocratic” backstop. Northern Ireland businesses were even more in favour of both. So we should listen to political parties other than the Democratic Unionists and to businesses in the province when they strongly oppose the government’s “two borders” approach in its new backstop; a regulatory border between the mainland and Northern Ireland and a customs border, if not actually at the border, between north and south.

We should also take note of the fact that allowing the Northern Ireland assembly a veto, then approval or disapproval every four years over whether Northern Ireland maintains regulatory alignment with the EU, does not respect the integrity of the single market.

Agreeing on permanent Northern Ireland membership of the single market would, I think, provide it with an enormous economic benefit, enough to result in similar demands from Scotland, and possibly Wales. If that were to happen, for Northern Ireland, support for the deal from the DUP would evaporate, but the EU would have less reason, though still some reasons, to oppose it.

Anyway, we will see how it goes. The closer you get to a date, the riskier it is to predict events. When Theresa May was prime minister, “nothing has changed” became a cliché and a bit of a joke. For those who watch Brexit developments for the financial markets, however, the Johnson backstop proposals are not a game-changer.

Malcolm Barr of J P Morgan, one of the City’s most assiduous Brexit-watchers, sees only a 5% probability of an orderly Brexit on October 31 based on the Johnson proposals and a 10% chance of a no-deal Brexit. The prime minister says he will die in a ditch rather than delay Brexit beyond the end of the month but that leaves an 85% probability that the Article 50 process will in fact be extended, whether he asks for it or not. Most of that 85% is based on the expectation of a pre-Brexit general election later in the year. A second referendum is given the same overall probability (10%) as an early no-deal Brexit.

All of which raises the question of when, if ever, the country should ready itself for a no-deal Brexit. There is a chance, as noted that it happens in 24 days’ time, and Downing Street is looking for ways to frustrate the Benn Act, intended to prevent it, and leave “do or die” on October 31. But most observers think the Act is watertight and, while there is some evidence from surveys that factories are engaging in some stockpiling, it is on nothing like the scale of earlier this year, in the run-up to the original March 29 Brexit deadline.

We should not, however, dismiss the possibility of a no-deal Brexit, though at a later date. The circumstances in this would be most likely to arise would be a general election which results in a Tory majority – more or less what the polls are suggesting this time – and with at least some of the anti no-deal Tory rebels no longer in the House of Commons. This would give the prime minister a much freer rein, which could include taking the UK out of the EU without a deal at the end of January.

If so, then whenever it happens, according to Sajid Javid, there will be a policy response ready and waiting. The eyecatching announcement in the chancellor’s Tory conference speech was a commitment to raise the national living wage to £10.50 an hour over five years, which attracted a mixed-t-hostile reaction from business.

He also said that he had “tasked the Treasury with preparing a comprehensive economic response to support the economy”, and that “working closely with the Bank of England, we’re ready to draw on the full armoury of economic policy if needed”.

That makes sense. Compared with the breezy assurances from other ministers, including the prime minister, that it will be alright on the night, the chancellor is at least acknowledging that there will be a no-deal economic shock to be countered, and is examining ways of doing so.

Though the economic impact would not be on the scale of the financial crisis more than a decade ago, some of the elements of the policy playbook from that period could be deployed. So the Bank of England would cut interest rates, as is now acknowledged by most members of its monetary policy committee, may unveil another round of quantitative easing (QE) and ensure there is an adequate supply of liquidity in the system.

Unlike in 2007, however, the scope to cut rates is limited; then they were at 5.75%, now 0.75%, and QE, then a novelty which had an impact, has now lost much of its power.

As for the Treasury, a decade ago it cut VAT by 2.5 percentage points, had a car scrappage scheme and announced some immediate additional infrastructure spending. These days, it is said, there are more “shovel ready” infrastructure projects ready to go than then. But it is not clear that trying to boost consumer spending by cutting VAT would be the appropriate response when a demand shock to the economy is accompanied by a supply shock. This is also why Mark Carney has warned people not to expect too much of monetary policy in the event of a no-deal Brexit.

This is why a “comprehensive economic response” to a no-deal Brexit would have to include direct support to businesses, and to farmers, to ease them through the immediate impact of a no-deal Brexit. Indeed, the government has a name for this, Operation Kingfisher. Alongside Operation Yellowhammer it suggests, if nothing else, that somebody in government is a bird fancier.

The trouble is with this that for many businesses, and farmers, short-term support will not be sufficient to cope with something that has broken their business model. The Johnson version of the backstop has not taken a no-deal Brexit off the table. Something needs to do so.

Sunday, September 29, 2019
Corbyn's not popular, but many of his ideas are
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.

Boris Johnson and Jeremy Corbyn are, on the face of it, about as far apart as it is possible for two political leaders to be. There is no love lost, and very little common ground. Or perhaps not. People say to me that we have prime minister and worst opposition leader, simultaneously, in living memory.

Whether that is true or not, the similarities could be greater than the differences. Neither, for example, has a credible or workable plan for leaving the European Union.

The Johnson plan, or non-plan, began with a demand that the EU remove the Irish backstop from the withdrawal agreement or there would be no talks, then decided it was better to talk even without that commitment from the EU, and now appears to be based on offering reheated proposals from the Theresa May era which have already been rejected by Brussels.

Leaving with no-deal, which has been rejected by Parliament, becomes the alternative, even though the prime minister is required by law to seek an extension of Britain’s EU membership if he fails to conclude a deal by October 19. Nothing is guaranteed, including his government’s respect for the rule of law, and it may be that the government is trying to provoke the EU into not agreeing an extension.

But it is a strange way to proceed. Before Johnson became prime minister, many offered the assurance that once he took office he would, as when London mayor, surround himself with sensible people. If so, they must be locked in the Downing Street bunker.

Ministers, meanwhile, are subject to no-deal delusion. I hear quite a lot from business people who have meetings with ministers that it has become a dialogue of the deaf. When Michael Gove told the House of Commons that the retail and auto sectors were ready for a no-deal Brexit, he had clearly been attending a different meeting from the one they were at.

Those sectors have publicly put him right and a new survey from the Federation of Small Businesses shows that of the two-fifths of firms who think a no-deal Brexit will hurt them, only a fifth have properly planned for it. Two-thirds say that, given the range of uncertainties, they do not think it is possible to plan.

Labour’s Brexit position is no more credible. A Labour government, it seems, would quickly break the negotiating impasse and conclude a deal. Then it would offer this deal, against the alternative of staying in the EU, in a referendum.

But, apart from the fact that swiftly-concluded deal and Brexit are a contradiction in terms, it is hard to see how such a proposal would come anywhere near providing Leave supporters with a democratic outlet. After getting through a withdrawal agreement, Labour would want to stay in the customs union and single market, which for some reason have become anathema to many Brexiteers, much more so than they were three years ago.

Labour backs freedom of movement and, indeed, appears to want to extend it beyond the EU. Its referendum offer would be seen by voters as near-EU membership versus actual EU membership. For many Leavers, if it ever came to that, that would be no choice at all.

Beyond Brexit, the similarities between Johnson and Corbyn go further. Gone are the days when the choice was between a fiscally responsible Tory party and fiscally incontinent Labour. Tories used to be able to lambast Labour’s unfunded proposals.

No more, if we do have an election this autumn, it will be a contest between very large unfunded proposals. As I noted last week, the case for the greater use of fiscal policy is now made. But this is different from splashing the cash as if there is no tomorrow, and we can be sure that both parties will be doing it.

It remains to be seen how much this week’s Tory conference, which has been rained on by the Supreme Court’s rejection of Johnson’s prorogation of Parliament, has in the way of big and expensive new proposals. But we have already seen more than £13bn of extra public spending for next year announced by Sajid Javid, the chancellor, and the government has big ideas about raising the higher rate income tax threshold from £50,000 to £80,000, taking the low paid out of National Insurance (NI) and removing stamp duty from property purchases under £500,000, as well as spending a lot more on infrastructure.

The tax threshold plan would cost £8bn a year, according to new research from the Institute for Fiscal Studies, while increasing the NI lower limit to £12,500 to remove the lower-paid from it would carry a £17bn annual bill. That is a lot of money and, as I say, there may be more to come.

Labour, which has had its conference, announced another tranche of spending proposals. They included free personal care for all over-65s and the abolition of NHS prescription charges. It can only be a matter of time before Labour goes back to the free dental care and glasses that were a feature of the 1948 National Health Service.

Whether they do or not, one element of Labour’s proposals is that private sector businesses will pick up the bill, for example for the shadow chancellor’s idea of a 32-hour working week. When some years ago, France adopted a 35-hour maximum working week, we all scoffed. Now Labour wants to go one better. I have no axe to grind on behalf of independent schools but I would be concerned about proposals to fold them into the state sector.

It may be that none of these ever see the light of day. Corbyn is a populist, but he is an unpopular one, though two City firms, Citigroup and Deutsche Bank, have suggested that a Corbyn government which remained in the EU would be better for the economy than a Tory administration which left without a deal.

Disturbingly for business, for me, and for many people who read this column, Labour’s proposals are popular, even if the party under Corbyn is not. Policy for policy, a £10 an hour minimum wage, replacing universal credit, renationalising the railways and the utilities, free care for the over-65s, getting rid of prescription charges, abolishing university tuition fees (very popular in the 2017 general election) and increasing income tax for the highest paid, do better in polls than Tory ideas for increasing the higher rate threshold, cutting stamp duty or taking the low paid out of NI.

When both parties are splashing the cash, it matters who has the better vote-winning ideas. The Tories have work to do on many things, and this is one of them.

Saturday, September 21, 2019
Let's get fiscal, but avoid the mistakes of the past
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 a busy month for central banks. A few days ago America’s Federal Reserve cut official interest rates by a quarter of a point, citing weaker business investment and exports. A few days before that, the European Central Bank (ECB) announced what its chief economist described as a comprehensive package of measures, which included a cut in one of its rates, the deposit rate, from -0.4% to -0.5% and the resumption of quantitative easing (QE) at €20bn (£17.7bn) a month from November.

Neither decision was without controversy. The Fed split three ways, with one member of its decision-making committee favouring a bigger rate cut and two none at all. The ECB’s moves produced much tut-tutting, particularly from Germany and the Netherlands, with the head of the Dutch central bank, Klaas Knot, saying they were “disproportionate to the present economic situation”.

On one thing, however, central bankers can agree, and this also applies to the Bank of England though it, as expected, did not join in with the others in changing interest rates on Thursday, though its tone was noticeably more “dovish” than before.

It is that there is a limit to what central banks can do. Monetary policy had its moment a decade ago, when the financial crisis hit, and it has continued to have its moments since then, with ultra low interest rates and very large dollops of quantitative easing (QE). But the fact of that action, which leaves little room for rates to be cut further, and amid convincing evidence that QE has lost the potency it once had, means the focus is shifting and, according to some central bankers, should shift further. Fiscal policy – public spending increases and tax cuts – needs to play a bigger role.

Mario Draghi, the outgoing ECB president, has been most vocal on this. “It’s high time fiscal policy took charge,” he said last week. “If fiscal policy had been in place, or would be put in place, the side effects of our monetary policy would be much less.”

This is a particular issue in Europe, where a debate is raging in Germany about fiscal po0licy and the country’s balanced budget rule. Its finance minister Olaf Scholz has said that Germany is ready to provide a stimulus of “many billions” should recession make it necessary.

The argument, however, goes beyond Europe. The Organisation for Economic Co-operation and Development (OECD), in a new interim economic outlook which was downbeat about UK growth prospects – 1% this year, 0.9% next, and much worse if there is a no-deal Brexit – also made the fiscal point.

Loose monetary policy, it said, should be accompanied by fiscal policy, it said, adding: “Fiscal policy needs to assume a bigger role in supporting growth in the advanced economies. Exceptionally low interest rates provide an opportunity to invest in infrastructure that supports near term demand and offers benefits for the future.”

For the Federal Reserve and the Bank, the point barely needs making. Though Mark Carney, the Bank governor, has made the point that there are limits to what the Bank can do, particularly in the event of a no-deal Brexit, a significant fiscal relaxation is already taking place. Bank economists estimate that Sajid Javid’s spending review this month, which boosted public spending next year by more than £13bn compared with previous plans, will add 0.4% to Britain’s gross domestic product over the next three years.

As an aside about the Bank, I had in my diary November 7 for Carney’s final inflation report press conference but now it seems as if that date could come and go without his successor being announced. Political uncertainty, it appears, means governor uncertainty, with the appointment of a new one possibly delayed by the prospects of a late autumn general election. I don’t imagine that he wants to extend his stay for any longer than necessary, but the chances of his still being there when the Bank publishes its February inflation report (he was due to leave at the end of January) have increased.

The Federal Reserve, which has now switched to cutting rates, based its earlier hikes partly on the fact that Donald Trump, who putting it mildly is no fan of the Fed, had unleashed his own fiscal expansion, mainly through tax cuts. Now the president’s policies, notably his trade war with China, are slowing the US economy, but already this fiscal year the budget deficit has topped $1 trillion (£800bn).

Trillion dollar deficits now extend into the indefinite future in America, even though the president’s plan to transform US infrastructure has yet to see the light of day.

The logic of a shift towards more activist fiscal policy in Europe, including Britain, looks incontrovertible, even though Germany is moving to this understanding very reluctantly. Austerity fatigue set in some time ago, and borrowing costs are low. That is why, as well as some tax cuts later this autumn, the chancellor is keen to announce some meaty increases in infrastructure spending next year.

When, however, do we start to worry that governments are repeating the errors of the run-up to the financial crisis? Then, you will recall, public finances were vulnerable going into the downturn and the subsequent fiscal repair job was all the more demanding, and longer lasting. Only now, a decade on, have we seen a meaningful public spending relaxation in this country.

America looks to be an outlier in this; Trump’s tax cuts were big and expensive and the budget deficit is running at 4% of GDP even at the top of the cycle. Britain is different. The underlying, or “structural” budget deficit is running at just over 1% of GDP, despite what looks like an overshoot this year. That compares with an average of 3.3% of GDP in the four years leading up to the crisis. There is room for manoeuvre, which the government seems determined to use.

The main argument here is one of timing. The Office for Budget Responsibility (OBR) has warned of a £30bn annual hit to the public finances in the event of a no-deal Brexit; in other words an £30bn or roughly 1.5% of GDP boost to borrowing.
The Resolution Foundation, in a new report, suggests that a no-deal would require a £60bn policy response; £40bn as a straightforward fiscal boost to increase demand and help the economy to avoid a deeper recession, and £20bn in “emergency supply support” to help businesses through the worst of any disruption.

The actual policy response would depend on the extent of the damage. One reason why Philip Hammond, Javid’s predecessor, held back was to keep some powder dry in the event of needing it to respond to a no-deal downturn. A government that went into such a downturn with the fiscal afterburners already turned on would risk a double hit to the public finances.

One way or another we are getting a fiscal relaxation, and that is no bad thing. But, as I am sure the Treasury is reminding the chancellor, the line between a responsible loosening of fiscal policy and something that stores up big problems for the future is a narrow one.

Sunday, September 01, 2019
The record pay squeeze is over - but maybe not for 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.

Plenty of crazy and alarming things are happening in British politics but, leaving those to others for now, and turning to a slightly happier story, we are on the cusp of a rather different and significant moment, and it has been a long time coming. Within the next few weeks regular pay in Britain, in real terms, should finally move above pre-crisis levels. The longest pay squeeze in modern times – even exceeding one during the Victorian era - will be over. Bring out the bunting.

Currently, regular pay in Britain, adjusted for inflation. Is just 0.8% below the level established in April 2008, more than 11 years ago. It has been a lost decade and more for pay and, as I say, we have not seen anything like this in modern times. Nobody back then could have imagined that the hangover from the crisis would last so long.

The reason we can expect this milestone to be passed is that we have returned, decisively, to meaningful increases in real wages. Regular pay is currently rising by 3.9% a year in cash, or nominal, terms, against an inflation rate of 2.1%, making for real wage rises of nearly 2% a year.

Though you would not know it from the gloomy noises coming from Britain’s high streets, some of which verge on the suicidal, this is good news for consumer-facing businesses. It helps explain why official retail sales figures show a 3.3% increase on a year earlier while, even in a slow-growing economy, consumer spending in the second quarter was up by 1.8% on a year earlier. Along with government spending, the consumer is what is keeping the economy going. If it were not for weak Brexit-related consumer confidence, lower now than in the immediate aftermath of the referendum according to Gfk, the consumer would be keeping the economy going more.

That 3.9% figure is shared by the public and private sectors, which is also worth noting. Part of the reason for the lost pay decade was the austerity-driven squeeze on the public sector, which included periods both of pay freezes and below-inflation settlements for public employees. Now, partly helped by the timing of the latest National Health Service pay settlement, public sector sector pay is rising at its fastest rate since May 2010, the dawn of the coalition government’s age of austerity under David Cameron and George Osborne.

It has been anything but a tea party for private sector workers during this period, of course. Pay settlements lurched downwards in the wake of the financial crisis and have taken years to recover to anything like pre-crisis norms. People chose the security of a job over above-inflation pay awards, collectively pricing themselves into work, until the labour market became tight enough to force the hand of employers.

Many economists expected that hand to be forced well before this, and that the traditional Phillips curve relationship between unemployment and wage rises would have kicked in before now to give us 4%-plus wage rises. The lower the unemployment rate, the greater the upward pressure on pay, in normal circumstances.

The circumstances of the past decade have not, of course been normal. Apart from unemployment and a tight labour market, the other moving part in this is productivity. Broadly speaking, firms can afford real wages of 2% a year if productivity is rising at a similar rate, which is its historic average. Productivity is the route to rising prosperity.

But productivity, as you will know, has not been rising. The main measure, output per hour, was only 0.5% higher in the first quarter of this year, the latest figure, than at the end of 2007. It has fallen fractionally over the past year and looks to have suffered a bigger drop in the second quarter of this year. It is going nowhere fast.

That is one reason to be cautious about the extent to which the current pay revival can be maintained. Pay rises that are not matched by productivity gains are unlikely to be sustainable, and have already got the Bank of England twitchy about their inflationary consequences. At some stage there will be a productivity revival and, as far as the outlook for pay is concerned, it cannot come soon enough. But it is not there yet, and is not in sight.

It is only fair, too, to point out that while regular pay is closing in on pre-crisis levels, there is some way to go before that is true of total pay, including bonuses. Average total pay still has some way to go before it catches up with the previous peak, achieved in February 2008. It is still 5% below what it was then and the clue to why it is still lagging may be in the name. Total pay includes bonuses and they are a lot lower than they were in the heady days leading up to the worst of the financial crisis, and not just in financial services.

Going back to regular pay, where there is a much smaller gap to make up, the concern about whether this is a steady march towards the sunlit uplands, and years ahead of near-normal real wage rises, lies with that familiar elephant in the room, the threat of a no-deal Brexit.

A promising outlook for real wages was snuffed out three years ago by the pound’s sharp fall as a result of the referendum. This had the effect, through higher import prices, of pushing up inflation, putting the squeeze back on real take-home pay. It is a straightforward relationship.

A no-deal Brexit would see another big sterling fall from the pound’s already weak position, as everybody in the markets knows, possibly a bigger one than in 2016. Inflation would rise again, through the import price route.

This time, however, it would be compounded by the impact of tariffs and shortages on prices, including food prices. Ministers have already warned that food prices would be likely to rise in the event of a no-deal Brexit. The National Institute of Economic and Social Research (Niesr) has said that inflation could rise to more than 4% even in the event of what it describes as an “orderly” no-deal Brexit.

If such a Brexit would be very likely to push inflation up, for a variety of reasons, it would also be likely to push wage growth lower. Niesr’s projections are that it would snuff out growth and push up unemployment, the response of business to which would be to rein back pay increases.

There are plenty of reasons to avoid a no-deal Brexit, of course, beyond the fact that it would mean that the current recovery in real wages was likely to prove to be another false dawn. It is the most damaging form of Brexit ad we are in great danger of lurching into it. But we should add this to the collection of reasons for steering clear of it. It would be a great pity if, after more than lost decade for pay, we were to retreat back into the gloom again.

Sunday, August 25, 2019
Scrapping HS2 would derail Javid's infrastructure plan
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.

Sajid Javid is a man with a plan, and he is not keeping it secret. The chancellor may only have been in office for a month, but a month can be a very long time in politics, and he has already made clear when asked that his ambition is to undertake a big increase in infrastructure spending, irrespective of the Brexit outcome.

During the Tory leadership contest he talked of creating a £100bn national infrastructure fund, probably to be spent over five years and, while he did not win that contest, he has taken that ambition to the Treasury with him.

Nor is this a sudden burst of thinking from Javid. When he was communities’ secretary two years ago he argued for a £50bn fund for housing and housing infrastructure, to deliver on the government’s pledge of 300,000 new homes a year but was rebuffed by Theresa May and Philip Hammond.

The logic is compelling. Britain badly needs more infrastructure spending, nationally and in the left-behind regions, for transport, energy, new technologies such as electric vehicles, social housing, broadband and so on. The days when the UK could attract foreign direct investment on the basis of a flexible workforce, low taxes and membership of the single market, in spite of poor infrastructure, are on the way out. In future we will need better infrastructure.

From an economic perspective, it is also compelling. The excitement over the so-called inversion of the yield curve this month has provided a reminder of just how low yields, or market interest rates, are on government bonds, gilts. 10-year gilts are yielding less than 0.5%, 30-year just over 1%.

And while the government might expect to pay a slightly higher rate than this on the issuance of new gilts, long-term interest rates remain significant below 2%, the long-run expected rate of inflation. The real cost of borrowing is negative. Markets are almost pleading with the government to borrow, particularly borrowing that improves the economy’s productive potential.

Javid can also argue that other avenues have been exhausted, most notably that of trying to get the private sector to take up the infrastructure burden. George Osborne’s ambition was to align the desire of pension funds and insurance companies for stable long-term returns with the need to spend more on infrastructure during a time of austerity. The results were disappointing, partly because the institutions did not want to be landed with project risk. The new chancellor can say that he is cutting out the middleman.

£100bn more infrastructure spending over five years would raise public sector net investment by around 1% of gross domestic product and would make a meaningful difference to this country’s record. And, while the rewards of better infrastructure on, for example, productivity, accrue over the long-term, this is one area where you cannot put off until tomorrow what can be done, cheaply, today.

So is it all plain sailing? No, for these things never are. The fiscal timetable is already looking crowded for this autumn. There will be a short-term spending review, possibly next month, to give year-ahead allocations for government departments.

There is still the significant prospect of a no-deal budget, short-term fiscal measures to boost the economy in the event of the country leaving the EU without a deal. These measures could include dusting off some of the 2008 playbook, when VAT was cut, as well as direct measures to support businesses in difficulty. Javid’s £100bn infrastructure boost could be part of this, and the National Infrastructure Commission has identified some “shovel ready” projects, which could be put in place quickly.

My sense, however, is that the chancellor would prefer to unveil his infrastructure programme in a “peacetime” budget after the immediate Brexit dust has settled, say in November. That may or may not be possible.

Another issue is something the Treasury is never relaxed about, the state of the public finances. Government borrowing is low, after a decade-long fall but, while it is early days, the figures so far this fiscal year show that it is going up again.
Public borrowing so far this year is £6bn or 60%, up on last year, largely reflecting higher public spending. There is no cause for alarm yet but at minimum a presentational challenge lies ahead. Next month the figures will incorporate an additional £12bn a year of borrowing as a result of a change in the treatment of student loans.

A no-deal Brexit, leaving aside any fiscal measures introduced in response, would further change the picture, adding a potential £30bn a year to borrowing, according to the Office for Budget Responsibility.. Britain’s public finances, having surprised markets by how healthy they have been, would soon be shown in a much less flattering light. It would take some artfulness to add an additional £20bn a year to borrowing for infrastructure spending in this context. It can be done, but the markets would need to be carried along with it.

Finally, the biggest risk to Javid’s effort to put in place a game-changing infrastructure programme comes from his Downing Street neighbour. Boris Johnson has admitted to doubts about HS2, the high speed rail project, as well as once promising to lie down in front of the bulldozers to stop a third runway at Heathrow.

Neither project is perfect, and HS2 has many of the bad habits of infrastructure projects that we thought were behind us, including cost overruns and wasteful procurement. But if it goes ahead, we will wonder in future why there was ever any doubt about it, as is the case with HS1, which links St Pancras with the Channel Tunnel.

The review ordered by the government has put the project in doubt. It could be scrapped, or curtailed at Birmingham, to the chagrin of northern business leaders. Opposition to it, a combination of Nimbyism and ideological opposition from some think tankers to big public projects, is strong but it will be hard to argue that the government is serious about infrastructure if HS2 bites the dust.

It is not a question of using the money for other infrastructure projects in the regions, such as linking northern cities, both are required, as is the third runway at Heathrow. The decades-long farce over additional airport capacity in the southeast, similarly, cannot be allowed to go on for much longer.

It may be that the HS2 review is akin to the short delay Theresa May imposed on the Hinkley Point nuclear power station on taking office, before giving it the go-ahead, and that HS2 is given the green light later in the year, after the Johnson government has conducted its own due diligence..

If not, it will be hard for the government, and most particularly the chancellor, to argue that he is transforming Britain’s infrastructure. Big projects matter, as well as lots of smaller ones.

Sunday, August 11, 2019
The top 1% pay a lot of tax - will they stay or go?
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 I want to lift my sights high. So high, in fact, that it takes me to the very top of the income distribution. These are the people who earn many times the average salary, are mainly not Premier League footballers (though they clearly do), and who are endlessly fascinating.

I do so for three reasons. The very well-off, the top 1%, and even more so the top 0.1% will become even more important as a source of income tax revenues if Boris Johnson carries out his leadership pledge to reduce the tax burden on those slightly lower down the income scale.

That pledge, you may recall, was to increase the threshold at which people pay the higher, 40%, rate of income tax from £50.000 to £80,000. I don’t get the sense that the government is yet moving heaven and earth to deliver on that pledge but, when it does, the proportion of income tax revenues paid by those on incomes above £80,000 will rise.

It is already, as you will know, high. This year, according to Her Majesty’s Revenue and Customs (HMRC), 29.6% of all income tax revenues will be paid by the top 1% of taxpayers, and just over 50%, 50.1% to be precise, by the top 5%. Very soon, it seems, the top 1%, who account for roughly a seventh of incomes, will be paying a third or more of income tax revenues. Their share 20 years ago was 21%.

It is important to note that we are talking about only one tax here, admittedly the important one of income tax, which will bring in £190bn this year, which is skewed in this way. Others by and large are not.

This takes me on to a second reason for writing about the highly-paid. The income tax system is already progressive – the top 50% pay 90.8% of revenues and the bottom 50% just 9.2% - and Labour would want to make it more so. Many at the bottom pay no income tax at all.

Labour’s current plans envisage introducing the 45% tax rate on incomes of £80,000 or more, and 50% on incomes above £123,000. If your earnings are £80,000 or thereabouts and the Johnson government carries out his pledge to raise the threshold, voting Labour would imply a significant personal sacrifice.

Mainly I am writing about the top 1% this week, however, because the Institute for Fiscal Studies has been digging into the data and come up with some fascinating facts about those at the top if the income ladder. The IFS is undertaking a larger review, the Deaton review, into inequalities. That will look at why some people have such high incomes. Are they benefiting from scarce talent, an ability to innovate or being successful wealth creators, or are they exploiting their market power at the expense of others?

That is for later. In the meantime, we know more about the top 1% than we did.
So, as the IFS points out in its report, The characteristics and incomes of the top 1%, by Robert Joyce, Thomas Pope and Barra Roantree, the top 1% are disproportionately male, middle-aged and based in London. Men constitute 83% of the top 1% and 89% of the top 0.1%, which I shall leave here without comment.

The top 1% has become, like the economy as a whole, more geographically concentrated. Though people in the top 1% - some 310,000 in any given year – can be found in most parts of the country, half are in just 65 (out of 650) parliamentary constituencies, predominantly in London and the southeast. In 2000, half of the very rich were spread over 78 constituencies.

Nationally, to get into the top 1%, a taxable income of £160,000 is required, while nearly £650,000 is needed to make it into the stratosphere of the top 0.1%. The higher the income, the more that it is likely to consist of more than just salary. So a quarter of the incomes of the top 1% are in the form of partnership and dividend income. Roughly a third of them are business owners.

Whether it is possible to keep up with the Joneses depends very much on where you live. A middle-aged man (45-54) in London with an income of £160,000 is in the top 1% nationally but not even in the top 5% among his peer group in the capital. To be in the top 1% in London for a middle-aged man would require an income of £700,000. There is always somebody considerably richer than you.

That may be why people in London and the southeast, particularly higher-income people, are in danger of losing touch with how most of the country lives. As Joyce, a deputy director of the IFS, puts it: “The highest-income people are very over-represented in the country’s south east corner, most of them are men, and many are in their 40s and 50s. This geographic and demographic concentration may be one reason why many of those on high incomes don’t realise quite how much higher their incomes are than the average. “

There is another point that emerges from the research which could be important in the future. It is easy to think of those on the highest incomes as both a privileged group but also an unchanging one. That is not the case.

A quarter of those in the top 1% this year will not be in the group next year and only half will still be at the top in five years’ time. Very few will be in the top 1% all their lives. People have good years and bad years, and they move in and out of the top 1%.

Between 2000-01 and 2015-16, for example, nearly 6% of men born in 1963 found themselves in the top 1% of income earners at some point. That is why, until quite recently, promising to soak the rich with higher taxes was considered to be bad politics. People aspired to be well-off, to make it to the top of the tree, and many did, if only temporarily. Taxing aspiration – and many would favour higher top rates than Labour’s proposed 50% - was considered to be a bad idea.

There is a wider point about the top 1%, which may offer another reason for proceeding with caution. Increasing taxes on the rich is everybody’s favourite way, apart from the rich, to increase revenues and pay for the public services that everybody wants.

Often, however, this is based on the assumption that there is a golden goose sitting there an waiting to be plucked. The figures, however, suggest otherwise.

This is a changing group not a fixed one. It is quite mobile, and probably able to take its talents elsewhere.HMRC figures show a 13% drop in the number of “non-doms” in Britain in the past year, and a drop of 6,000 in so-called high net worth individuals. It is also capable of varying its income and using tax-planning, to minimise its tax liabilities. Tax plans which aim to get a lot more revenues out of the top 1% are almost certain to disappoint.

That does not mean they will not happen. Things have changed from the days when Lord Mandelson could say, on behalf of New Labour, that “we are intensely relaxed about people getting filthy rich, as long as they pay their taxes”

People are no longer so relaxed. Average earnings, in real terms, are still fractionally below the levels prevailing before the financial crisis. And, though they are rising again now, memories of the squeeze are still raw. When a rising tide lifted all boats people were less troubled about very high incomes than they are now.

There is also the strong suspicion, which the IFS is examining, that the rich do not deserve their rewards. . Even the Johnson plan of raising the higher rate threshold was not as popular as he might have expected. Economic arguments against soaking the rich and killing the golden goose have not changed but the politics has moved on.

Sunday, August 04, 2019
This sterling slide has logic on its side
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 new government is less than a fortnight old but already we have seen a flurry of announcements and, it seems, cash pouring out of the Treasury as if there is no tomorrow. So, on your behalf, I have been trying to make some sense of this, by reading Boris Johnson’s speeches and pronouncements since he became prime minister. Somebody had to.

He has, as you would expect, a nice rhetorical flourish. Whether that is all he has, we will find out in coming months. So, he suggests, “we will look back on this period as the beginning of a new golden age for our United Kingdom”.

He is willing, he says, to “go the extra thousand miles” to engage with the EU and insists “there is scope to do a new deal” before October 31, defying “the doomsters, the gloomsters”. The chances of a no-deal Brexit, he has repeated, are “a million to one”.

When it comes to splashing the cash, there is so far a little less than meets the eye. Talk of new hospitals and extra money for the National Health Service is not new money but an allocation, perhaps sped up a little, of the 70th birthday present for the NHS announced by Theresa May last year and due to come through over the next few years.

The government’s flagship domestic announcement is 20,000 extra police officers over three years, which will roughly reverse the cuts since 2010, will have extra money attached. Whether there is a political future for this kind of cut-and-spend strategy remains to be seen.

There will be £2bn more for northern infrastructure projects, spread out over a period, and £2.1bn more for no-deal preparations, though at least half of this will be spent after October 31, and some of it may have been announced before. More than £100m will be spent on no-deal advertising; a public and business information campaign.

I have not spotted anything much on tax-cutting plans, which featured a lot in the leadership contest, though perhaps that has to wait for the autumn budget. That itself has become a source of intense Westminster and Whitehall speculation, with suggestions that the budget could come before October 31, potentially opening the way for a defeat of the government and a general election. We shall see.
What you really want to know is whether there is anything that amounts to a coherent Brexit strategy in what we have heard so far.

Currency traders are a practical lot. Many of them, perhaps a majority, probably supported Brexit. But they can recognise bluster when they see it, though they might have a ruder term for it, and they know that that is what they been hearing from the new government. Johnson has erected a giant sell signal over the pound and they have been happy to oblige.

This is the third phase of sterling’s Brexit adjustment. The first came with the referendum itself which, as noted here recently, was the sharpest fall for any major currency in the post Bretton Woods era, which now stretches back for nearly half a century.

The second was in October 2016, and May’s “Brexit means Brexit” phase, when she ruled out future membership of the single market and customs union.

The third phase, which took the pound down to $1.21 and €1.09 last week, was sparked by an article by Michael Gove, the new chancellor of the Duchy of Lancaster, who is in charge of no-deal preparations and who said no deal was now the government’s working assumption. Only when Johnson tried to dial down on the no-deal rhetoric was its fall halted.

Whether this third phase persists, or whether there will be pause until a fourth phase in the autumn, when a no-deal Brexit itself drives the pound below parity with the euro and close to it with the dollar remains to be seen.

We should be clear about why this has been happening. The markets, in pushing the pound lower, are judging that Britain’s economic prospects will be worse as a result of Brexit. And, as a more considerable prime minister Margaret Thatcher once said: “You can’t buck the market.”

Under Johnson we have moved further away from a Brexit deal with the EU, a withdrawal agreement followed by a transition period. For the past three years, detailed negotiations between the two sides came up with a solution which, while far from perfect, was workable.

Now that solution, the withdrawal agreement, is declared dead by the government, and Johnson has demanded that the Irish backstop be removed as a condition for talks on a new deal in the very limited time available.

Ministers, it seems, are required to describe the backstop as undemocratic, even though it is backed by the majority in Northern Ireland, who would also have preferred to stay in the EU, and an overwhelming majority of businesses in the province. The Johnson approach, which has echoes of Donald Trump – Mexico must pay to build the wall is not so much that of a bull in a China shop as a Pamplona run. It is the art of the no-deal.

In the space of a few months we have moved from the prospect of a close relationship with the EU post-Brexit to a mood of mutual distrust and antagonism. There will be plenty of people who are gullible enough to blame the EU for this, but that does not really wash. Any flexibility it might have shown in the political declaration accompanying the withdrawal agreement, to get Brexit over the line, has been thrown back in its face.

Indeed, when the new prime minister talks of post-Brexit deregulation, and moving the UK further away from EU rules, the more that Brussels will regard the backstop as necessary to protect the integrity of the single market. Those people who have worked diligently on alternative arrangements for the Irish border, if they have confidence in them, should have no problem with the backstop, because it would not come into force.

It is striking that so little has been learned over the past three years. The assumption has always been that the EU, rather than sticking together, and backing Ireland, will cave. It has not worked so far, and there is no reason why it should.

There is also, however many strategic geniuses are advising Johnson, a fundamental misunderstanding about a no-deal Brexit. It is not all about avoiding temporary shortages of drugs, keeping the planes flying, maintaining clean water and ensuring the supermarket shelves are not too empty in the run-up to Christmas. It is not all about paying Welsh hill farmers for the lambs they cannot sell in France.

It is about the fact that they and those engaged in many other activities, become no longer viable, so the hill farmers stop breeding lambs and some of the car factories move elsewhere. It is about the fact that a no-deal Brexit, as Whitehall’s own analyses show, is easily the worst form of Brexit. It is also about the fact that, contrary to what the new foreign secretary says, it puts us into the worst possible position to negotiate a new trade deal with the EU.

And, if the strategy is all about getting a Johnson government elected with a larger majority, on the evidence so far there would still be no workable plan for Brexit, while leaving open the possibility of a Labour government under Jeremy Corbyn. Not a good prospect, as the currency markets know only too well.

Saturday, July 27, 2019
Tricky times call for a lucky chancellor
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 three ways of viewing Boris Johnson’s first few days as prime minister, and in particular his “fire and hire” approach to his new cabinet. Apart from demonstrating that no job is as insecure as that of a cabinet minister and their special advisers, it was curious man and woman management from a new leader apparently committed to Tory unity, and needing the loyalty of his MPs in coming weeks.

The smart money in the markets and the view of many in Westminster is that stepping up no-deal preparations and insisting that the Irish backstop be removed from the withdrawal agreement is all about preparing the country for a “blame somebody else” election in the autumn, in which no-deal opponents in the House of Commons and Brussels are the enemies and the patriotic thing is to support Johnson’s Tories. Risky, particularly with the Brexit Party still around.

The second possibility is that, having filled the cabinet with Brexiteers, they will be obliged to support even modest reassurances offered by the EU in the political declaration, and an orderly Brexit can proceed. Risky too, given that any of them could resign, and the fact that hardline ERG (European Research Group) Tory MPs do not appear to have been bought off by some of their number making it to the cabinet.

The third possibility, a no-deal Brexit, would see the Dunkirk and Blitz spirit being invoked, and the Johnson government taking the rap for the short and long-term consequences, which a few weeks of preparation will not prevent. No doubt Europe would also be blamed.

We shall see. There is no easy way of attaching probabilities to these possibilities, but in broad terms they would run in the order I have set them out, with an election most likely and no-deal Brexit least.

Let me, however, lift my gaze above the short-term uncertainties. We have a new chancellor, Sajid Javid who, unlike some of the other cabinet appointments last week, appears eminently suited to the job. Will he be a good chancellor and, perhaps as importantly, will he be a lucky one?

In some respects he is already lucky. As a result of the combined efforts of George Osborne and Philip Hammond, he inherits a budget deficit which, at £23.5bn or 1.1% of gross domestic product in 2018-19, was the lowest for 17 years. The new administration has to decide what its fiscal rules will be, including whether to stick with the vague target of eliminating the budget deficit by the mid-2020s, but the starting position is a good one.

The labour market, meanwhile, is another bright spot. Unemployment is at its lowest since the mid-1970s and the employment rate – the proportion of working-age people in work – is close to record highs. Average earnings growth, at around 3.5%, is above the 2% inflation rate and providing consumer spending support to the economy. The economy has slowed significantly but things could be a lot worse.

If Javid were to be a really lucky chancellor, however, he would enjoy something denied to both his predecessors, the return to normal rates of productivity growth. Osborne had reason to expect productivity to bounce back after the financial crisis. Instead it stagnated, forcing the Office for Budget Responsibility (OBR) to downgrade the outlook for the public finances. Hammond also presided over productivity that was a mere 1% higher when he left office as when he became chancellor.

This matters. Had productivity over the past decade grown in line with its long-run trend, it would be about 20% higher than it is, with most of that translating into a larger economy. And, for those who think productivity only matters for economists, the Office for National Statistics’ recently calculated that private sector wages would be £5,000 a year higher than they are had productivity achieved trend growth and pay increased accordingly. £5,000 a year is equivalent to an 18% boost in full-time private sector average earnings.

Productivity is due a revival. At 3.8%, the unemployment rate cannot fall much further and the growth of employment, constrained by the availability of workers, has begun to slow.

There is also the promise, so far largely unrealised in this country, of a significant boost to productivity for the new technologies of artificial intelligence and robotics. Though there has often been scepticism about the contribution of new technology to productivity growth – three decades ago the US economist Robert Solow said that you see computers everywhere except in the productivity statistics – there is also a sense that we could be on the brink of something big.

Chancellors, of course, make their own luck. And, while many of the ingredients of higher productivity are long in the making – investment, infrastructure, innovation, skills and education – some things can be done in the short-term.

Britain is suffering from investment starvation. Businesses have been slow to invest since the financial crisis and particularly reluctant since the EU referendum. Expecting that to change until Brexit is clarified is probably for the birds but Javid is, in any case, preparing the ground for an autumn budget.

We know from his leadership bid that he is drawn to the idea of taking advantage of low borrowing costs – the yield on 10-year gilts is currently just 0.71% - to launch a £100bn national infrastructure fund.

There are plenty of good ideas for “levelling up” growth in the regions through increased private investment. The Tory MP and Neil O’Brien set out proposals for enhanced investment allowances in the regions in his recent report, Firing On All Cylinders, for the think tank Onward. He also called for a corporation tax rate of 12.5%, matching that of Ireland. That would go down like a lead balloon in Dublin.

We do not know how long the Johnson government has, and for that matter how long Javid will be at the Treasury. There is an air of the temporary about the Johnson government. Most chancellors have time to get their feet under the table.

Apart from the untimely death of Iain Macleod in 1970, after just a month as chancellor, the shortest serving modern-day chancellor was John Major in 1989-90, 13 months, though he went on to be prime minister.

Assuming Javid can hang around, he could ride the tide of rising productivity and technology. Somebody has to. It is long overdue.

Sunday, July 21, 2019
Counting the cost of a Johnson government
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 a new prime minister is about to take over, there is normally a sense of excitement, even optimism. In the case of Boris Johnson, however, assuming the polls are right and he is duly elected by Tory party members this week, there is also a powerful sense of trepidation.

New prime ministers normally take office as a result of a general election. On the road to victory, their policies, as set out and costed in manifestos, will have been subject to the closest scrutiny, from the opposition and from the media. Before even making it into the manifesto, they will have been subject to a long, behind-the-scenes process of scrutiny, to make sure that they are credible.

Where this does not occur, it often goes wrong. Nobody was more pivotal to the New Labour government of Tony Blair than Gordon Brown. But when he took over as prime minister without an election in 2007, the policy cupboard was bare even before the financial crisis hit, and his premiership did not work out well.

Theresa May, who also succeeded to No.10 without an election, had ideas, but most of them turned out to be unworkable and were quietly dropped after the 2017 election. Her legacy speech, delivered last week, suffered from a distinct lack of material.

Johnson is in a much weaker position than either of them. Both had been at the heart of government over several years, 10 in the case of Brown as chancellor, six for May as home secretary. Johnson, in two undistinguished years as foreign secretary, was a peripheral figure. The wheels of government did not depend on his presence.

Though he has been dreaming of the top job all his life, he is probably the least prepared for it of any recent prime minister, as he has sometimes shown over the past two or three weeks. Instead of carefully-tested and costed policy proposals, ideas have been tossed out, almost daily, to get through the next hustings or interview.

There is a positive element to this. It could suggest that once he is safely ensconced in 10 Downing Street, again assuming not late and successful burst from Jeremy Hunt, many of the most expensive ideas will be either quietly forgotten or put in the filing cabinet marked “long-term ambitions”.

Philip Hammond, who has been enjoying his last few days as chancellor by settling out markers against a no-deal Brexit, is fully expecting to return to the backbenches for the first time in two decades. His successor, and the assumption in Westminster is that it will be Sajid Javid, the current home secretary, will not want to preside over a borrowing binge which, alongside the sterling crash that would result from the wrong kind of Brexit, would mean that the new chancellor’s immediate task would be one of crisis management. Poisoned chalices do not become much more toxic than that.

Fortunately, there is an easy way out of this. It used to be said of currency forecasters never to combine a forecast with a date, because that way you would be right in the end. The same goes for tax and spending promises.

No timeline has been attached to the tax and spending promises that Hammond, with a nervous eye on the public finances, has been getting very jumpy about. The two most eye-catching Johnson promises – increasing the higher rate threshold (the point at which people start paying the 40% tax rate) from £50,000 to £80,000, and raising the National Insurance threshold to £12,500 - do not come with a timeline attached.

That means these pledges, assuming g they are not quietly forgotten, could legitimately be stretch out over many years. The hit of roughly £20bn a year to the public finances from these two policies might still eventually occur but it would take several years. The coalition’s government’s pledge to raise the personal allowance to £10,000, made in 2010, was not delivered until the 2015-16 fiscal year. There is no guarantee that a Johnson premiership will last. It might be fleeting.

One thing Johnson has put a firm timeline on, of course, is leaving the EU, which he has said must and will be on October 31. If he sticks to that, given that there is no time to renegotiate the EU withdrawal agreement before then, and the EU has said that its agreement with the UK (but not the British Parliament) would stand even if there was more time, a no-deal Brexit would appear to be where we are heading.

Currency markets cannot quite make up their minds whether this is even a possibility. Sterling’s fall was broken last week on the view that both a no-deal Brexit and a general election have become less likely. The former was based on the view that, following the vote to insist that Parliament has to meet in October on Northern Ireland, proroguing it to push through a no-deal Brexit will be more difficult. That, in turn, could mean that Tory no-deal opponents do not need to bring down the government, and force an election, to prevent a no-deal exit.

That leaves the question of how the new prime minister will get down from his Brexit pledge. The Office for Budget Responsibility (OBR) provided a timely warning last week that, if he has concern for the economy, a no-deal Brexit is something to avoid.

The OBR’s exercise, predictably, has brought an outbreak of the usual “Project Fear” nonsense. But the fiscal watchdog, which is required to assess the fiscal risks facing Britain, would have been failing into its duty had it not assessed the impact of a no-deal Brexit, alongside other risks.

The way it did it was to take the milder version of the International Monetary Fund (IMF) no-deal, no-transition scenario, published in April, and apply it to the public finances. The OBR did not itself predict the recession outlined in that scenario (with gross domestic product down 2% by the end of 2020 and 4% below the existing official economic forecast) but used it as a basis. It could have used more negative scenarios. There are no credible positive no-deal scenarios, either for the short or long-term.

The OBR’s no-deal stress test pushes up government borrowing by around £30bn a year and public sector net debt – the national debt – up by a huge £272bn by 2023-4. That is the product both of higher borrowing and the assumption that, in the event of no deal, the Bank of England would be obliged to roll over the term funding scheme for the banks. £272bn is a big additional bill for future generations as the cost of a no-deal Brexit; the potential cost of a Johnson government.

Surely action would be taken to mitigate the effects of a no-deal Brexit? Yes and the OBR assumes such action would be forthcoming from the Bank. Were there to be an emergency budget with tax and spending measures, they would add to the additional debt, not reduce it. Tax cuts that pay for themselves, in the spirit of the Laffer curve, are few and far between.

Nor would there be much help from withholding the £39bn divorce bill, even leaving aside the implications for Britain’s international reputation from doing so. Staying in the EU for an extra seven months has already brought the size of the bill down to around £33bn, according to OBR officials. That is equivalent to one year’s extra no-deal borrowing for Britain. It is about 0.2% of EU annual GDP, hardly enough to break its bank.

Sunday, July 14, 2019
Friendless pound needs the kindness of strangers
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.

Even before Sir Richard Branson offered his opinion on the pound, I was intending to write about sterling this week. This is a time of year when many people think about the exchange rate more than at other times and encounter the reality that businesses and the markets have been dealing with for the past three years. The pound, unsurprisingly in the light of the current uncertainty, has taken on a weaker tone recently.

Branson thinks sterling will go to one-for-one parity with the dollar in the event of a no-deal Brexit this autumn, from $1.25 now, and, while that is a touch below market expectations, it is in the right ballpark. With the euro worth almost 90p, equivalent to a euro-sterling rate of €1.11, the pound would be headed below parity with the single currency, embarrassingly.

Already, for tourists, even current very low market exchange rates are an unattainable dream. Those leaving it late and changing currencies at the airport have already experienced the reality of a sub-parity euro. Staycationing has its merits.

Sterling has been the Brexit barometer over the past three years. Even knowing that, I found it hard to believe, as has been claimed, that the pound’s fall on the referendum result in June 2016 was the sharpest for any major currency in the floating rate era, which extends back to the early 1970s. Surely there have been bigger sterling falls, not least when the pound tumbled out of the European exchange rate mechanism (ERM) in September 1992.

It is, however, true. The sterling index, which measures the pound’s average value against other currencies, fell by 9.2% in the 48 hours after the referendum, and by 11.4% over two weeks. That compares with 5.7% and 8.6% respectively when sterling crashed out of the ERM. The pound had a bigger cumulative fall over 2007-8, during the financial crisis, falling by more than 25% in total. But what was a drawn-out affair and was followed, as is typical, by a recovery. Currencies tend to overshoot.

This time, however, there has been no recovery. Sterling is lower now than it was in the early days after the referendum, against both the dollar and the euro. A measure of how weak the pound has been over the past three years is its average value against the dollar, $1.30, compares with $1.65 over the 10 years leading up to the summer of 2016, and $1,66 in the 30 years leading up to it.

Sterling’s recent fall was halted briefly last week by testimony from the Federal Reserve Board chairman Jerome “Jay” Powell, pointing to an early cut in US interest rates, and by the release of monthly gross domestic product (GDP) figures in the middle of last week. It is worth briefly reflecting on them. The 0.3% rise in monthly GDP in May, reported by the Office for National Statistics (ONS) was in line with the consensus, and represented a partial bounce from the 0.4% drop recorded in April. Car factories had shut down in April as a result of the original March 29 Brexit deadline and restarted again.

The figures also showed a 0.3% rise in GDP for the March-May period compared with the previous three months, which was better than expected, but was entirely the product of data revisions. The nerdy explanation is that the ONS revised down February’s monthly GDP slightly, shifting it into March. That made March-May better but the question for the second quarter as a whole remains. If June was as gloomy as the purchasing managers’ surveys suggested, there will be a small fall in GDP in the quarter. If not, it will be flat, or there will be a tiny rise. Whichever way, growth has slowed significantly, though it is too early to say whether that has continued into the third quarter.

Some people, of course, welcome a weak pound. John Mills, the founder of JML, the Labour donor and prominent Brexit supporter, is a tireless campaigner for a permanently low level for sterling.

If devaluation was the road to riches, though, we would be all as rich as Croesus. Sterling’s fall is now mature enough to suggest that we should now be on the upslope of what economists call the J-curve; devaluation initially produces a trade deterioration because imports are more expensive, followed by a later improvement because of improved export competitiveness.

It is not, however, happening. Britain’s trade deficit in goods widened by £15.7bn to a huge £153.5bn in the 12 months to May. There have been some distortions in the figures this year but the underlying picture is one of deterioration, not improvement.

This is where it becomes concerning. The worsening of Britain’s trade deficit in goods is only one aspect of this country’s balance of payments problem. In its Financial Stability Report, published on Thursday, the Bank of England highlighted this vulnerability.

As it put it: “A current account deficit indicates that national investment is larger than national saving, and therefore must be financed by net borrowing from overseas. The UK’s deficit widened to 5.6% of GDP in 2019 Q1. This is large by international standards. Since 2016, the UK has relied on substantial gross capital inflows from foreign investors to fund its current account deficit.”

The UK. It added, is “vulnerable to a reduction in foreign investor appetite for UK assets, which could lead to a tightening in credit conditions for UK households and businesses”. Britain, to draw on an earlier phrase used by Mark Carney, is dependent on the kindness of strangers or, at least, a low enough exchange rate to make UK assets cheap enough for foreigners to want to buy. A high proportion of those flows have been into commercial property.

The Bank thinks sterling would be riding for a fall in what it describes as a disorderly Brexit. Under that, it says, sterling along with a range of UK assets “would be expected to adjust sharply”, its euphemism for fall out of bed. The pound would probably not fall as much as the 27% the Bank has allowed for in its famous, or infamous, stress tests for the banks.

Can sterling regain its poise, if not for this year’s summer holidays, perhaps next year? The pound has few friends at the moment, probably because of the political situation. Adam Cole, chief currency strategist at RBC (Royal Bank of Canada) Capital Markets agrees that no-deal would produce a big fall for the pound but even exit with a deal would not have much of a sterling upside, because markets would still fear other political developments, including a general election. The only meaningful upside for the pound, he suggests, would be if Britain reversed its decision to leave the EU. Anything is possible, but that looks unlikely.

Sunday, July 07, 2019
Brexit bluster comes home to roost as growth hits the buffers
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 a figure comes out which really pulls you up short. Just such a figure was published a few days ago. The purchasing managers’ index (PMI) for Britain’s construction sector slumped last month. Already weak at 48.6 in May (levels below 50 signal a decline in output), it plunged to 43.1 last month. Not only was this exceptionally weak, but it represented the biggest fall in output since April 2009, when the economy was still mired in the 2008-9 recession, the worst since the Second World War.

The details of what IHS Markit,, which compiles the survey, described as “an abrupt loss of momentum” for construction were as bad as the headline figure. As Tim Moore, an associate director of IHS Markit put it: “The latest survey reveals weakness across the board for the UK construction sector, with house building, commercial work and civil engineering activity all falling sharply in June. Delays to new projects in response to deepening political and economic uncertainty were the main reasons cited by construction companies for the fastest drop in total construction output since April 2009.”

Construction is, of course, only one part of the economy and, while as noted last week it has recovered well since the crisis, it only accounts for about 6% of gross domestic product. Isolated weakness in construction does not mean trouble for the whole economy.

Except that the construction PMI was accompanied by weakness in the surveys for other parts of the economy. The manufacturing PMI fell to 48 last month, from 49.4 in May. It had been expected to bounce back after the stockpiling boost in the first three months of the year.

The service sector PMI, meanwhile, dropped from 51 to 50.2, with “subdued activity often attributed to sluggish domestic economic conditions and greater risk aversion among clients in response to ongoing Brexit uncertainty”. The “composite” PMI, a weighted average of all three sectors, dropped to 49.2, signalling the first drop in private sector activity since immediately after the referendum.

These PMIs, suggesting the lights are going out all over the economy, are not isolated reading. The CBI’s growth indicator, published last weekend, show3ed the fastest fall in private sector activity since 2012.

The British Chambers of Commerce quarterly survey for the second quarter, also last week, showed a very weak manufacturing sector and a slight uptick for services, but pointed out that “the uptick in activity was not enough to outweigh the significant drop in these indicators in the first quarter”.

We will see this week if the weakness in the surveys is matched by the official data, with a string of releases, including construction, production, services and monthly GDP for May. Even if GDP showed a monthly bounce in May, the arithmetic for the second quarter, and avoiding a quarterly drop in GDP, is very challenging.

The significance of the surveys, meanwhile, was that they showed that we have seen a weakening through the quarter, and a downward trend that accelerated last month.

It is easy to see why this is. Three years ago Britain voted for Brexit, even though its advocates had not serious idea or plan on how to deliver it. Boris Johnson, who was instrumental in securing a vote to leave, had no clue then about how to achieve Brexit and, three years on is not providing much of a clue now. Many “Back Boris” supporters, I think, must be similarly clueless.

Jeremy Hunt, who started off as the sensible one in the leadership debate, has been obliged to join Johnson in the mosh pit of extreme silliness, being prepared to embrace a no-deal Brexit even if it as almost as bad as the financial crisis of 2008.
Apparently eyecatching announcements, such as the one revealed to this newspaper last weekend, of bringing in the former Canadian prime minister Stephen Harper to negotiate a “Canada-plus” trade deal with the EU cannot get over the fact that (a) prime ministers do not do trade negotiations and (b) you first have to have a withdrawal agreement passed by parliament.

For every bluster in the Tory leadership race, there is counter bluster. For every unicorn there is a rival one. When a Tory chancellor has to warn the candidates to be the next Tory prime minister to rein in the ridiculousness of their tax and spending plans you know we have reached peak irresponsibility.

There is only so much you can throw at an economy without doing serious damage. We have moved in the space of a few months from the sensible position of leaving the EU under a carefully-negotiated withdrawal agreement and then entering trade talks during a transition period, to one in which pretty much anything could happen, most of it bad. The blame for missing the March 29 Brexit date, and for the situation we find ourselves in, rests solely with the Brexit hardliners, inside and outside parliament. The chickens have come home to roost.

I hear a lot of nonsense talked about this. Some people are daft enough to think that business surveys are biased in favour of a particular result. They are not. IHS Markit, which produces the PMIs, has no political axe to grind but produces its surveys as a tool for business, the financial markets, governments and central banks. The CBI has been producing surveys of its members since the 1950s and was careful last weekend to set the rather alarming verdict of its latest growth indicator in context.

Boris Johnson’s commitment to leaving the EU on October 31 – a commitment on which he is almost sure to fail – is praised by some of his more slavish followers as promising an end to the uncertainty.

It does nothing of the sort, of course. All it promises is another four months of uncertainty, as people and businesses wonder whether he will take us over the cliff-edge of a no-deal Brexit, or whether parliament will prevent it, possibly by forcing a general election, and the new round of uncertainty that would provoke.

A no-deal Brexit would, of course, not mark the end of uncertainty but the start of a more intense phase of it. Beyond the short-term disruption and the very real prospect of long-term damage, Britain’s future trading relationship with our biggest trading partner would be up in the air, and probably stay there for some time.

The other bit of nonsense I sometimes hear is that there is nothing specific to Britain about the current economic situation. The global economy, plainly, is suffering from the fact that there is a protectionist in the White House and his tariff wars, now directed at Scotch whisky, are hitting world trade. Successful exporting nations in Europe, notably Germany, are suffering.

Europe, however, is holding up far better than Britain, according to the purchasing managers’ surveys. The eurozone construction PMI stood at 50.8 last month, nearly eight points above its UK equivalent, and consistent with modest growth. The eurozone composite PMI, covering all sectors, is at 52.2, compared with the UK’s 49.2. Germany’s composite PMI is 52.6. The difference is Brexit.

How do we regain our composure? You have to hope that whoever wins the Tory leadership contest is better in government than they have been in campaigning for it. You do not have to be Brenda from Bristol to hope that a general election can be avoided. But,. To coin a phrase, it’s the hope that kills you.

Sunday, June 30, 2019
Ten years of recovery, yet not a happy anniversary
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 an important moment. Ten years ago, 10 years tomorrow to be precise, Britain’s economy began to crawl, bleary-eyed, out of the deepest recession since the Second World War. The anniversary brings with it questions. How strong, or weak, has the recovery been? What kind of recovery, in terms of sectors of the economy, was it? And, the question I get asked most often, how long can it last?

The recovery itself was slow to get going. I well remember the concern, in those dark days of 2009, when it appeared that other economies had begun their post-crisis recoveries but Britain had not. Initial figures from the Office for National Statistics (ONS), indeed, suggested that the upturn started later. Its first estimate for the third quarter of 2009 was a drop of 0.4% in gross domestic product, a sixth successive quarterly decline, and economists were criticised for predicting a small GDP increase.

The economists were right. ONS figures now show that GDP edged up by 0.1% in that third quarter of 2009, giving way to somewhat stronger growth later. It has not been unbroken growth. In 2012 there were small GDP declines in the second and fourth quarters. Because they were not consecutive they did not count as a recession, though initial figures from the ONS did show that the recovery “double-dipped” back into recession in 2012 and was on the brink of a “triple-dip” recession.

On the basis of the latest ONS figures, which include last week’s revisions to growth rates up to 2016, the economy has achieved an average growth rate of 1.9% over the past 10 years. Its strongest years were 2014 and 2015, its weakest was last year. You can draw your own conclusions about that.

The growth average over this recovery, 1.9%, compares with 2.8% over the long recovery from 1992 to 2008, which was brought to an end by the financial crisis, and 2.9% for the 1981-90 recovery under Margaret Thatcher. Growth has been around a percentage point lower on average, than during those two previous upturns. One caveat, though it is a small one, is that recent figures are more prone to revision.

A below-par recovery has happened despite an exceptional monetary stimulus. Every member of the monetary policy committee (MPC) who voted to cut interest rates to 0.5% in March 2009 would at the time have been astonished to think they would be only fractionally higher, at 0.75%, now. None of them, by the way, is still on the MPC. There has been £435bn of quantitative easing.

That has saved the economy from even weaker growth. The fact that growth has not been stronger would be put down by some to deficit-reduction, or austerity. Nobody would seriously argue against the proposition that a fiscal tightening will give you weaker growth than otherwise, but it would also be wrong to attach all the blame for the growth disappointment to fiscal policy. The hangovers from the crisis, particularly the banking hangover, played a big part and the causes of productivity stagnation run deep, and are for another day.

The big winner in the recovery is, perhaps surprisingly, the construction sector. Based on the latest figures, its output is 34% up on the mid-2009 trough, though only 11% up on the pre-2008-9 recession peak. Service sector output is up by 22% and 17% respectively, and has the most consistent performance.

Manufacturing has been the poor relation; its output is up by only 10% since mid-2009 and is down by 3% compared with the pre-recession peak.

Does this recovery still have legs? Ten years is a long time, and this is now a mature recovery, though as noted it is not as long as the 16-year upturn that preceded the crisis.

It remains possible that when the statistics are available in a few weeks’ time, this will turn out to have been a very downbeat anniversary. After two successive monthly GDP declines, the arithmetic is challenging for the second quarter, which ends today, and the National Institute of Economic and Social Research predicts a 0.2% GDP decline, though the Bank of England expects a 0.2% increase.

The news from some sectors of the economy is grim. Car manufacturing so far this year is down by 21% on last year. The CBI’s distributive trades survey said retail sales volumes in the year to this month fell at their fastest pace since March 2009, when the economy was mired in recession, though adding that some of that may have been due to exceptionally strong comparators a year ago. Consumer confidence has weakened across the board, according to the latest GfK index.

What we can say with certainty is that growth, at best, has slowed to a crawl. Recoveries do not die of old age. This recovery is not under threat from a sudden and aggressive hike in interest rates from the Bank, the kind of thing that has sounded the death knell for previous upturns, though the investment weakness of the past three years, coupled with a reduced flow of EU workers, has increased the Bank’s concerns about the amount of spare capacity in the economy.

It is under threat from a related self-inflicted wound. Though I think we will avoid it, and Boris Johnson has said that the chances of a no-deal Brexit are a million to one, the more that people and businesses fear it the more it will exert a downward influence on the economy. This 10-year anniversary could be a lot happier than it is.

Sunday, June 16, 2019
Johnson's dead cat tactics on tax and a no-deal 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.

Now that Boris Johnson has decisively won the first round of the contest among Tory MPs, and is runaway favourite to win among the membership, we have to take seriously the prospect of a Johnson premiership. In this strange tribal mating contest, in which those who have the biggest and most colourful tail feathers to shake do best, he will be hard to beat.

There are two things that, so far, define the Johnson pitch. One is a stonking great tax cut for higher-rate taxpayers, by means of raising the basic rate limit, the higher rate threshold, from £50,000 to £80,000. On its own, when fully in place, that would cost £20bn a year, but about half would be clawed back by increasing the National Insurance ceiling. People with earnings in that bracket and above would see their marginal rate of income tax and NI in that range, currently 42%, drop to 32%. This is a huge tax cut for the better-off.

The other main feature is his willingness to embrace a no-deal Brexit. The scale of Johnson’s first round victory and the defeat of a cross-party (but Labour-led) bid to rule out no deal has seen those who follow these things in the City raise the probability of a no-deal Brexit on October 31 from 10% to around 25%. Sterling slipped as a result.

There is still a belief in the markets that Parliament find a way of avoiding a no-deal Brexit, even if it means a vote of confidence and a general election under the new leader. That, for the markets and for business, might be just an out of the frying pan and into the fire moment. They, to slip into the kind of phrase beloved of the new Tory leader, would have no obvious way of steering between the Scylla of a Johnson no-deal government and the Charybdis of a Corbyn administration.

The question, as always with Johnson, is how seriously we should take the things he is saying. Indeed, a possible explanation was provided by the man himself, six years ago, when he was London mayor. Writing about a European Union proposal to put a cap on bankers’ bonuses, he said it was purely a distraction, a “dead cat” strategy.

Borrowed from the “rich and fruity vocabulary of Australian political analysis”, as he put it, the best thing you can do to divert attention is, as Johnson’s Australian friend put it, is “throwing a dead cat on the table, mate”. The key point made by the Australian friend, who I am guessing is Lynton Crosby, who has successfully managed campaigns for Johnson, is that instead of focusing on other things, everybody will be saying: “Jeez, mate, there’s a dead cat on the table!”

On this view, Johnson’s proposed tax cut, together with all the talk of a no-deal Brexit, are not only aimed only at the narrow electorate of Tory members, but are also dead cats.

The more that people focus on the tax idea, and whether it is fair and affordable (no in both cases) the less that people will concentrate on his record as foreign secretary and a list of foibles as long as both of your arms. Similarly with no deal. There is, as the writer George Trefgarne has suggested, a clear parallel with the infamous £350m a week on the side of the bus in the referendum. It was wrong, and everybody knew it was wrong, but the more that people concentrated on it, the less that other issues got the scrutiny they deserved.

Johnson is not the only one using the dead cat strategy. When Michael Gove pledged last weekend to replace VAT with a version of the purchase tax it replaced when the UK joined the European Economic Community in 1973, it looked like a pretty obvious diversionary tactic.

The risk of all this money flying around in the Tory leadership contest, a combined £84bn, is that it threatens to make even Jeremy Corbyn and John McDonnell look like models of fiscal prudence.

But I am guessing that nobody seriously expects them ever to be implemented, either because they would never get through the House of Commons – ask Philip Hammond about his experience of securing parliamentary approval for even mild controversial measures – or because once the deceased feline has served its purpose, it will be quietly buried.

I would hope that some Tories, including Johnson, still care about the budget deficit, which is expected to be nearly £30bn this year, and about debt. Public sector net debt, to remind you, is still rising in cash terms. At a whisker under £1.8 trillion (£1,800bn) it is more than five times its level 20 years ago, more than three times what it was before the 2008-9 financial crisis, and up by nearly £800bn since the Tories came to power (in coalition) in 2010.

That is a lot of debt as the backdrop to extravagant promises to splash the cash. There is also, to be clear, no pot of gold waiting to be spent. Hammond, whose days as chancellor may be measured in weeks given the number of people who have been offered his job, often by the same candidate, has kept something back for a no-deal Brexit and what was supposed to be a comprehensive spending review this year. The candidates with the most extravagant promises are also those willing to risk the extensive economic and fiscal damage from a no-deal Brexit.

What should a new Tory prime minister do, as opposed to making undeliverable promises? Three things. The first is to demonstrate clearly an end to austerity, essential to anybody pursuing a fairness agenda. That sounds expensive but it is not. Ending the cuts for unprotected departments would cost just over £2bn a year by the early 2020s, while doing so on a per capita basis would cost just over £5bn.

That was supposed to be the agenda for the spending review, which now looking highly unlikely this year. Tax cuts are good, when they can be afforded, but introducing them alongside continued austerity is politically cackhanded.

Second, the new Tory leader needs to repair relations with business, and quickly. Every business owner I come across has a similar story. Even leaving aside their deep worries about Brexit, they feel neglected and put-upon. For most it is a catalogue of government imposts. Including auto enrolment, the apprenticeship levy, the national living wage and business rates. For most, the reductions in corporation tax in recent years have been largely irrelevant. They need direct help.

Finally, the Tories are nothing if they cannot demonstrate that they can be trusted with the public finances. The modest moves I have suggested would not compromise that. The ideas that some of the Tory candidates have been floating certainly wood.

I realise that is a fairly dull set of tail feathers to shake around in a technicolor contest, with not a dead cat in sight. But it makes sense. And, if nothing else, add it to the many reasons why I shall never be prime minister.

Sunday, June 09, 2019
As growth stagnates, we yearn for the go-go days of the 80s
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 these days it feels a bit like the 1980s. Younger readers will not know, and older readers need reminding, that back then the toll of jobs being lost, mainly in industry, was sufficient for ITN’s News at Ten, to be able to run a nightly map.

The headlines for manufacturing jobs are bad again. Ford’s announcement of the closure of its engine plant at Bridgend, a town I know, will be devastating for the up to 1,700 people whose jobs are directly affected and the thousands more in the supply chain.

Similar considerations apply to the 4,000 jobs directly at risk at British Steel in Scunthorpe, and the 3,500 that will go with Honda’s closure of its plant in Swindon. In both cases, supply chain job losses will add to the woe.

I would not overdo the comparison. The manufacturing shake-out in the 1980s had a much more immediate effect and was much larger in scale. In those days, partly because of demographic factors (the baby bulge of children born in the 1960s) a decent rate of economic growth was associated with high and rising unemployment. There was even a productivity miracle. These days, weak growth is accompanied by very low unemployment and there is no productivity growth. Either despite or because of this, or because of the deep visions in the country, we appear to be nostalgic for the 1980s. A YouGov poll a couple of days ago showed that by 37% to 28% people think life was better then than now.

In the 1980s, importantly, there was a free trader rather than a protectionist in the White House. And back then Margaret Thatcher was instrumental in creating the European single market, providing a greatly expanded home market for British business. Currently, of course, her Conservative party is trying to navigate how to take us out of the single market.

I think of the 1980s because there was a regular debate, certainly in the first half of the decade, about whether growth was petering out. Those worries were largely misplaced; there were four years in the 1980s when growth exceeded 4%, including 1983 and 1985, and the average over the 1982-9 period was more than 3.5%. This was a period when, notwithstanding those manufacturing job losses, the economy rediscovered its dynamism. We got out mojo back.

Now, concern over whether growth is petering out is more justified. Last week saw the publication of the three purchasing managers’ surveys for manufacturing, construction and services. Two of them, for manufacturing and construction,
showed a drop below the key 50 level, pointing to sectors which are contracting.

The other, for services, picked up marginally to 51, but this is consistent with barely any growth. The UK economy, according to these surveys, is performing worse than the eurozone.

And, according to Chris Williamson, chief economist at IHS Market, which produces the surveys, they are consistent with an economy that “remained broadly stagnant midway through the second quarter”. There was a similar message last weekend from the CBI’s growth indicator.

Spring definitely has not sprung, according to these surveys, nor on the basis of other evidence. After a surprisingly strong first quarter for consumer spending, a 0.7% quarterly rise, the British Retail Consortium suggests retailers are struggling, while private new car sales are down on a year ago.

For business, the deteriorating global environment, partly because of Donald Trump’s trade wars, is a constraint on exporters, though we should not expect a repeat of the surge in imports in the first quarter to beat the original March 29 Brexit deadline.

The news is quite gloomy, and little or no growth is not a good position to be in. In some respects, however, there is nothing much to see here. We knew that the first quarter was unusual, a 2.2% increase in manufacturing output reflecting temporary pre-Brexit activity, including stockpiling, and contributing to a 0.5% rise in gross domestic product.

There was always going to be payback for that in the current quarter, and that is what we are seeing. If growth slows to 0.2% in this April-June quarter nobody will be much surprised. That was expected even before the release of the latest surveys. If it is weaker than that, perhaps dragged down by the huge reductions in vehicle production in April, a few eyebrows will be raised.

The question is where we go from here. Growth of 0.2% a quarter is lamentably weak, and about a third of past norms, and what the economy was achieving in 2014 and 2015. Capital Economics suggests that the latest bout of political uncertainty; the end of Theresa May’s tenure and the Tory leadership contest is likely to mean that growth will “stay lower for longer”, either because there will be a further Brexit delay or because the winning candidate, after realising that no better Brexit deal is available, will attempt to leave without one.

It does not need repeating that a no-deal Brexit would make the current near-stagnation of the economy look good. There is no such thing as a managed no-deal, and a no-deal Brexit would greatly risk tipping a fragile economy over the edge.

Businesses may take some reassurance from the fact that Parliament is opposed to a no-deal Brexit, and will be given the option by the Commons Speaker to exert itself, but that itself opens up whole new areas on uncertainty. How will the apparently irresistible force of most Tory leadership candidates insisting we will leave on October 31, meet the immovable object of the EU’s stated opposition to amending the May withdrawal agreement? I think it will be resolved by a tail-between-the-legs request from the new Tory prime minister for another extension of the article 50 process sometime in October. But there are other possibilities, including a general election and a second referendum.

Uncertainty is the common theme. It is bad for growth, particular when it is combined with a strong sense, particularly among businesses, that politics has lost its bearings. Thinking back again to the 1980s, there were plenty of challenges, including the Falklands War, high unemployment, the miners’ strike and the great power nuclear stand-off in what turned out to be the dying days of the Soviet Union.

Businesses knew, however, that the Tory party was on its side and that they could live with a Labour government. They would struggle to say that now.

Sunday, June 02, 2019
London bankrolls the rest of the UK - and that's not healthy
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 I want to talk about something, based as always on statistical fact, that is guaranteed to raise the hackles. If you live in London and the southeast you will be even more convinced that your taxes are subsidising the ne’er do wells in the Midlands, the North, Scotland, Wales, Northern Ireland and even parts of the South.

If, on the other hand, you live in those other regions and countries, you will be confirmed in your view that the UK economy is dangerously London-centric and tilted towards the gilded south-eastern corner of the country, a situation that urgently needs tackling.

The figures, from the Office for National Statistics, released a few days ago, show that in 2017-18, the latest fiscal year for which this kind of detail is available, London ran a fiscal surplus, a budget surplus, of £34.3bn. Taxes raised in London exceeded public spending in London by a very large amount.

London has the biggest fiscal surplus, followed by the southeast, the capital’s hinterland, which in 2017-18 had a budget surplus of £20.4bn, The East of England, also influenced by the London factor, also had a surplus, albeit smaller, £5.9bn.

Outside these three parts of the UK, which together account for just under 37% of the national population and 16% of its land area, everywhere else runs a budget deficit. The biggest is in the north-west, £20.9bn. Scotland, based on a geographic share of North Sea revenues, had a deficit of £13.3bn in 2017-18, slightly smaller than that for Wales, which of course has a smaller population, which had a deficit of £13.7bn. Northern Ireland’s fiscal deficit was £9.2bn.

To be fair to the north-west, its large deficit partly reflects its size of population. On a per capita basis, the largest fiscal deficit per head in 2017-18 was Northern Ireland, £4,939, followed by Wales, £4,395, and the north-east, £3,667, the north-west, £2,884, and Scotland, £2,452. In all these places taxes raised fell short of public spending by thousands of pounds on average for every person.

But to also be fair to London, the south-east and the East of England, much of the recent improvement in the public finances would not have happened without their contribution, There were big improvements in the fiscal positions of London and the southeast between 2015-16 and 2017-18, while deficits were becalmed in many other regions. London and the southeast did the heavy lifting.

That is enough figures. What does it mean? We are a single country, the UK, and as such very good at redistributing these surpluses and deficits. The taxes raised in London and the southeast make possible higher spending on public services, and on benefits and tax credits, in the rest of the country.

Just to illustrate that, in 2017-18, London’s tax take was £150.1bn and the southeast’s £121.4bn, a large chunk of the UK total of £753.1bn. The UK’s average revenue per head was £11,434, figures greatly exceeded by London, £17,090, and the southeast, £13,427.

Before coming on to what all this means, let me address a couple of urban myths. One is that, because London is awash with civil servants, it is not surprising that it has an economic advantage over other regions.

It is not true. London has just over 80,000 civil servants, less than a fifth of the national total, and dependence on public sector employment is typically higher elsewhere. Past regional policy involved the dispersion of civil service and other public sector jobs to the regions. This has proved to be something of a double-edged sword in recent years. In the period since 2010 roughly half a million public sector jobs have been cut.

Myth number two is that London gets the lion’s share of infrastructure spending, without somehow paying for it. It is true that the capital has dominated infrastructure spending, on the far from irrational grounds that an international city like London has to be seen to be working, and has seen a lot of spending, from the Olympics through to the yet uncompleted Crossrail project.

This spending is, however, included in the figures. So far this century, London has the third highest spending per head, including capital spending, in the UK, after Northern Ireland and Scotland, but has continued to run a fiscal surplus, because of its higher tax take. The southeast and the East of England, incidentally, both fiscal surplus regions, have the lowest public spending per head.

So what is it? Many years ago, researching a book, North and South, I tracked the decline of regional headquarters, in favour of London. Companies that used to have their headquarters close to their production facilities, in Leeds, Manchester, Birmingham, Liverpool, Glasgow, Cardiff or Belfast, no longer did so, in many cases because those production facilities had been moved offshore. This “headquarters effect” boosts London’s tax take at the expense of the rest of the country. In that respect, perhaps, the streets of the capital are paved with gold.

It is part of a wider phenomenon. The City of London is a huge generator of tax revenues and the combination of financial centre – the biggest in Europe – commercial centre and seat of government guarantees the dominance of London and its hinterland. In America the financial centre, New York, is different from the seat of government, Washington, as it is in Germany, with Frankfurt and Berlin. France is Paris-centric and Italy Rome-centric for the same reason that the UK is London-centric.

Can and should anything be done about it? Brexit, according to the government’s own cross-Whitehall assessments, will widen the regional divide rather than narrowing it. It will hurt the fiscal deficit regions of the Midlands and North, as well as Wales, Scotland and Northern Ireland.

Labour has been mulling over proposals to shift many of the Bank of England’s operations to Birmingham, though I doubt the City is ever going to move meaningfully from London. The fact that the Houses of Parliament are falling down is seen by some as an ideal opportunity to move the seat of government northwards, though I have not detected much appetite for that in Westminster.

Spending more on infrastructure in the regions would help but would not be a panacea. We can build on successful initiatives like the Northern Powerhouse but, as noted, this has not yet steered the northwest towards a fiscally sustainable position.

The challenge is to spread the success of one economically and fiscally successful part of the country, London and the southeast, without damaging it. It is a challenge with no easy solutions, as successive governments have discovered.

Sunday, May 26, 2019
When China sneezes, the world catches a cold
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 said that we owe to Metternich, the distinguished 19th century diplomat, one of the most famous phrases used about the global economy. In an era when Europe dominated the world economy, he came up with: “When France sneezes. Europe catches a cold.” That was easily adapted, with the rise of the United States, to: “When America sneezes, the world catches a cold.”

It remains true today. The sneezing fit that began in America’s housing market in the 2000s gave us the global financial crisis of 2008-9.

There is, however, another country we should worry about in the sneezing stakes, highlighted by the Organisation for Economic Co-operation and Development (OECD) is in latest economic outlook. China’s rise is not new, but it is still easy to understate its importance to the world economy.

China’s gross domestic product at market exchange rates is about two-thirds of that of America, and ranks as the second biggest economy in the world. The EU, if counted as a single economy, slots in between the two. On a purchasing power parity basis, adjusted for relative prices, China’s economy is the biggest in the world and more than 20% bigger than America. On that basis, incidentally, the EU economy is 7.5% larger than the US.

The OECD, which revised down its growth forecast for the world economy to what it described as a sub-par 3.2% - its forecasts for Britain are for 1.2% growth this year and 1% next, on the assumption of a smooth Brexit – cited weak import growth in China as a key factor in the downturn in world trade.

Amid Donald Trump’s trade war with China, which has taken its toll on trade flows between the two countries – both export and import volumes are showing annual percentage falls in the mid-teens – there is plenty of collateral damage. China’s reduced appetite for imports is hitting Europe, and in particular the export powerhouse of Germany, as well as Japan and other Asian economies.

It is being felt in Britain. Though it is easy to mock Britain’s export performance in China – Germany sells four times as much – exports have been rising, to £18.5bn for goods and £23.1bn for goods and services last year. China is still a smaller export market for Britain than Ireland, along with America, Germany, the Netherlands and France, but the value of exports to China last year was almost three times the level a decade earlier.

China is, of course, a prime source of imports for Britain, £44bn last year for goods alone, and last year’s goods and services deficit with China was a chunky £22bn.

But the Chinese economy matters for exporters, could matter much more in the future, and it matters a lot for some now. Jaguar Land Rover’s £3.6bn loss for 2018-19 including special factors, was for a range of reasons. High among them was the drop in sales as a result of what it described as “the backdrop of a weaker China market”.

That, as far as JLR is concerned, is putting it mildly. Last month it saw sales in Britain up 12.1% on a year earlier, with US sales up 9.6%. But sales in China were down by a staggering 45.7% on a year earlier, contributing to an overall fall in sales of 13.3%.

The White House’s additional tariffs on Chinese imports will cost the average American household $831 (£660 a year), according to research from the Federal Reserve Bank of New York. The OECD is not alone in calling for an easing of trade tensions, which are taking their toll, to put the global economy back on track.

There is a wider point, also highlighted by the OECD. As it says: “The post-World War II process of globalisation driven by multilateral agreements that allowed ever-increasing trade openness is being challenged.”

When Brexit and Trump’s election victory happened within a few months of each other in 2016, it represented a lurch towards protectionism. The US president was explicit on taking over; “protection will lead to great prosperity and strength.” In each case, however, the tide of globalisation had already begun to ebb. It is not clear, even as the economic costs of trade wars rise, that attitudes will change.

After many decades in which the growth in world trade had been seen to lead global economic growth, the period since the crisis has seen trade struggle to keep up. Protectionism had increased before Trump came and along with other factors such as the availability of export credit, reduced trade growth. The US president was more explicit but was going with the flow, particularly towards China.

Attitudes to globalisation, meanwhile, had shifted. The boost to consumers from cheap Chinese imports, which at one time used to be seen as a key practical benefit of globalisation, gave way to concern, though many years too late, about the loss of traditional manufacturing jobs.

Where do we go from here? It would be naïve to think that an outbreak of sweetness and light between America and China is on the cards, even if the current trade dispute is would down. Google has been forced to restrict Huawei’s access to some of its apps and updates. The battle for control of the 21st century knowledge economy is joined.

For China, which had already seen a growth slowdown from an average of 9.5% a year since the late 1970s to roughly 6% now, this is the first serious challenge to tis rise. The poster-boy of globalisation is adjusting to a world of de-globalisation.

The assumption by Western countries that a richer China would become less addicted to unfair trade practices and appropriating the intellectual property and technology of others, may now never be tested.

China, naturally protectionist and suspicious of the West, will have been reinforced in that view by America’s tactics under the Trump. If protectionism comes naturally to the leader of the free world, why should the leader of a traditionally closed world be any different? As we have seen in the negotiations between America and China, son far at least, replacing subtle Western pressure on China with the sledgehammer has not paid dividends.

Meanwhile, under the Made in China 2025 programme, China will seek to match or exceed US standards across a range of advanced manufacturing sectors, including aviation, artificial intelligence, robotics and chip manufacturing, and will thus have less need of the West.

It does not need to be like this. In his recent book The Third Pillar, the former Indian central bank governor and candidate for next Bank of England governor Raghuram Rajan, writes: “There is a dialogue to be had which can reduce concerns on all sides, though the rise of a new power, challenging an earlier hegemony, is always difficult. That dialogue becomes much harder if China suspects the developing world is ganging up as well as if China becomes more repressive politically.”

That looks to be where we are at. Nobody wins trade wars and, to be fair, insufficient attention was paid to the fact that there are costs as well as benefits from globalisation. There are plenty of costs in the current deep global trade tensions, and it is hard to see any benefits.

Sunday, May 19, 2019
EU workers are returning - but maybe not for 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.

Every so often some figures come along which change your perceptions. This happened a few days ago. We have got used to the idea that the number of European Union nationals working in Britain has been falling. Indeed, this fall has contributed to a tight labour market and recruitment difficulties across many sectors.

So, for example, during the course of 2018 there was a 61,000 drop in the number of EU nationals working in Britain, and the total was down by almost 90,000 from its 2017 peak. Having risen by an average of nearly 140,000 a year since 2004, this drop in the number of EU workers represented quite a turnaround.

That was the story, and it chimed in with what businesses have been saying. It was a surprise, therefore, when official figures last week showed that, far from falling, the number of EU workers in Britain recorded a rise of 98,000 in the year to the first quarter. This meant, incidentally, that the cumulative rise in the number of EU nationals working in Britain since just before the referendum is 237,000, to the current total of 2.38m.

It was driven in the past 12 months by workers from Romania and Bulgaria, up by 70,000 over the year, with smaller rises of 9,000 in so-called EU8 workers – those from Poland, Hungary and the other countries which joined in 2004 – and 14,000 in workers from the longer-term EU14 Western European EU members. But it was a rise nevertheless. Does it mean the tide has turned?

Before answering that question, it is worth rehearsing why EU workers have been such a benefit for the UK economy. They have a high employment rate; 82.7% of EU migrants of working age are in jobs compared with 64.8% of non-EU foreign nationals in Britain.

They have not prevented a rise to record levels in employment levels and rates among UK nationals, have had a zero to minimal impact on wages for indigenous workers, and have been net contributors to the public finances, paying more in than they take out. Though freedom of movement has become toxic in the Brexit debate, it has been one of the great advantages of EU membership for this country, filling important gaps in the labour market.

If there is a concern about the latest figures, taking them at face value, it is the change in the mix of EU workers. Not to impugn Romanians and Bulgarians, but many of them find themselves in lower-skilled jobs, for which they are often overqualified, than earlier waves of EU migrants. Those lower-skilled jobs need to be filled but the contribution of these workers, including to the public finances, is proportionately lower.

The question is whether we should take the figures at face value, and I have to say that I smell a bit of a rat. The figures for EU nationals working in Britain are not seasonally adjusted, so have to be interpreted with care. There has in the past sometimes been an increase in the number of EU workers in the UK in the first quarter of the year, perhaps reflecting the fact that firms seek to recruit for the year in the early months.

This year, however, the jump was exceptional, 107,000 between the final three months of 2018 and the first quarter of this year. It contrasted with a quarterly fall a year earlier. It was entirely responsible for the turnaround.

What was going on? The Office for National Statistics has identified no special factors in the rise. It seems to me, however, that we might have seen the human equivalent of pre-Brexit stockpiling. Firms, in other words, rushed to recruit ahead of the initial March 29 Brexit date and EU nationals, keen to establish a foothold in the UK labour market, were keen to be recruited.

March 29 has come and gone and so might this temporary blip in the number of EU workers in Britain. It would be better if this were not so but normal service, in terms of a fall in the number of such workers, seems likely to be resumed, for familiar reasons. EU nationals feel less welcome, are uncertain about their future status and have suffered a pay cut measured in their own currencies because of sterling’s weakness. There are also often better opportunities closer to home.

The future, assuming Brexit goes ahead, and this week’s European Parliament elections will provide a lot of sound and fury about that, will bring greater difficulties for British firms in recruiting workers from other countries. In this debate, everybody loves skilled workers, and skilled migrants, but turn their noses up at the unskilled, even though there are plenty of unskilled jobs to fill.

Most people would also regard Britain’s manufacturing sector as the heartland of skills, and it is here where Britain’s post-Brexit immigration regime could bite very hard. The government is very likely to adopt a system in which there is a salary floor of £30,000 a year for both EU and non-EU migrant workers, implying that unskilled workers fall below that threshold while skilled workers are above it.

But, as Make UK, the former EEF, which represents Britain’s manufacturers, has pointed out in evidence to the government, such a floor would make it hard for firms to employ foreign workers. Currently 11% of UK manufacturing workers are EU nationals.

Nearly nine in 10, 88%, of manufacturing employees, including senior engineers, earn less than £30,000 a year. Design draughtsmen and women, who design and modify components, undertake technical calculations, and draft technical specifications using computer-aided design and manufacturing, would fit most people’s definition of a skilled occupation.

Yet, as Make UK points out, most such workers do not earn more than the £30,000 threshold, including 67% in the North West and 86% in Yorkshire & the Humber. More than 90% of all manufacturing employees in the West and East Midlands, Wales, the South West, the North East and Yorkshire & the Humber earn less than £30,000 a year.

Some would say that the response of firms to this would be to recruit more home-grown talent, and to train up more workers. But surveys show that this is the chosen route of the vast majority of businesses already, and they only turn to migrant workers when they have to.

In future, that will be much more difficult to do, and the economy will suffer as a result. The latest increase in EU nationals working in Britain, sadly, looks very much like a blip.

Sunday, May 12, 2019
There's no need to sacrifice growth to save the planet
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 get away from climate change these days. Most people would agree that it is a bigger issue, certainly for the long-term, than the one that has been unnecessarily preoccupying us for the past three years. Parliament has trouble agreeing on much these days but it has this month declared “a climate emergency”. The Environment Agency has warned that entire communities may have to be moved because of flooding and coastal erosion.

Climate change is also actively affecting policy. The Scottish government has just cancelled a planned cut in air passenger duty, because reducing the cost of flying would run counter to its ambition of making Scotland a zero-carbon economy before the middle of the century. In a different political environment, Philip Hammond could use the same logic to end the long freeze on fuel duty, which has lasted all this decade.

That we should be concerned about climate change is not in doubt, and it did not take the recent Extinction Rebellion protests to create that concern. Sir David Attenborough tops the list of Britain’s national treasures and his warning of a climate “catastrophe” in his BBC programme, Climate Change – The Facts, had a big influence. As he put it, we face “irreversible damage to the natural world and the collapse of our societies"

Not all of the problems of the natural world.are due to climate change, but many are, and last week’s report from the Intergovernmental Science-Policy Platform on Biodiversity and Ecosystem Services (IPBES made for sobering reading.

Around a million of the world’s 8m plant and animal species (5.5m of which are insects), face extinction. Three-quarters of terrestrial environment and two-thirds of marine environments have been “severely altered” by human intervention and there has been an 85% drop in wetlands in the past thee centuries.

According to Sir Robert Watson, the chairman of IPBES: “The health of ecosystems on which we and all other species depend is deteriorating more rapidly than ever. We are eroding the very foundations of our economies, livelihoods, food security, health and quality of life worldwide.”

This is not something, in other words, we can ignore. There is a feedback loop from the natural environment to economic activity and prosperity. It is not a question of the economy or the environment; the two are intimately linked. A report on Thursday from the Institute for Public Policy Research’s Centre for Economic Justice declared that “environmental breakdown has reached a critical stage” and added: “Our current economic model is fundamentally unsustainable.”

Is it? Sometimes in this debate there is a crude lesson drawn on economic growth and the environ-ment, which is that the only way of saving the planet is by giving up on growth. Not many sensible people say this explicitly but many activists do, and it is not far below the surface even in some of the heavyweight reports. The IPBES notes a 15% increase in global per capita use of materials since 1980 as one of the factors behind environmental degradation.

It is, however, plainly the case that you can both have economic growth and do right by the planet. The UK’s expert committee on climate change, in a recent report, noted that there has been a 44% reduction in Britain’s greenhouse gas emissions since 1990, alongside a 75% increase in real gross domestic product. Economic growth and reduced greenhouse gas emissions have gone hand in hand.

Britain has had a better record than most, but in the first 15 years of the current century there were more than 30 other countries, mainly advanced industrial countries, which combined economic growth with falling emissions.

Those following this debate will be aware that the official way of measuring greenhouse gas emis-sions is not the only one. The young activist Greta Thunberg told MPs last month that Britain was guilty of “creative carbon accounting”. What she meant, I think, is the reduction in emissions since 1990 is on a production basis.

On a consumption basis, taking into account air transport, shipping and the fact that Britain has, not through choice, contracted out much of its manufacturing to high-emitting China, she argued that the true reduction in emissions by this country since 1990s is closer to 10%, according to some re-searchers.

Even accepting this lower figure for emissions reductions does not change the underlying argument that you can have economic growth while reducing your contribution to global warming. Undermining Britain’s achievements, which include a record run this month without the use of coal for electricity generation, is hardly the best way to gain public and political support for the measures and sacrifices that will be needed to achieve a 100% reduction in emissions by 2050.

The committee on climate change wants legislation for net-zero greenhouse gas emissions by 2050, to cover all sectors of the economy, including international aviation and shipping. It wants that target achieved by domestic actions, not through the purchase of carbon credits.

Those actions include, according to the committee: “ A supply of low-carbon electricity (which will need to quadruple by 2050), efficient buildings and low-carbon heating (required throughout the UK’s building stock), electric vehicles (which should be the only option from 2035 or earlier), devel-oping carbon capture and storage technology and low-carbon hydrogen (which are a necessity not an option), stopping biodegradable waste going to landfill, phasing-out potent fluorinated gases, increasing tree planting, and measures to reduce emissions on farms.” The cost, it says, will be be-tween 1% and 2% of GDP. The benefits could be considerable.

Are these measures consistent with continued economic growth? Yes, very clearly, though they will require a considerable and prolonged programme of investment. It is not being unduly optimistic to say that greener growth will bring significant opportunities.

As the committee puts it: “The UK could receive an industrial boost as it leads the way in low-carbon products and services including electric vehicles, finance and engineering, carbon capture and storage and hydrogen technologies with potential benefits for exports, productivity and jobs.” With some slightly more astute political leadership than we have seen recently, it should also be eminently possible for it to go with the grain of public opinion.

Britain can, then, combine economic growth with lower carbon emissions, and with other action to reduce the impact of economic activity on the environment.

The bigger challenge is whether this can happen globally, particularly in countries
in a different stage of economic and industrial development than Britain. Global greenhouse gas emissions did not rise much over the 2014-16 period but rose in 2017 and 2018. Last year’s increase was 1.7%. Every 1% of global economic growth produced an increase of nearly 0.5% in emissions. Britain is doing well but there is a lot of work to be done globally.

Sunday, May 05, 2019
Robots aren't destroying jobs, but nor are they boosting 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 future is, by its nature, something that is yet to happen. In some ways though, what we think of as the future – things like artificial intelligence (AI) and robots – are already with us. So, without wanting to sound like some terrible advertising slogan, the future is now, and that allows us to make an early assessment of its impact.

To pessimists, new technologies like AI and robotics are always going to be a destroyer of jobs on a vast scale. People will be replaced by machines that, in many cases, will be a lot smarter than they are.

I have always argued, by the way, that while some jobs might be replaced by machines employment would not be. Technology would in future create as many jobs as it destroyed, if not more. It is not the best example but the cottage industry that has grown up to replace smashed smartphone and tablet screens, and can be seen in every high street and shopping centre around the country, clearly would not exist if there were no smartphones and tablets.

The optimistic argument about AI and robotics goes a lot further than “they won’t bring mass unemployment”. The argument here is that these technologies will unleash a period of strongly rising productivity and prosperity, shaking us out of our post-crisis lethargy and into a much brighter and better future. The march of the machines, in other words, should be something we welcome with open arms.

As it happens, a couple of new reports, one from the Organisation for Economic Co-operation and Development (OECD), its latest employment outlook, and the other from the Chartered Institute of Personnel and Development (CIPD) speak to this very subject.

The OECD’s outlook is called The Future of Work and goes into every aspect of the labour market effects of new technologies. It notes that we are in an era of more rapid diffusion of technology. In America it took seven decades for the proportion of households with landline phones to rise from 10% to 90%, while for mobile phones it took only 15 years, and for smartphones eight years. Business spending globally on information and communication technologies (ICT) has risen rapidly and there has been a fivefold increase in sales of industrial robots this century.

Across the 34 members of the OECD, 14% of jobs are said to be at high risk of automation and 31.6% at risk of significant change as a result of new technologies. For the UK the figures are 11.7% and 26% respectively. “The manufacturing sector is at high risk, but so are many service sectors.” It says. “And, even though the risk of automation is low in health, education and the public sector – many people will be affected because those sectors employ a large share of the workforce.”

On automation, the OECD agrees with me that we should not confuse the risk to individual jobs with the risk to overall employment. As it puts it: “Despite widespread anxiety about job destruction driven by technological change and globalisation, a sharp decline in overall employment is unlikely. While certain jobs may disappear, others will emerge, and employment has been growing overall.”

This does not mean we can relax entirely. People will need help, and training, to transition out of the jobs that are being replaced by machines and into new ones. Some workers, and some regions, are at greater risk. Young people, particularly those with no post-school education, are at the greatest risk says the OECD.

The CIPD, in a survey carried out with PA Consulting, found that a third of 759 businesses it questioned had invested in AI and automation over the past five years. The employment effects were, contrary to fears, positive; 35% saw more jobs in the areas affected, and 25% less. By nearly three to one, 44% to 18%, employers said AI and automation had made jobs more secure. Among employees, more than half, 54% said these new technologies had not helped them do their job better. There was little evidence that AI and automation were associated with significant productivity improvements, which the CIPD puts down to “lack of thought and planning on how people and technology are working together”.

It is, as I say, early days but it is fair to draw some initial conclusions. There are sector like retailing, which saw a 2.4% drop in employment in the year to the first quarter, where an effect on jobs from automation, such as customer-operated checkouts, can be detected, though separating that from other factors affecting jobs is difficult. In Northern Ireland I came across a firm that had no alternative but to automate because of the loss of EU migrant workers. I am sure there are many others.

Overall, however, it is hard to detect an employment effect. Britain’s employment rate is at a record high. At 76.1% it is near the top of the OECD league table, behind only Germany, New Zealand, Japan, the Netherlands, Sweden, Switzerland and Iceland. But, in Britain and elsewhere, there is a stubbornly high proportion of people low-skilled jobs. Automation, which might be expected to render many of these low-skilled jobs redundant is going hand in hand with an increase in their number. To be optimistic about the productivity consequences of new technology, you would want to see many of these low-skilled jobs automated out of existence.

The OECD has some other interesting comparisons. The UK has a lower proportion of temporary workers than average but a higher proportion of part-time and self-employed workers. Flexibility operates in many different ways.

What it is not doing, so far at least, is producing any evidence at a macro level that AI and robotics are bringing an increase in productivity. Though the picture in the UK is worse than most for productivity, it is hard as yet to detect any sign that the optimistic technology story, the one in which it brings noticeably stronger increases in productivity and prosperity, is happening anywhere in the OECD. The optimistic technology story, in other words, has yet to reveal itself.

That may be because we are still in the foothills of shifting the UK and other western economies into a higher gear. I am sure there are consultants reading this who can point to discernible, technology-driven productivity gains for their clients. It may be that the pioneers of AI and robotics are by trial and error merely paving the way for others who will be able to drive meaningful and lasting productivity gains and a future of rising prosperity, more leisure time and more people in skilled rather than unskilled jobs. That has always been the great promise. We can only hope it becomes a reality.

Sunday, April 28, 2019
This may be as good as it gets for the public finances
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 we had an object lesson in how official figures can be simultaneously disappointing and very good. Not that many people follow these things closely, but for those who do, last month’s data for public borrowing – the budget deficit – represented a bit of a setback.

March’s borrowing total of £1.7bn was £0.9bn up on a year earlier, breaking a run in which the latest figures have tended to be lower. It was also more than £1bn above City expectations.

Thus, instead of coming in at or below the latest official forecast from the Office for Budget Responsibility (OBR), made just last month, the 2018-19 total for public borrowing, £24.7bn, was nearly £2bn above it.

It is testimony to the fact that Britain’s budget deficit has ceased to be a significant concern for markets that nobody much batted an eyelid at these numbers. The bigger picture, the unalloyed good news, was the huge fall in borrowing that occurred in 2018-19 compared with the previous year.

That £24.7bn total, 1.2% of gross domestic product, was £17.2bn lower than the near £42bn figure for 2017-18. From the giddy and dangerous heights of £153bn and 9.9% of GDP in 2009-10, this has been a formidable fiscal repair job.

Before answering the question of whether the process of deficit reduction can go any further from here, and whether it should, let me provide a bit of perspective.

There is a lot of popular misunderstanding about what was promised on the budget deficit and what has been achieved. When, in 2010, George Osborne embarked on his deficit reduction strategy, the aim was not to have got rid of the entire budget deficit by now.

What he intended to do was eliminate the deficit on current public spending – so only borrow to invest – adjusted for the economic cycle, together with lowering public sector debt as a percentage of GDP.

Both aims have been achieved, though a little later than hoped. The cyclically-adjusted current budget deficit was supposed to have bene eliminated by 2015-16. It all but happened a year later, falling to 0.1% of GDP in 2016-17, and the government has now been in surplus on that measure for two years in a row, by 0.9% of GDP in 2018-19. Public sector net debt did fall as a percentage of GDP in 2015-16 but then rose again. It is now falling. At the latest count it is 83.1% of GDP, though that equates to a hefty £1.8 trillion.

The budget deficit fell a lot in the latest fiscal year, because tax revenues were buoyed by faster growth in pay, strong retail sales boosted VAT receipts and public spending remained under tight control. Low unemployment helped in this regard.

How does the performance of the public finances compare with what was expected around the time of the referendum? The last “clean” forecast from the OBR, in November 2015, before the referendum was announced, anticipated borrowing figures of £49.9bn in 2016-17, £24.8bn in 2017-18 and £4.6bn in 2018-19. The outturns have been a cumulative £32bn higher than that.

The OBR’s first post-Brexit forecast in November 2016 got the economy right, its GDP forecast was the most accurate in its history, but the deficit wrong. Compared with that borrowing is a cumulative £60bn lower, though that gap will narrow if, as seems likely, the deficit figures for the next three years are higher than predicted then. The big picture is that borrowing is higher than expected before the referendum – by now it was expected that we would be moving into a run of overall budget surpluses – but so far lower than predicted immediately afterwards. Growth has been more deficit-friendly than expected.

Where do we go from here? There is a notional target of balancing the budget by the mid-2020s but few, inside or outside government, take it too seriously. It would be easy to conclude at this stage that this, or rather 2018-19, will be as low as it goes for the budget deficit. The deficit has been fixed, and the political incentive to go further is no longer there.

Theresa May has promised the end of austerity and Philip Hammond, perhaps reluctantly, has been obliged to go along with it. This year will see the first of the big increases in NHS spending coming through and, if there is a spending review this year – Brexit may yet thwart it – other departments will expect their share of largesse. Austerity, to judge by a record number of food handouts by Trussell Trust food banks in the latest 12 months, as well as other indicators, is far from over.

There is also the possibility of a Labour government, which the Tory party implosion brings closer by the day. The left-leaning Institute for Public Policy Research (IPPR), which has some influence in the Labour party, suggests the UK should be aiming for the European average for spending of nearly 49% of GDP, compared with what it says is the current level of 40.8%. Official figures suggest something lower than that, 38.5% of GDP but, either way, a very big increase in spending is suggested.

There is a way of squaring the circle. Productivity means an enormous amount for the economy and for the public finances. If we could be confident that productivity growth was to return to something like normal levels , roughly 2% a year from zero now, it would be possible to be very confident about the outlook for the deficit.

Government can do something about it. Hammond has talked in recent days about a spending review that is focused on raising productivity. One way of doing that is to reduce the huge productivity gap between London and the rest of the country, and projects such as the £39bn Norther Powerhouse Rail project, providing better and faster links between Liverpool, Manchester, Leeds and Sheffield, would help in that regard.

Under his chancellorship the balance is shifting towards more public sector investment – in net terms the 2018-19 figure was the biggest since the financial crisis – so there is hope. There is also the danger that the extra spending to be announced this year will just be a sticking plaster to try to get the economy, and the Tories, through their Brexit withdrawal symptoms. In which case, this may as good as it gets for the budget deficit.

Sunday, April 14, 2019
The trade deficit soars, in a terrible time to be an exporter
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.

Now that the Brexit process is guaranteed to stretch on for many more months, if not years, there is a limit, which may be close to being reached, on how much new there is to say. I shall bear that very much in mind in my choice of topics. We may be neither properly in, nor out, for a very long time, and most probably beyond October 31, the latest departure date.

Business is relieved that a no-deal Brexit has been avoided, and will continue to be avoided. But it is alarmed that the limbo could go on fo0r a very long time. Make UK, which represents Britain’s manufacturers, describes as a “heavy blow” the fact that firms will have to maintain “stockpiles of parts and materials at great cost” to cover all eventualities. Perhaps eventually, if this drags on long enough, firms will decide that Brexit is never going to happen and they can just carry on as before. But we are not there yet.

In the meantime, the false alarms and Brexit deadlines are having an impact on
the economic data, good and bad. The latest monthly gross domestic product (GDP) figures for February surprised on the upside, rising by 0.2% against expectations of no change on the month. These figures are still bedding in, as are analysts’ predictions for them. Nobody expected a sharp fall in GDP in December, initially reported as a 0.4% drop, although nobody thought either that it signalled that the economy was falling off a cliff.

The 0.2% rise, it seems, owed something to pre-Brexit stockpiling, with the Office for National Statistics (ONS) noting evidence that “some manufacturing businesses have changed the timing of their activity as we approached the original planned departure from the European Union”. There will be a degree of swings and roundabouts in this; there is only so much stockpiling that firms can do and this month’s production shutdowns in the motor industry, originally timed for Brexit, may drag down industrial output. But for now the GDP numbers have been helped.

A stockpiling effect can be observed when it comes to trade, and it is here in which the hope has to be that temporary factors are indeed at work. New figures show that in the latest the latest three months, December-February. The trade deficit in goods was £41.4bn, a record, and £6.5bn up on the previous three months.

Over the latest 12 months, Britain was in the red on trade in goods by a whopping £146.4bn, another record, and too close to £150bn for comfort. Even taking into account services, in which the UK runs a surplus, the deficit widened sharply in the latest three months and was just under £39bn over the latest three months.
That £146.4bn, by the way, compared with an annual goods trade deficit of £138bn for the whole of 2018 and £118bn in 2015. Until 2012, the deficit had never been above £100bn; 20 years ago it was comfortably below £30bn

How much of the latest deterioration was due to pre-Brexit stockpiling? Samuel Tombs of Pantheon Macroeconomics highlights a surge in trade with the EU; exports as well as imports were higher in February. But, given that we import more from the EU than we export, the net effect is to widen the deficit.

Beyond these temporary factors, however, there is an uncomfortable truth for a trading nation like ours. This is a terrible time to be an exporter. After a temporary fillip in 2017, thanks to a stronger global economy and sterling’s referendum fall, the volume of exports of goods fell last year and is falling now, with a sharper fall in non-EU than in EU exports. Both are down on a year ago, even with the stockpiling factor.

We have a protectionist in the White House, as my colleague Irwin Stelzer discusses today, and a slowdown in the global economy which is partly the result. The International Monetary Fund once thought this would be a year in which the world economy got back to its pre-crisis growth norm of around 4% growth; now it has revised its forecast for this year down to 3.3%. And, of course, there is Brexit.

A paper to be presented at the Royal Economic Society’s annual conference at Warwick University this week, Renegotiation of Trade Agreements and Firm Exporting Decisions, by Meredith Crowley, Oliver Exton and Lu Han, finds that in the period after the referendum there was a significant negative effect on the willingness of firms to export.

In particular, according to the research, based on what the authors call “trade policy uncertainty”, more than 5,300 firms which had intended to start exporting to the EU decided against doing so, while more than 5,400 businesses stopped selling into the EU market. The Brexit vote provided a “natural experiment” in introducing uncertainty over future tariffs and other trade restrictions into a situation in which there was not uncertainty before.

Though the authors stress that smaller firms are most likely to be affected, one of the challenges for the government over many years has been in trying to get more smaller firms to export. Brexit has had the reverse effect.

We do not know, of course, where we will end up, and when the uncertainty will lift. Lord Macpherson, Treasury permanent secretary until 2016, its top civil servant, says there is now no chance of a trade agreement with the EU by the time of the next election, due in 2022 (but watch this space), and probably not by the one after that (2027).

We do not know, either, when the protectionist threat from America will lift. The IMF has taken an axe to its forecast for world trade growth for this year but is predicting a pick-up next year. That may be optimistic.

Exporting matters. “Export or die” used to be the theme of public information films, encouraging the British public to forego their purchases of luxury goods, so that they could earn valuable foreign currency in export markets. There was a time when you had to go on a long waiting list for a British-made car because of the preference for exporting.

More recently, George Osborne, when chancellor, made great play of reviving Britain’s great exporting tradition, with his pledge in the 2012 budget to double exports to £1 trillion a year by 2020. That is next year and, looking at where we are today, that target looks set be missed by around £350bn. He would no doubt say that the target, which was always very ambitious, was thrown off course by Brexit. The challenge now is not to double exports but to achieve any growth at all.

Sunday, April 07, 2019
Britain's minimum wage, 20 years old, is an unlikely success story
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, to take your mind off other things, which will do us all some good, let me talk about a British success story. It has helped prevent low-paid workers being exploited by the minority of unscrupulous employers, it has put a brake on rising inequality and it has not prevented a strong and sustained rise in employment.

It is also celebrating an important milestone; 20 years old this month. I refer to the national minimum wage, now the national living wage for those aged 25 and over. It has just risen, on April 1, to £8.21 an hour, with lower rates ranging from £3.90 for apprentices to £7.70 for 21-24 year olds.

When it was introduced, in April 1999, there were 27m people in employment in the UK, and the employment rate for the 16-64 age group was 71.3%. Twenty years on, nearly 6m more people are in work – the total is 32.7m – and the employment rate stands at a record 76.1%.

I am going to own up at this point to the fact that at two points in those 20 years, I worried that there would be a cost to jobs as a result of this policy. One was when the minimum wage was introduced by Tony Blair’s Labour government, when it risked introducing an unnecessary inflexibility into Britain’s flexible Labour market. The other was after the 2015 election, when George Osborne announced the national living wage for those aged 25 and over, and provided low-paid workers with a significant pay boost, one which had not had the benefit of the expert analysis of the Low Pay Commission.

But, and this is a mea culpa, both Ed Balls, who was instrumental in the introduction of the minimum wage and Osborne, who increased it with the living wage, judged it well.

I remember Balls explaining to me how the government, on the advice of the Low Pay Commission, had chosen the initial level of the minimum wage, £3.60 an hour for those aged 22 and over, by careful consideration of where it fell within the existing wage distribution, Setting it too high, in other words, could have had adverse consequences for jobs. For Labour, the minimum wage was also important as a backstop at a time when tax credits were being introduced. Without it, employers might have passed on too much of the responsibility for workers’ incomes to the state.

Osborne’s living wage, similarly, has not hit employment, far from it, though it has put some sectors under strain, of which more in a moment. But if its aim was to create “an economy that works for everybody” after five years of austerity it may have come a little late.

The success of the minimum wage is set out well in a new report from the Low Pay Commission, chaired by Bryan Sanderson. In the past, the pay of the lowest-paid workers has risen more slowly than those in the middle and at the top. The minimum wage has ensured the opposite, boosting the annual pay of those at the bottom of the wage scale by roughly £5,000 a year.

As Sanderson says of its introduction 20 years ago: “The conventional wisdom of the time was that minimum wages simply forced low-paid workers out of their jobs. But over the last 20 years, the national minimum wage has shown that this is not necessarily the case. It has raised pay for the lowest paid without damaging employment.”

The current living wage of £8.21 an hour would have been just £6.54 had it risen in line with average earnings from that initial £3.60, and only £5.39 had it gone up by the consumer prices index. The UK’s minimum wage, at its inception, was in the middle of the range of OECD countries; now it is near the top.

It covers around 2m workers and its so-called “bite” – the minimum wage as a proportion of the median wage for all workers – has risen from 44% in 2001 to within a whisker of 60% now. While workers overall have suffered a drop of 4% in real wages since 2008, the financial crisis, those on the minimum wage have seen their real wages rise by 13%.

Most striking of all has been the apparent lack of any detectable adverse effect on jobs. Actually, there was good evidence at the time of its introduction that a minimum wage, sensibly set, would not hit employment. The death was announced last month of Alan Krueger, who served as chair of America’s Council of Economic Advisers under the presidency of Barack Obama. Tragically, his family said he took his own life.

In the early 1990s he and David Card published a hugely influential paper, Minimum Wages and Employment: A Case Study of the Fast-Food Industry in New Jersey and Pennsylvania. They had the advantage of being able to conduct a real-life comparison between New Jersey, where the minimum wage went up from $4.25 to $5.05 an hour in April 1992 and Pennsylvania, where it remained constant.

Far from cutting employment in New Jersey, it rose, while in Pennsylvania it fell. There may have been other factors in that fall, but their robust conclusion was: “We find no indication that the rise in the minimum wage reduced employment.”

So is it all plain sailing for the minimum/living wage? I would be failing in my duty if I did not mention that the living wage, in particular, is not well loved by many in some sectors of the economy, notably hotels, restaurants, retailers and, perhaps most of all, the care sector. Added to other burdens, including business rates, the apprenticeship levy and a reduction in the supply of EU migrant workers, it is seen by many as another government impost which makes business more difficult. Though the Low Pay Commission examines in detail the impact of the minimum wage on different sectors of the economy, it is by its nature a blunter instrument than the old sectoral wages councils.

Those vulnerable sectors have to be watched, as do politicians. There is a risk that the minimum wage becomes part of an election bidding war. Labour has pledged to raise the minimum wage for all workers over the age of 18 to the level of what is also called, confusingly, the living wage, though this one is set independently of government and is expected to be at least £10 an hour by next year, according to Labour. Set by the Living Wage Foundation and voluntary, it is currently £9 an hour across the UK and £10.55 in London.

It would be a great pity if the minimum wage were tested to destruction with increases bigger than the market can bear. It has been a British success story.

Sunday, March 31, 2019
A customs union beckons - and it won't stop trade deals
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 week on in the Brexit process and I am worried. I may have used up all my best adjectives too soon. This thing could get even madder. And, in a few weeks’ time, the short rein of Theresa May as prime minister will soon be over; the only former Bank of England official, as far as I know, to have made it to the top job. She lost heavily again on Friday.

For all her faults, there was always an element of “cling on to nurse for fear of something worse” about Theresa May. Who knows who the 100,000 members of the Tory party, one of the least representative electorates in the world, could inflict on us? And then there’s Jeremy Corbyn waiting in the wings.

But let me be positive. Last week saw the House of Commons seize control of the order paper for a series of indicative votes on the way forward. They have been criticised for failing to agree on any option but that rather misses the point. They do point to a way forward if MPs are prepared to remove their party blinkers.

So, for example, a perfectly sensible proposal from George Eustice, the Tory Eurosceptic former agriculture minister who resigned in protest over May’s withdrawal agreement, was the pure “Norway option” of Britain rejoining the European Free Trade Association (EFTA) and thus staying in the single market and European Economic Area (EEA). It was heavily defeated by 377 votes to 65. Only a minority of Tory MPs and a tiny handful of Labour MPs supported it. It suffered from its authorship.

EFTA countries have profited from their relationship with the EU, whether by being in the single market, as with Norway, Iceland and Liechenstein, or by mirroring it closely, as with Switzerland’s large range of bilateral deals with the EU. All have a higher proportion of trade with the EU than Britain does.

On the other hand, the “Norway-plus” Common Market 2.0 proposal, combining EFTA-EEA with a comprehensive customs arrangement, attracted a lot of Labour support but very lukewarm Tory backing. Combine the two and Norway – staying in the single market - favoured by me since immediately after the referendum, could yet still be a runner. I fear, however, that like Monty Python’s Norwegian blue it is now a dead parrot.

The two indicative votes which came closest last week, and around which a consensus could build this week, were for a permanent customs union with the EU, as proposed by Kenneth Clarke, the former chancellor, which lost by just 272 votes to 264, and a second or “confirmatory” referendum, defeated by 295 to 264.

Let me say at the outset that anything with Clarke’s name attached to it deserves to be taken very seriously. As chancellor from 1993 to 1997, not only was he a delight to deal with but he presided over a strong recovery in the economy that in normal circumstances would have seen the Tories romp home in the 1997 election.

But then, as now, the party was riven with disagreements over Europe – maybe it would have been better if it had split irrevocably back then – and also tarnished by the biggest government humiliation since the current one; Britain’s involuntary and embarrassing exit from the European exchange rate mechanism in September 1992.

Does staying in a permanent customs union with the EU make sense? Let me explain. The central point is that within a customs union there are no internal tariff barriers. Exports from Britain to the EU would not attract tariffs, and neither would export to the UK from the EU. Within the customs union there is tariff-free trade.

There is not, of course, tariff-free trade from outside the customs union; a common external tariff would apply to imports from the rest of the world, as it does now. Being in a customs union would settle the problem of so-called rules of origin. Anything originating within the customs union would satisfy the requirement for tariff-free trade within it.

It would, as Clarke said in the Commons, “keep the minimum needed for frictionless trade and an open border in Ireland. We would also need some understanding or moves on regulatory convergence, but that does not need to be dealt with at this stage.”

Is not the fundamental flaw of a customs union that it restricts Britain’s ability to negotiate independent trade deals with other countries? No. As the trade expert Sam Lowe of the Centre for European Reform says he is now tired of pointing out, being in a customs union with the EU does not require Britain to sign up to the EU’s common commercial policy, under which it negotiates trade deals with other countries. The common external tariff would constrain Britain’s freedom of manoeuvre, preventing this country from offering tariff concessions, but would not prevent trade deals from being negotiated, particularly concerning services, which are the dominant part of Britain’s economy.

Are there other disadvantages? A customs union is, in the jargon, trade diversionary. It favours inefficient domestic producers at the expense of more efficient ones overseas. That applies particularly to agriculture. But an increasing proportion even of agricultural imports are tariff-free.

A customs union does not tick every box, as Clarke told the Commons. He also favoured the “Common Market 2.0” option of staying in the single market as well. The main drawback for this, and for any of the other indicative vote ideas that might rise above the pack this week is the current state of British politics.

May made no commitment to being bound by these votes and her successor would probably not be bound at all. No future Tory leader or prime minister would submit to the will of the Commons on a customs union or the single market if that was not already their position.

That is why, constructive though these votes may have been in purpose, they may turn out to be a waste of time. Not only that but their outcome will still be seen as second best by the many MPs, and voters, who would rather we just stayed in the EU. Their second-best solution should be to maintain as close a post-Brexit economic relationship with the EU as possible but for many of the most ardent Remainers it is a second referendum or nothing. I would warn them that, while polls point to a modest Remain lead in the polls, most voters have learned very little from the chaos and humiliation of the past three years.

Onto the next chapter and, I presume, a further extension of Britain’s “limbo” period; neither in noir out. At some stage the fun must stop.

Sunday, March 24, 2019
Britain shouldn't be too glad to be grey
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 recent days we have had another stunning demonstration of the potency of the job-creating machine that is the British economy. While surveys have suggested that employers are beginning to cut back on recruitment, there was no evidence of this in the official figures.

Overall employment rose by 222,000 in the latest three months for which data are available, November-January, and the employment rate for the 16-64 age group rose to 76.1%, a new record. The unemployment rate dropped to 3.9%, its lowest since November-January 1974-5. And, while only a minority of the net new jobs created over the latest three months were traditional full-time employee jobs, 93,000 out of 222,000, weaker than recently, the others being part-time employment and full and part-time self-employment, these were still strong figures.

And so we have the usual trade-offs. We have strong employment but weak business investment; the weakest of any major economy over the past 2-3 years. Are firms recruiting as an alternative to investing? For some that is not a choice, but for others it is, and it is being made.

There is also strong employment versus weak productivity, which has stagnated for a decade and has weakened again recently. These latest employment figures, alongside weak gross domestic product figures, guarantee further productivity weakness.

Then there is the pay puzzle. Average earnings growth is currently 3.4%, which in the case of total pay (including bonuses) is marginally lower than it was. Real wages are rising, but not by much. And, while you would not expect the kind of pay growth we had when unemployment was last as low as it is now, 44 years ago, when wage increases were well above 20%, you might expect it to be stronger than it is.

All these things; falling business investment, stagnant productivity and weak growth in wages are, of course, intimately linked. A return to the pay norms, not of the 1970s but the pre-crisis era, in which you would expect earnings to be rising by 4.5% to 5% rather than by less than 3.5%, requires a sustained revival in productivity.

There may, however, by another factor which helps to explain the current combination of circumstances, certainly weak pay and productivity, and it is the greying of the labour market. The average age of British workers is increasing and that may have important consequences.

More than half of the increase in employment over the past year has been concentrated in the 50-64 age group. And, if we look a little longer term than that, the concentration of employment growth in older age groups is striking.

Thus, in the past 10 years, there have been 3.175m net new jobs created in Britain, a great achievement. Of these, 591,000 have been among people aged 65-plus and 1.868m have been for those in the 50-64 age group. Thus, 77% of the rise in employment over the past 10 years has been among workers aged 50 and over. This is quite a figure.

Over 20 years, to provide a longer-term comparison, there has been an increase of just over 5.7m in employment. Of this, 854,000 is among the 65-plus age group and 3.2m among 50-64 year-olds. Over 20 years, 71% of the rise in employment has been among workers aged 50 and over.

Why is this happening? Some of it is a cohort effect; people moving from younger into older age groups. Much of it is to do with pensions. The gold standard of UK occupational pensions two decades ago has been badly tarnished and many older people can no longer afford to retire.

A bigger effect has been changes in the state pension age, both actual and in prospect, and this has impacted particularly on women, who have seen their state pension age increase rapidly from 60 to 65-plus. Nearly 60% of the increase in 50-64 employment over the past decade has been among women.

Add in age discrimination legislation and the removal of the default retirement age, which means that retiring old Joe when he reaches the age of 65 is now a matter of negotiation, and often compensation, and there is a cocktail of factors pushing up the average age of the British worker. Another is that younger people are staying longer in education.

How does this relate to the bigger picture of stagnant productivity and weak wages? I realise here that I am steeping into a minefield, but I shall do so gingerly. On the old adage that you can’t teach an old dog new tricks, there is quite a body of evidence that suggests that, the older the workforce, the weaker that productivity is likely to be. They are in general less innovative and less open to new ideas.

Research conducted on behalf of the government, and published a couple of years ago, suggested that a reduction in the proportion of 22-49 year-olds in the workplace, either because of more older or more younger workers, is associated with a drop in productivity.

An International Monetary Fund study three years ago, The Impact of Workforce Ageing on European Productivity, found that “workforce ageing in likely to be significant drag on productivity growth over the next few decades”. Every 1 percentage point increase in the 55-64 age cohort in the workforce was likely to be associated with a drop of 0.8 percentage points in productivity growth, it said.

For this and other reasons, the rise in the proportion of older workers is likely to be associated with weaker wage growth. Among other things, with fewer dependants and mortgages perhaps paid off, they are less likely to push for big pay rises.

A new study by the Bank for International Settlements in Basle, Can an ageing workforce explain low inflation?, concludes that a rising participation rate of older workers is one of the explanations for weaker growth in wages in recent years. It is still the case that falling unemployment will mean faster wage growth – the Phillips curve – but older workers nevertheless mean weaker than otherwise wage growth.

I would be the first to say that it is good that more older people are working, assuming that they want to. One constant theme from readers over the lifetime of this column has been discrimination against older workers. But we also have to accept that the greying of the workforce has other consequences, for pay and productivity

Sunday, March 17, 2019
Views from the brink: how slow growth and uncertainty leave firms on the edge
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, amid the Brexit chaos – which grows ever more chaotic by the week – have we learned about the economy? Alongside Philp Hammond’s spring statement, the Office for Budget Responsibility (OBR), revised down its growth forecast to 1.2% for this year, the weakest since the crisis, and predicted that the economy will expand by an average of about 1.5% over the following four years.

That assumes a smooth Brexit, a brave but necessary assumption (the OBR is required to forecast on the basis of government policy) and reaffirms that, even if we get over the short-term hurdle, the challenge of lifting Britain’s growth rate to something like past norms will remain considerable.

The OBR is gloomier about business investment than it was, expecting a fall of 1% this year, similar to last year’s drop, and growth averaging only just over 2% a year from 2020 onwards. This is no strong revival of pent-up investment some talk about and will leave productivity growth languishing at just over 1% a year in the medium-term.

The official forecaster is more comforting about future earnings growth, which it sees rising by just over 3% a year, and rising employment, which it thinks will continue, though at a significantly slower pace than over the past few years.

That combination is good for the public finances as, oddly, is weak business investment; when firms are investing, which can be offset against tax, it is bad for corporate tax revenues. Rising inequality is also good for the public finances. The top 0.1% in Britain are doing very well and generating a lot of income tax receipts. That, without dwelling on it today, could be a golden goose that gets cooked if there is a change of government.

So we have the strange situation in which growth disappoints but the chancellor’s room for manoeuvre has increased. It was thought he would have £15.4bn of room for manoeuvre for this year’s spending review, and possibly some tax cuts; now the OBR thinks it is £26.6bn, though half of that could disappear as a result of the new treatment by official statisticians of student loans.

Those are the headlines but what I wanted to do today is try to get under the bonnet of the figures and tap into what the Institute of Chartered Accountants in England and Wales (ICAEW) describes as “the economic instability resulting from the current uncertainty”. The ICAEW on Friday also revised down its growth forecast to just over 1%, an outlook it described as “frail”.

Two weeks ago I launched a bit of informal “crowdsourcing” to try to take the pulse of what was happening to small and medium-sized firms in Britain amid the uncertainty, following one reader’s claim that a “meltdown” was under way. The results, as I stressed then and stress again now, were never going to be scientific but do provide an insight.

In particular, they have enabled me to identify four categories of business in Britain. First on the list are those for whom the phone stopped ringing even before the current heightened uncertainty, and which are hanging on and hoping that something will turn up.

Typical descriptions of current business activity from those in this category were “sales slump”, “dramatic decline”, a warning that a mild decline now would turn into bankruptcy in the event of a no-deal Brexit, and “a disaster with a 60% drop in revenues”.

One business said turnover “fell off a cliff” last autumn, had stabilised this year, but was still well below normal. Another said that the current “plunge” in orders was worse than anything during the financial crisis a decade ago, which others also drew comparisons with for the “suddenness” of the downturn. Yet another said that this year had been “a complete blank” for new orders. One feared that the current sales downturn would be followed by “years and years of misery”. Quite a few thought we were on the brink of recession. Worrying.

Then there was a second category of firms. These were ones for whom business is currently fine, but who believe that a big reason for that is pre-Brexit stockpiling, either here in Britain or by customers in Europe. The fear among them was that this is giving a false reading of the underlying strength of their businesses and that there will be payback later.

Some firms it should be said, report business as usual; my third category. Business owners in this group are exasperated by the political shenanigans and wish that we could move on from Brexit and tackle some of the other issues that concern with them. But for them life goes on, and they and their customers are getting on with it.

Finally, there were the businesses which are doing well; gaining market share and exploiting new opportunities. For some of these, business has never been better, while others are continuing on a strong growth trajectory. If you wanted to be optimistic about the outlook, you would take your cue from these.

It is, of course, the balance between these four types of business which will determine what will happen to the economy over the next 12-18 months and indeed beyond. The biggest category of responses I received fell into the first category; that of firms experiencing a sharp and pronounced downturn and unsure of when it will come to an end.

That may reflect the nature of my initial query, which was based on the experience of a firm experiencing similar problems. It was not, as I say, scientific. But it is also the case that when growth is slow – and the surveys suggest it is even weaker than the snail’s pace expansion of the latest official figures (0.2% over three months), more businesses will be in trouble.

We know that retailers are having a tough time, with many casualties already. The housing market is deep in the doldrums too, as the latest downbeat survey from the Royal Institution of Chartered Surveyors confirmed. Other sectors are struggling.

Business and consumer confidence need a lift, or some of the tales of woe I have been hearing will have only one result. It is not entirely obvious this weekend where that lift might come from.

Sunday, March 10, 2019
Quantitative easing worked, just don't make a habit 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.

How time flies. It is hard to believe that it is 10 years since the Bank of England brought an entirely new type of monetary policy, for Britain at least, blinking into the sunlight. Quantitative easing (QE), a complicated name for something that many people do indeed find complicated, was launched then and is still with us.

The misunderstandings then were considerable. When the policy was launched in March 2009 Mervyn King, now Lord King, did a television interview with the then BBC economics editor Stephanie Flanders, to try to explain it.

His mission to explain was not helped by some hysterical comment. Though the worst offenders have often got the economy wrong, some predicted that the Bank’s initial tranche would lead to doom, disaster and hyperinflation, which was wrong on all three counts.

This is, however, a good time to look at QE, and not just because of the anniversary. The experiment, and experiment it was, may be coming to an end.

Theresa May, herself a former Bank official, said in her now notorious first party conference speech as prime minister in October 2016, the “citizen of nowhere” one, that QE had had “some bad side effects”. It had enriched people with assets and made those without them suffer, she said. Those in debt had benefited while those with savings had suffered. A flabbergasted Mark Carney was ready to hop on to the next plane to Canada.

The prime minister, not for the first time, got it wrong. QE was launched, with an initial £200bn in 2009, followed by a further £175bn in 2011-12 and a final (so far) £60bn in August 2016. It was done because, at the time, Bank rate had been cut to what was then the rock bottom of 0.5%, and that was deemed to be not enough to steer the economy away from deflation, falling prices, and towards a sustained recovery.

It worked, then as more recently, by ensuring that the drop in short-term interest rates – Bank rate – to a record low, was accompanied by a fall in long-term rates. Large-scale purchases of government bonds raised their prices and lowered their yields; the yield on government bonds, gilts, feeding through to lower long term interest rates throughout the economy.

There was no deflation, which was the great worry in 2009, and the recovery, while by no means strong in its early years, took hold and lasted. It did not lead to hyperinflation or, indeed, to very much inflation at all. There was no double-dip recession. As a policy which contributed to getting the economy off the sick bed, QE has to be seen as a success.

Nor is the criticism of QE, that it benefited the wealthy “haves” at the expense of the have-nots, valid. Bank researchers looked in detail at this last year, using official data for the distribution of wealth. It found that percentage gains from the policy were “broadly similar” across households and that, while those at retirement age saw the biggest increases in wealth, younger people benefited from stronger incomes. Andy Haldane, the Bank’s chief economist, said that the policy “did not have significant adverse distributional consequences”. The adverse distributional consequences were, as the research shows, more imagined than real.

So what should happen to QE? Central banks in recent weeks have been executing, if not handbrake turns, then at least important shifts in direction.

America’s Federal Reserve, which a few weeks ago was on course to persist with its strategy of raising interest rates, has entered a period of pause. It is still unwinding its QE, to the tune of $50bn (£38bn) a month but may come under pressure to pause that too.

The European Central Bank, which called a halt to its QE at the end of last year, on Thursday announced a downgrading of its growth forecasts and revived a policy intended to make cheap funding available to the banks, so-called TLTRO, targeted longer-term refinancing operations. Markets were a bit spooked by its announcement.

The Bank has also scaled down its interest rate language, partly because of Brexit, partly a slower global economy. It may not now raise interest rates this year, and at 0.75% Bank rate is half the level at which it would begin to unwind its QE. A no-deal Brexit would in all likelihood lead to lower interest rates and possibly more QE.
QE then, is very much still with us and, indeed, the assets purchased under it will be sitting on central bank balance sheets for some time to come. It is there to be used again.

But, despite the record, in future it should be used very sparingly, if at all. It should be kept for emergencies and their aftermath, not as a routing tool of monetary policy.

This is because of the danger of the slippery slope towards genuine magic money trees. For some people, the fact that central banks could electronically create money out of thin air offered just too much temptation.

It spawned a range of imitations which, unlike QE, were never properly anchored, and which were often promoted by people who did not understand the original. QE was kept honest because it is reversible; once the assets purchased under the policy are sold off, the money created to purchase them is cancelled. Over the long-term the policy is neutral.

The variations on QE are, however, not. “Helicopter money”, the idea of which became popular in the wake of QE, involved the equivalent of a helicopter drop of money on every household in the country. It is the equivalent of using monetary policy, and newly created money, to provide the kind of cash handout which is normally the preserve of fiscal policy. It is unanchored.

“People’s QE”, once favoured by Jeremy Corbyn – it may still be – involved the same sort of process but with the money created used to finance infrastructure projects. It can be made honest, if the money created was used, for example, to buy tradeable infrastructure bonds. But many of its proponents did not envisage that such a step was needed.

Then there is what many regard as the ultimate magic money tree, modern monetary theory (MMT). Though this was invented in the 1990s, before the recent wave of QE, it has increased in popularity, particularly among the left in America.

It argues that countries with their own sovereign currency and central bank, and a floating exchange rate, face no constraint on the size of budget deficit they can run, because the central bank can create the money needed to cover it. If that creates inflation, then taxes have to rise to rein it back. But inflation, not the deficit itself, is the constraint on policy.

A furious row has broken out in America, notably between conventional Keynesians such as Paul Krugman and Larry Summers, and the MMT crowd.

The fact is, however, that nobody would be even giving MMT a hearing were it not for the QE experiment undertaken by central banks over the past 10 years. That is as good a reason as any for locking QE away in a cabinet marked “only break glass in case of emergency”.

Sunday, March 03, 2019
This sterling rally was built on shaky 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.

For those of you who like a fact to kick off the day, how did sterling, as in pound sterling, get its name? The answer, which is shrouded in the mysteries of Middle English, is that it could have come from starling, as in bird, which featured on early coinage, or “sterre”, Middle English for star, which was on some Norman coins in circulation in Britain.

I mention this because sterling has been in the news. Though it slipped a little towards the weekend, It has had a good week. Currency dealers have been watching the parliamentary shenanigans very closely, and decided that they merit marking the pound higher. As in the period since the June 2016 referendum, sterling has been acting as Brexit barometer.

While it would be an exaggeration to say that currency markets now think that it is all over, and that a no-deal Brexit has been definitely avoided and an extension of the Article 50 process beyond March 29 is a near certainty, the fact that things have been moving in that direction propelled sterling to the giddy heights of $1.33 and €1.17.

Simon Derrick, the veteran currency strategist at BNY Mellon in London, said the pound’s rise was overwhelmingly explained by the prospect of a delay of some weeks to Brexit, and that markets had not yet thought through the implications of other developments, such as the Labour party’s apparent shift to supporting a second referendum. He also noted that at $1.33, sterling was not much above its post-referendum average of $1.3050.

This, by the way, compares with a $1.58 average for sterling against the dollar for the three years before 2016. Currency markets effectively downgraded the economy, and the pound, after the Brexit vote.

In the low $1.30s, then, the pound is still in what dealers would see as a neutral range. But it is above its post-referendum closing lows of just over $1.20 and €1.08. What might push it higher still?

Adam Cole, currency strategist at RBC (Royal Bank of Canada) Capital Markets, has in response to client requests updated his subjective Brexit probabilities. They are now 5% for a no-deal Brexit, down from 15%; 35% on exiting on March 29 with a deal, 40% on exiting later, also with a deal, and 20% on Brexit not happening at all, possibly as a result of a second referendum. A second vote, he suggests, would be 60% likely to overturn the result of the 2016 referendum.

Of these various outcomes, he argues, there would be scope for a small 2%-3% rise in the pound on exit with a deal now, or after a short delay. The most sterling-friendly outcome, as its performance since the referendum implies, would be for Brexit not to happen.

These exercises are useful . They show why last week’s tilt away from a no-deal Brexit and towards a Brexit delay have been positive for sterling.

Sterling’s performance is also, however, on the face of it a little odd. The prospect of a delay to Brexit came because a weakened prime minister had to give ground to parliament, including members of her own cabinet. The political crisis, which is afflicting both main parties, has deepened rather than gone away.

In response to the prospect of delay, one of her junior ministers, the Eurosceptic George Eustice, himself resigned on Thursday, the 12th minister to resign over Brexit in less than nine months. This is still a chaotic government blundering from one Brexit crisis to the next, not normally a recipe for a strong currency. Sterling had the good grace to soften a little on news of that resignation.

Nor, as was shown by Theresa May’s earlier strong resistance to extending article 50 beyond March 29, is it clear that a delay is anything other than a recipe for further muddle and confusion. As Emmanuel Macron, the French president, has said, delay has to be for a purpose, not merely so that the prime minister can keep banging her head against a parliamentary brick wall. Other EU member states have to agree a delay. They probably will, but on their terms.

Without March 29 as a hard stop, meanwhile, May has lost some of her domestic leverage. Hard Brexiteers can happily reject her withdrawal agreement, even if the attorney general Geoffrey Cox succeeds in extracting minor concessions, without that rejection resulting in an immediate no-deal. But that rejection would still leave Britain vulnerable to a no-deal Brexit a few weeks later.

That is why, while sterling has been enjoying the high life, there is not much joy elsewhere. As always, what is sauce for the sterling goose is not necessarily sauce for the domestic economy gander. It is now a given that when the pound goes up, the FTSE 100 goes down, because a high proportion of UK large quoted company shares are dollar-denominated.

It is also the case that developments that were greeted with enthusiasm in the currency markets were received rather less warmly by bodies representing British business.

“A short extension of article 50 simply moves the cliff edge back a few weeks and it doesn’t offer UK manufacturers confidence that we will not crash out of the EU a short time later than expected,” said Stephen Phipson, chief executive of Make UK, formerly the EEF, the manufacturers’ organisation. “This will be catastrophic to a sector that employs close to 3m people and accounts for almost half of our country’s exports.”

Carolyn Fairburn, director general of the CBI said the prospect of a delay to Brexit was merely “an option on sanity”, a small step away from the no-deal Brexit that would be “a wrecking ball on our economy”. Mark Carney provided a guarantee that if it were to happen, the Bank of England would be taking a wrecking ball to its growth forecasts.

For that reason, then, sterling’s recent strength may be no more a reliable guide to the future than February’s unseasonably warm weather was to the idea that we have relocated the country to the Caribbean. There is many a slip twixt cup and lip, and there will be many Brexit twists and turns in coming months for currency markets to digest.

UBS, the Swiss bank, put it well in a note from its chief investment office, warning people not to get carried away with sterling’s rally. All options remained on the table, it warned, including a continued political impasse and a no-deal Brexit. That still offered the possibility, it warned, of a further significant fall in the pound, to $1.15 against the dollar and to one-for-one parity with the euro. Not even those who see salvation in devaluation should want those circumstances to materialise.

We should, therefore, be a little cautious about sterling’s revival. It tells us something but, just as we talk about spot exchange rates, it is a spot judgment. These things change, and they could go either way. Some people like uncertainty, including some in the markets. They can expect plenty of that in the next few weeks.

Sunday, February 24, 2019
Housing is creaking - and not just because of 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.

Every month these days a little battle is played out. Downbeat data is released on the housing market, to be immediately followed by comments from estate agents and others in the property industry. Their general take can be summed up in the opening lines from that song in the musical Annie: “The sun’ll come out tomorrow, bet your bottom dollar that tomorrow, there’ll be sun!”

I do not begrudge them for trying to look on the bright side. If you are in a business which relies on housing turnover going up, and benefits from rising house prices, this is a testing time. The housing market has, in some key respects, never got over the global financial crisis of a decade ago – transactions remain well below pre-crisis levels – and it is suffering a renewed downturn now.

Annual house price inflation has, according to the Nationwide building society, petered out almost completely. Prices last month were just 0.1% up on a year earlier, having come down from more normal 5%-6% growth three years ago.

The Halifax reported a rather alarming 2.9% slump in prices last month, bringing strong echoes of the crisis years, though it reported almost as big a rise in December. It too thinks annual house-price inflation has all but petered out. Asking prices, to take another measure, have had their weakest year for a decade.

I know, at this point, what some people will be thinking, that house prices are too high and any softening, to the point where they are now rising by a few percentage points less than wages, has to be a good thing.

But there is good and bad house weakness. Good house price weakness is when extra homes tilt the balance and make houses more affordable. Bad house price weakness is a reflection purely and simply of weak demand.

It is the bad version that we are seeing at the moment. According to Rics, the Royal Institution of Chartered Surveyors, new buyer enquiries for home purchases have weakened for the sixth month in a row and are now at their weakest since the crisis. It is become commonplace to see this as a problem mainly affecting London and the south-east but it is now widespread; the weakest readings in the latest survey were the east and west midlands.

If prices were determined by demand alone, they would be even weaker than now. But, in the market for existing homes, as opposed to new build properties, supply is also very weak. The Rics survey reports that, apart from a brief downward spike immediately after the referendum in 2016, instructions to sell are also at their lowest since the crisis.

The supply pipeline is also weak according to surveyors, with surveys and appraisals lower than they were a year ago. Potential sellers do not want to sell into a soggy market. If they can do so they would prefer to stay put. High transaction costs, notably stamp duty, are a powerful disincentive to move.

It is tempting to blame most of this on Brexit. Consumer confidence is down and so is the willingness of households to commit to major purchases. That is reflected in a weak market for new cars and, in the absence of Help to Buy incentives, people’s appetite to take the plunge in the market for existing homes.

There is a strong element of the Brexit argument in the Rics survey. It is widely blamed by surveyors for the current malaise in the market. There is also a strong sense that, once it goes away, things will be better. So the outlook for the next three months on sales, prices and new instructions are all dire but those looking 12 months ahead are better. Though I think they are being optimistic about Brexit going away in 12 months - it will be with us for many years - I take their point.

The housing market malaise is not, of course, all or even mainly because of Brexit, though it is to blame for the current uncertainty. There are two other big elephants in the room. The first is affordability. Official figures show that the average house price in England and Wales is 7.8 times annual full-time average earnings. The ratio has continued to climb in recent years, even since the crisis.
Over the past 20 years it has more than doubled in England - up 123% - and nearly done so in Wales; up 92%. Viewers in Scotland have their own figures but they have also gone up substantially.

It is true, of course, that ultra low interest rates affect the affordability calculation when it comes to monthly mortgage payments, making bigger mortgages more affordable. But high prices are still a mountain to climb when it comes to deposits.

And, even though wage growth has picked up, at a little over 3% it is not making much of a dent in high house price-earnings ratio. Older readers will remember a time when you took out a mortgage you could barely afford, confident in the knowledge that salary rises would come to the rescue. Things are different now.

The other elephant is the Help to Buy scheme, beloved of my friends in the housebuilding industry, where it has been like manna from heaven. First-time buyers have been steered towards new housing by Help to Buy equity loans on up to 20% of a property’s value in most of the country and up to 40% in London..

This has had two effects, neither of them healthy. By tilting first-time buyers towards new-build homes it has distorted patterns in the existing homes market.
Young people who used to buy older homes, including “doer-uppers”, now have a powerful incentive to buy new properties. Normal housing market chains are not having a chance to form.

The second effect has been to push up prices for new properties relative to existing homes. Again this comes out clearly from the affordability data. In the early 2010s the house price-earnings ratios for new and existing homes were similar. Since then, however, they have diverged significantly. The latest figures are that the ratio for new homes is 9.7 - the average new home costs nearly 10 times average earnings - compared with 7.6 for existing homes. First-time buyers are being pulled into higher-priced homes and, ultimately, more debt.

Brexit, then, is a problem for the housing market as it is for the economy. But there are other big problems, of affordability and of the need to wean us off Help to Buy. Fixing the housing market will take a very long time.

Sunday, February 17, 2019
How to end austerity without breaking the bank
Posted by David Smith at 09:51 AM
Category: David Smith's other articles

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

Theresa May, by all accounts, is promising to splash the cash to deserving causes like some modern-day Lady Bountiful. Labour MPs in leave-supporting constituencies who support her withdrawal agreement are being promised more money, as are businesses kicking up about the consequences of a no-deal Brexit.

The government has already allocated more than £4bn for Brexit preparations, most but not all for getting ready for no-deal. Though some of that no-deal spending would have happened anyway, and there will be few examples quite as bad as the transport secretary Chris Grayling’s phantom cross-channel ferries, money is being spent.

The civil service, creaking under the strain of leaving the EU, is growing in size. After years of cuts in numbers, and a low of 416,000 in the second half of 2016, the home civil service had added about 20,000 extra people by September last year, and has been busy recruiting more over the winter.

The additional spending comes on top of the prime minister’s insistence on a generous 70th birthday settlement for the National Health Service. Its spending will be £20.5bn higher in England in real terms by 2023-24. Add in Scotland, Wales and Northern Ireland and you get to about £25bn.

The House of Commons Treasury committee, reporting last week on the fiscal impact of that NHS birthday gift, together with other measures last autumn which included an earlier than expected raising of tax allowances, declared that the government’s stated objective of eventually balancing the budget “now has no credibility, so cannot be used by parliament to hold the government to account”.

The objective of balancing the budget, ever, seems to have turned into a dead parrot. It has ceased to be. Somewhere in the depths of the Treasury you imagine Philip Hammond, his reputation as the most fiscally conservative chancellor on the line, head in hands and quietly weeping.

He would see it differently and that, without his resistance, the spending increases and tax cuts would have had to be much larger, and the prospective hole in the public finances much bigger. After him, he might say, comes the deluge.

The pressure, however, persists. This will be a big year for public spending, and not just because of Brexit. The Treasury is due to hold a comprehensive spending review and Liz Truss, the chief secretary, will soon give a speech setting out the priorities for it. The review is not definite; there are Brexit-related circumstances in which it might not happen, but it is planned.

The challenge is quite straightforward. As things stand, the NHS is getting plenty but most other parts of government are still in austerity mode. The NHS accounted for 11% of all spending on public services in the mid-1950s, 23% by 2000, 29% by 2010 and, on present plans, will be 38% of all spending by the 2023-24. That looks dangerously unbalanced.

A very good briefing note from the Institute for Fiscal Studies on the outlook for the spending review, by Carl Emmerson, Thomas Pope and Ben Zaranko, sets out the parameters. A normal spending review covers the next 3-4 years, though the IFS opens up the possibility this time of a one-year review, given that the uncertainty may not have lifted even by the time of this autumn’s budget.

It is not clear how much we will learn about it when the chancellor delivers his spring statement in less than a month’s time, on March 13. I suspect very little. The “spending envelope”, the amount in overall terms that the government intends to spend over the next few years, had at one time been expected in last autumn budget.

But that budget, held unusually early in October to clear the decks in November for parliamentary approval of the prime minister’s EU withdrawal agreement – and we know what happened to that – only really told us what will be happening to NHS spending. Will we see the envelope next month, so that we know what everybody else is getting?

Almost certainly not. The talk is of a “stripped down” spring statement consisting of a new official forecast, which itself will be subject to the uncertainty of how many of the known unknowns about Brexit have been resolved. The Brexit fog, to coin a phrase, will also provide the chancellor with a good excuse not to set out the spending parameters. Though the Commons Treasury committee was also sceptical about a “deal dividend” for the economy and public spending from an orderly Brexit, Hammond will not want to concede that point.

The question is what he should be doing in the spending review to meet his and the prime minister’s claim that “austerity is ending”, which is politically necessary, without damaging the public finances. Though people are often sceptical of whether “cuts” have occurred, it is clear that they have. The long-term trend is for public spending to rise. In the past decade it has fallen, by about £40bn in real terms. The hardest hit departments, which include the Ministry of Justice and the Department for Environment, Food and Rural Affairs have seen real cuts of some 40%. Local government has also seen very large cuts.

Here, the picture is rather more reassuring for the Treasury than might be thought. One aspect of austerity, the four-year cash freeze on most working-age benefits imposed by George Osborne, will come to an end in the 2019-20 fiscal year. Projections for the public finances assume that the freeze will be followed by inflation-linked increases in these benefits.

Ending austerity by stopping further cuts for departmental budgets is, meanwhile, not as expensive a proposition as you might think. The IFS calculates that avoiding real cuts for unprotected departments would cost just £2.2bn of extra real spending by 2023-24. Ending those cuts on a per capita basis would cost only £5bn. That is almost small change for a government that expects to spend not far short of £1,000bn – a trillion – by 2023-24. The public finances are healthier; the current budget deficit (on day-to-day spending) has been eliminated and the overall budget deficit is back down to pre-crisis levels.

But there is a limit. Money handed out in haste, as the prime minister appears to be promising, is almost certain to be badly spent. Britain’s neglected regions need the public investment that will bring much-needed economic regeneration, not short-term sticking plasters. Bungs are not a good basis for spending.

Any spending largesse this year also has to be measured. While the public finances have been transformed since the financial crisis, they face a renewed risk in coming years from the ageing population and the upward pressure that will put on spending on pensions, health and other areas. The Treasury will be accused of being mean-spirited in this year’s spending review but that is its job, and there is a reason for it.

Saturday, February 09, 2019
Not just a slowdown - we're stuck in a low gear
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.

Like all the best famous quotes, it is far from clear that Harold Macmillan, the former Tory prime minister, ever said when asked what he most feared: “Events, dear boy, events.” He certainly did not say another thing usually attributed to him, “you’ve never had it so good”, but a variation on it.

I could write a whole column on this. John Maynard Keynes probably never said: “If the facts change, I change my mind. What do you do, Sir?” Many of us have, however, written that he did. Fortunately these days we have an electronic record of what Donald Trump, or Donald Tusk, said, or at least tweeted.

Anyway, whether he said it or not, events do not just matter for politicians. They are hugely important for central bankers. In America, the Federal Reserve has backed off further interest rate rises, having done nine so far (but only to a level of between 2.25% and 2.5%), because of growth concerns.

The European Central Bank has ended its programme of quantitative easing (QE) but, in the light of a sharp slowdown in the eurozone’s big three economies – Germany, France and Italy – will be wondering privately whether it was right to do so.

As for the Bank of England, never before have I seen events, and in particular the single event of Brexit, dominate one of its quarterly press conferences as much as the one on Thursday, when to the surprise of nobody it left interest rates unchanged and, though the extent of it was slightly more of a surprise, significantly revised down its growth forecasts.

The impact of events on the Bank is not just that Mark Carney, its governor, has to answer more questions on Brexit than he is comfortable with, and who quipped that he no longer wakes up in the mornings but in the middle of the night, but also that it has taken it further away from what it wanted to do.

Plan A for the Bank was to gradually raise interest rates to a “new normal” of about 2%, from 0.75% now, in response to rising wage pressures and other indicators of limited spare capacity in the economy and because, after a long period in which official rates have bene close to zero, it made sense to think about normalising them.

Plan A has not yet been entirely torn up, but it has evolved into what might be best described as Plan A-minus. The Bank still sees scope for “limited and gradual” rate rises in coming years, for similar reasons as before, but they are now expected to be more limited, and more gradual.

There was a time when many in the City expected the next rise in interest rates to be in May. But what Carney described as “the Brexit fog” will not have lifted by then. Nor, looking at the Bank’s new forecasts, will there be much scope for raising rates in August or November. With the governor set to depart at the end of January next year – less than 12 months from now – the likelihood of him going without any further rate rises under his belt is increasng.

By the time of any sunlit uplands in the Bank’s new forecast, an eventual pick-up in growth to a hardly-booming 2% by 2022, it will be Carney’s successor who is in charge.

That the Bank has reduced its forecasts is not a surprise. Business surveys have pointed to a sharp softening of growth. The January purchasing managers’ surveys for manufacturing, construction and services were all weak, suggesting the economy has all but ground to a halt.

The Bank’s new forecast of just 1.2% growth this year, the weakest since the crisis and with a one in four chance of a recession (even assuming a smoothish Brexit), reflected that weakness.

It is not, I should say, all because of Brexit. Britain’s economy is affected by the colder wind blowing from the global economy which is also hurting, together with their own special factors, the other big economies of Europe.

The downgrade, the Bank said, “reflects softer activity abroad and the greater effects of Brexit uncertainties at home”. Though 1.2% growth makes an interest rate rise over the next 12 months much less likely, if not impossible, uncertainty is, one hopes, not a permanent condition. It should lift. Many of us thought it would have lifted by now. The Bank thought so last spring, after an apparent government-to-government agreement on a transition period.

That is why another aspect of the Bank’s new forecast is perhaps even more disturbing than the growth downgrade for this year from 1.7% to 1.2%. It has also reduced its forecast for the economy’s potential growth rate, its speed limit for coming years, which was 1.5% a year but is now down to a paltry 1.4%. This potential growth rate is the pace at which the economy can grow without generating inflation.

This is not the Rolls-Royce or James Bond Aston Martin we like to envisage when thinking of Britain’s economy in our mind’s eye. It is more like Derek “Del Boy” Trotter’s Reliant three-wheeler. It is the kind of speed you are doing when the police pull you over on the motorway for going too slowly.

Why has it happened? Productivity is again the main culprit. It was supposed to rise by 1% this year but, following the disappointing relapse I pointed out last week, that has been revised down to 0.25%, with a smaller downgrade for next year.

To improve productivity, the economy needs an increase in investment by businesses, which the Bank thinks has fallen by 3% over the past 12 months. Indeed, if you wanted just one piece of evidence of Brexit damage, this would be it. Britain since the referendum has been an outlier among industrial countries for the weakness of investment, Carney pointed out.

The weakness is expected to persist. In November the Bank had expected business investment to rise by 2% this year; now it expects a 2.75% fall. Next year’s predicted increase is half the 5% rate forecast three months ago. Businesses will not be fast out of the blocks, even when some of the current uncertainty lifts.

Can this low speed limit for the economy be improved upon? There is talk, notably in the Financial Times, of “Project After”, a Whitehall plan to boost the economy in the event of a no-deal Brexit with tax cuts, tariff reductions, extra spending and a monetary stimulus from the Bank.

But these, if implemented, would be all about trying to limit the damage from a bad Brexit outcome, not setting the economy on a new course. Despite them, we would be looking at a further reduction in the economy’s potential, its speed limit, not an improvement. Emergency packages are all about dealing with short-term emergencies. Lifting the economy’s potential will take a lot longer.

Sunday, February 03, 2019
Bogged down in Brexit while the economy festers
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 sometimes said that the gulf between businesses and ordinary folk has never been greater. People do not necessarily think that what is good for firms is good for them. An annual survey by Edelman, the public relations firm, just updated, found that 52% of people don’t think the way business is done is good for society, though they are even more damning of government.

On one thing, however, businesses and households are united. They are all feeling gloomy, thoroughly cheesed off with politicians and fed up with a Brexit process which goes around in ever decreasing circles.

I sympathise with that. As a news junkie, I will listen to pretty well everything but rarely have I used the off button more than in recent months. And don’t get me started on Question Time.

Anyway, the ICAEW, the Institute of Chartered Accountants in England and Wales, produces a reliable quarterly survey of business confidence, which I follow. It latest, for the first quarter, will be published tomorrow but I have had a sneak preview.

It shows that confidence has fallen to an index level of -16.4, the lowest since the economy was mired in recession 10 years ago during the global financial crisis. As the ICAEW demonstrates, confidence is closely linked to the politics of the Brexit process.

Its survey came too late to encompass the latest parliamentary votes but they will have done nothing to bolster confidence; dead-ends tend not to. The gloomiest sectors in the survey are retail and wholesale, followed by property and construction.

Its results are consistent with growth slowing to a crawl, just a 0.1% rise in gross domestic product this quarter, alongside a sharp slowdown in investment. More on that in a moment.

I said businesses and consumers are at one on this. The latest GfK index of consumer confidence was at -14 in January, the same as in December but five points lower than a year earlier and lower than in the immediate aftermath of the referendum. Households are now experiencing real wage increases again, according to official figures, and unemployment has not been this low since the mid-1970s. With inflation also coming down the “misery index” (the unemployment rate plus the inflation rate) is at low levels. People should be quite optimistic.

They are, however, worried about the future, and particularly about the economic outlook. A net 39% of people think the economic situation will get worse over the next 12 months, the gloomiest people have been on this for seven years, and approaching the level of concern we saw during the financial crisis.

The uncertainty that is driving down confidence will eventually lift. The House of Commons version of the withdrawal agreement that Theresa May will take to Brussels has little chance, but a version should eventually emerge that satisfies both sides and parliament. When that is, and how long an extension of the Article 50 timetable will be required beyond March 29 remain open questions. The risk of a no-deal Brexit is higher than it was before last week’s votes and is of great concern for business, which found the latest political shenanigans as unhelpful as any we have seen.

Getting beyond all this remains the challenge. Businesses complain that, because of Brexit, nothing else is happening, particularly in government. They are being asked to reassure customers while being offered nom reassurances or certainty themselves.

It cannot go on like this. Brexit has already given us three wasted years. If that continues into the next phase of talks – assuming there is a next phase – and it is allowed to dominate everything else, the damage will be compounded.

On this, I make no apology for returning to productivity, a pet subject of this column. There was a glimmer of hope just over three years ago, in 2015, that we were finally emerging from the tunnel of stagnant productivity. In the middle of that year, put per hour rose by nearly 2% compared with a year earlier, close to pre-crisis norms.

But we have had a relapse. Productivity in the latest 12 months is up by just 0.2% and, because of its intimate links to prosperity and living standards, not to mention competitiveness, that has to be bad news.

The National Institute of Economic and Social Research, Niesr, will this week devote a large chunk of its quarterly review to the productivity theme. There is not space here to feature every article but one, “The Anatomy of UK Productivity”, by Philip Wales of the Office for National Statistics, offers some useful insights, drawn from the data.

It shows that not all sectors have seen productivity slow in recent years but that about two-thirds have. Some of the sharpest slowdowns, worryingly because they are often regarded as jewels in our industrial crown, have come in telecommunications and pharmaceuticals. Textiles is another big slowdown sector. So too is financial services, another important sector of the economy. Though Wales does not say so, some of its slowdown reflects tougher post-crisis regulation.

What he does say, citing other researchers, is that “the slowdown in productivity growth derives in large part from the slowdown in a number of industries: notably the finance, manufacturing and telecommunications industries”. Fix those and you will be significantly closer to solving the productivity problem.

A second broad conclusion is that, while other countries appear to suffer from the “zombie” problem – keeping too many low-productivity firms in business – this seems ot be less the case in Britain. The problem here has been that many businesses which went into the crisis with high productivity emerged from it with lower productivity. The “zombies”, the exisiting low productivity businesses, actually declined in number.

A third result, which chimes with other research, is that foreign direct investment (FDI) is a key productivity indicator. This is a two-way street. Both foreign-owned firm that have invested in Britain and British firms that have themselves invested in other countries have much higher productivity than other businesses.
Median productivity for these FDI businesses is 114% higher than for other firms. Mean productivity per worker is a staggering 257% higher.

Finally, trade is an important driver of productivity. Taking firms which engage in international trade in goods, Wales and colleagues find that they are 70% more productive than non-trading companies. Adjusting for size of firm, FDI and other factors, traders were still 20% more productive than non-traders.

None of this necessarily provides a complete solution to the productivity puzzle but it offers a way forward. Whatever future we have it has to be one in which trade freely flows and we encourage more firms to trade. And it is one in which FDI has to be encouraged to move across borders.

A closed economy will become a permanently low productivity economy, with low economic growth and stagnant living standards. That is the danger, and the more we get bogged down in a messy Brexit the bigger that danger will be. There is a route map to higher productivity and prosperity, if anybody has the vision to follow it.

Sunday, January 27, 2019
The jobs keep coming - but where are they coming from?
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.

Britain’s labour market continues to both dazzle and puzzle. It dazzles because, as official figures last week showed, we have now have the highest employment level (32.5m) and employment rate (75.8%) on record and the joint lowest unemployment rate, just 4%, since the mid-1970s.

This is good news. Though as discussed here recently a job is no longer a guarantee of a decent standard of living, or even an escape from poverty, it is better than the alternative of not having a job.

In the latest 12 months, 328,000 more people are in work and 68,000 fewer are unemployed. The difference between the two is largely accounted for by the fact that significant numbers of people have come into work out of economic inactivity; not working and not looking for work. The economic inactivity rate, 21%, is the joint lowest since 1971. Employers are struggling to recruit, vacancy levels are high and pay growth is at its strongest for 10 years.

Nobody expected this. Normal economic relationships would have pointed to a slowdown in the labour market alongside the slowdown in economic growth. Normal relationships would also have suggested that, by now, productivity growth would have reasserted itself. Instead, Britain has strong employment but flatlining productivity. When growth is weak but employment strong, simple arithmetic means that output per worker, productivity, will suffer.

That is not the only puzzle. The good news in the figures on employment and unemployment coincides with some gloomy headlines on jobs, whether it is Jaguar Land Rover or Patisserie Valerie. It may not be such a puzzle. It takes time before such announcements feed through to the figures and it is also quite possible for quiet job creation to trump high-profile redundancy announcements. Just as we have moved away from the era of big negotiated pay settlements across the economy, so we are no longer in a world where announcements of job cuts by big employers shape the labour market.

That does not entirely remove the puzzle. Retailing is a sector which, through thick and thin, has tended to generate jobs, even as others were cutting back. According to the British Retail Consortium, however, there were 70,000 fewer people employed in retail at the end of 2018, compared with a year earlier. Those high street woes we keep writing about are real.

So let me, partly as a public service and partly in response to reader demand, try to solve some of these puzzles. The first concerns the short-term. How come, with so much Brexit uncertainty around, were firms so willing to recruit late last year? Employment rose by 141,000 in the September-November period compared with the previous three months.

This puzzle can be answered straightforwardly. Employers last autumn were not so gung-ho. While the number of employees rose by 58,000 in the latest three months, the corresponding figures in 2017 and 2015 were roughly 160,000. 2016, immediately after the referendum, was a special case. Most of the increase in employment during the latest three months, 93,000 out of 141,000, was self-employment. There is nothing wrong with self-employment but it has been unusual recently for its rise to exceed the growth in employees, and could point to some caution among employers.

What about that rise of 328,000 in employment over the latest 12 months? There is something unusual about it in that 262,000 of it, 80%, was accounted for by people aged 50 and over, and nearly 30% was among those aged 65 and over.

There is, of course, nothing wrong with that either but part of the labour market story, and indeed the record employment rate, is the age factor. Women who were entitled to receive the state pension at 60 are now having to wait until 65 or beyond, a change that has happened quickly and which many are upset about. It is one reason – there are plenty of others – why the female employment rate, 71.2% for 16-64 year-olds, has never been higher. The male rate, now 80.3%, was 92.1% in the early 1970s.

Employers have not generally minded the fact that women are staying in jobs for longer, or that age discrimination legislation limits their ability to get rid of oldies at what used to be normal retirement age. But these things have changed the character of employment to some degree.

What about the big one – where have the jobs been coming from? Here it is necessary to switch from one set of official data, the Labour Force Survey, to another, the workforce in employment figures.

These show that, compared with five years ago, most parts of the economy have been creating jobs. So comparing September 2018, the latest figures, with September 2013, there are 135,000 more jobs in manufacturing, 310,000 more in construction, 117,000 in wholesaling and retailing (despite the recent fall), 202,000 in transport, 295,000 in hotels and catering, 292,000 in IT and communication, 286,000 in health and social work, 307,000 in professional, scientific and technical work, 120,000 in arts and culture and a big 376,000 in administrative work.

If you wanted to be optimistic, though not necessarily surprised, it would be about the fact that the IT crowd has got bigger, with a quarter more jobs compared with five years ago. If you wanted to be downbeat, it would be about the fact that there are hundreds and thousands more administrative jobs in Britain.

Where do we go from here? Records are made to be broken, and there is no reason why the current record employment rate has to mark the end of the rise, or that unemployment cannot fall further from its current 4% rate. The past few years have taught us not to bet against Britain’s job market.

It is true that the history of the past 40 years or so tells us that the unemployment rate does not stay as low as 4% for long. From that low-point in the mid-1970s it went all the way up to 12%, and more than 3m unemployed, a few years later. It is currently less than half its post-crisis peak of 8.5%.

And, while low unemployment rates tend not to last, that is because tight labour markets have tended in the past to be inflationary, requiring a response in the form of sharply higher interest rates. When unemployment was 4% in the mid-1970s, pay growth accelerated to more than 25% a year.

The Bank of England is slightly uncomfortable about the fact that earnings growth has accelerated to a 10-year high of 3.4%, alongside continued weak productivity, but the inflationary dangers from this appear to be quite limited.

It is not hard at this juncture to think of reasons why the labour market might catch a cold, and most of them are Brexit-related. But it should not happen as a result of the Bank slamming on the brakes.

Sunday, January 20, 2019
After that defeat, even more reason to hug the EU close
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 worry about the future of hairdressers in this country. I say so because, if business people continue to tear their hair out at the current rate over the political shenanigans over Brexit, there will be nothing left for them to cut.

The House of Commons landslide defeat for the withdrawal agreement negotiated by the government and the EU may have been predictable but was nevertheless depressing. Most depressing, perhaps, was the extent to which it was celebrated not just by hard Brexiteers, as expected, but also by hard Remainers. At both extremes of the Brexit debate are people who will never be reconciled.

I say this not because the deal negotiated by the prime minister’s team was wonderful; it was not but no compromise agreement was ever going to be. Her address to the nation after her government had survived the confidence vote was as tone deaf as you would expect, and almost as bad as her “citizens of nowhere” speech to the Tory conference in October 2016. It is a canard to say that because more than 80% of people voted for the Tories or Labour in the 2017 election, the country is united behind Brexit. Many voted Labour because of its fuzziness on Brexit, a fuzziness which persists.

By the same token, the country is poorly served by Jeremy Corbyn’s stance. Though avoiding a no-deal Brexit is of paramount importance, insisting that the prime minister rules it out before he will agree to consensus-building talks with her is infantile. That would remove the tiny bargaining chip May has with the EU; that we could still shoot ourselves in the foot but it would hurt you a bit too.

Whether that works or not on the politically toxic issue of the Irish backstop, the prime minister deserves praise for the central aim of her approach to Brexit. It has been, certainly since the 2017 election catastrophe, to deliver on the result of the referendum while minimising the economic damage from doing from doing so.

That task has been made more difficult by her own over-hasty adoption of red lines. There was no need in the first flush of her premiership to rule out a modified form of single market membership or staying in a customs union. But minimising the economic damage has been the watchword since mid-2017. The withdrawal agreement was intended, as Michael Gove has said, to get Britain over the line on March 29, after which during a lengthy transition period the battle could be joined on how close a future relationship has with the EU. It was never part of the plan that the withdrawal agreement should fail, and fail so badly.

I still think, as do most City observers, that some form of the agreement will be adopted, after modifications, though that appears quite likely to require an extension of the article 50 process. The risk of a no-deal Brexit, while low, has not gone away. J P Morgan, for example, sees a 45% probability of Brexit on a deal close to the existing one, 25% for a second referendum, 15% a general election, 10% an extension of article 50 into the second half of the year and 5% a disorderly no deal. These probabilities are, of course liable to change, and I would put the risk of a no-deal Brexit a bit higher, but they provide a very useful barometer.

The influential Centre for European Reform argues that the only option for the prime minister in getting a withdrawal agreement through the Commons will be to further blur her red lines, so pushing Britain towards a softer Brexit. This could mean accepting a permanent customs union or an eventual Norway-style European Economic Area relationship. Both have so far been rejected by the prime minister but the clock is ticking.

In the meantime, it is worth rehearsing why May’s broader strategy, of trying to hug the EU as close as possible while respecting the referendum result made sense, even if her withdrawal agreement clearly needs work. Let me provide a flavour of the advantages of keeping the EU close.

EU membership, and in particular the single market, has been a significant factor in increasing the openness of the British economy; a key ingredient of growth and competitiveness. In the past half century, most of which has been in the EU, Britain’s exports have grown from 11% to 30% of gross domestic product. That openness increased with the creation of the single market in 1993.

The volume of Britain’s good exports to the EU has grown by more than quarter over the past 20 years, a period which included the deepest post-war recession and a separate later eurozone recession. Exports of services to the EU have grown twice as rapidly in recent years as those of goods.

It is sometimes said that the single market is unnecessary because some countries outside it have seen faster growth in exports to the EU than Britain. It is, of course, nonsense. Britain had a high level of trade integration with the rest of the EU before the single market came into being, while others started from a low base.
The single market, by creating a single set of standards across a market of more than 500m people, was always intended to facilitate two-way trade. For a US or Chinese exporter to Europe it has meant the same product standards not 28 different ones.

That is also true of exports from the EU to the rest of the world. The creators of the single market, most obviously Margaret Thatcher as the political force behind it and Lord Cockfield, the British European commissioner responsible for its implementation, always saw one of it purposes as providing a stronger platform for exports to the rest of the world. Tie that to the trade deals negotiated by the EU and roughly four-fifths of Britain’s exports are covered either by the single market or by EU trade deals.

There should be no surprise that exports to the rapidly-growing emerging world have increased more rapidly in recent years. The surprise for Britain is that they have not done so by more. Even now, Britain sells more goods to Ireland than to China and Brazil combined. Distance matters.

The openness afforded by EU membership, together with Britain’s flexible labour market and relatively deregulated economy, has meant that Britain has been a magnet for inward investment. We have to hope that this does not now only apply in the past sense.

Will the prime minister, by hugging other political parties, be able to craft an exit from the EU that involves hugging it close? You would hope so, and it clearly makes sense. She is not, however, one of life’s natural huggers.

Sunday, January 13, 2019
Record numbers in work, so why is poverty going 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.

What are we worried about? Ipsos-Mori, the pollster, asks a sample of people every month what are the most important issues facing Britain. Its latest poll, released a few days ago, showed that the top two concerns, Brexit and the National Health Service, were as you might expect.

More surprising, perhaps, was the third biggest public concern; poverty and inequality, named by 21% of people, the highest in the more than two decades it has featured in the survey. It was ahead of the economy, unemployment and immigration, public concern over which has dropped to its lowest level since 2002 even though net migration, at 273,000 in the latest 12 months (mostly from outside the European Union), is not that far below all-time highs.

That people are worried about poverty and inequality reflects well on them, even though the usual response from somebody like me would be that it too does not correlate well with the facts. All the reliable evidence on inequality, for example, shows that while it did rise a lot in the 1980s, it has not done so since, and if anything has come down a little since the financial crisis.

As for poverty, sometimes you have to feel sorry for government ministers, though this is not a popular view at the moment. Once it was quite straightforward. Any government would give its eye teeth for the situation Britain has at the moment, of a record level of employment, a near-record employment rate (the proportion of working-age people in jobs) and the unemployment rate hovering around its lowest since the mid-1970s.

When that government is also presiding over significant increases in the national living wage, what used to be the minimum wage, which rose by 4.4% last year and is due to rise by nearly 5% this year, you might think that it had all bases covered. Last year’s increase directly and indirectly boosted the pay of 5m workers.

So why the heightened concern? Some of it may be seasonal. In winter, and in particular in the run-up to Christmas, people are made more aware of poverty. This newspaper’s Homeless in Britain appeal, in association with Crisis, was an example.

But there is more to it than that. On inequality, even though the big rise occurred a long time ago, people are still entitled to take the view that absolute levels of it are too high, even though those levels are not changing very much. There is, too, a difference between what conventional inequality measures show and the perception that the extremely rich are pulling away from the rest of us.

As it is, even conventional measures show what many people would regard as an unhealthily skewed income distribution. Figures from Her Majesty’s Revenue & Customs (HMRC) show that the top 1% receiver 12.2% of pre-tax incomes (compared with 13.9% in 2009-10); the top 5% 24.4% (compared with 26.4%), the top 10% 33.8% (35.8%) and the top 25% 52.9% (55.5%). The richest quarter of the population receive more income before tax than the worst-off 75%.

Inequality concerns are not surprising, even if their rise is a little puzzling.
As for poverty, and this is a point regularly made by the Joseph Rowntree Foundation, the Institute for Fiscal Studies and the Resolution Foundation, we are in an era when a job is no longer any guarantee of prosperity.

The Joseph Rowntree Foundation records that 4m workers are living in poverty, up half a million over the past five years, and that two-thirds of the 4.1m children in poverty are in working households. IFS research shows that 57% of people in poverty are in households where somebody in in paid work, compared with 35% in 1994-5.

How have we come to this? One obvious explanation is that we have been in a period of unusually weak pay growth. Average total pay, in real terms, is still 5% lower than it was at the time of the pre-downturn peak in February 2008, more than a decade ago.

The answer to weak pay growth is stronger productivity, and the latest figures were disappointing, showing a drop in output per hour in the third quarter, for a rise of only 0.2% on a year earlier. It should be noted, however, that pay has underperformed even the lamentable performance of productivity in recent years. Productivity is up by 2.5% since early 2008 but real pay is down by 5%. That said, solving the productivity problem is a key element in reducing poverty.

In theory, the government’s boosts to the minimum wage, including a very significant increase when it was renamed the national living wage by George Osborne, should have bypassed the problem. The paradox of minimum wages, though, is that as a tool for reducing poverty they are blunt and rather ineffective instruments. Many of those on the national living wage live in higher-income households, because the main earner is in a better-paid job.

The other big change has been the interaction of pay and benefits. Tax credits, introduced by Labour under Tony Blair and Gordon Brown, formalised the idea of the government topping up inadequate pay. One of the reasons Labour also introduced the minimum wage was to prevent employers free-riding on tax credits by paying their workers very little and leaving the government to pick up the tab.

But the interaction of pay and the welfare system is not a happy one. In some cases, workers were only prepared to work the minimum number of hours (16) needed to qualify for in-work benefits, even when employers offer them more hours on better pay.

Universal credit is intended to solve many of the problems associated with the current hotch-potch of benefits and tax credits. It abolishes the 16-hour rule. But the further delays in rolling it out, and the very real distress caused to some who have been moved onto it by payment delays, shows that this is at best a work in progress.

Many workers in poverty, reliant on the state for part of their income, often a very significant part, have been subject to for the four-ear cash freeze on most working-age benefits and tax credits which began in 2016. The problems of poverty are, then, genuine, and they are not easy to resolve.

Ministers are not blind to them. While they understandably boast about the success of the job market, and the record employment it has generated, both Theresa May and Philip Hammond have talked about creating an economy that works for everybody.

High levels of poverty, particularly for those in work, show we do not yet have such an economy.

Sunday, January 06, 2019
Mind the gap - this could be the year we fall into 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.

We are just a few days into 2019, resolutions have already been made and broken, and many people have had a stab at predicting the outlook for the year. Forecasts are just forecasts, of course, and the real world can and does have a mind of its own.

In that sense, my piece a week ago recording that most forecasters had a good year in 2018, which generated much more than the usual interest, could be both a comfort and a warning. The comforting part is that forecasters do get it right. Less reassuring might be the thought that lightning does not strike twice.

While I am on that, many people, including my colleague Irwin Stelzer, have asked whether there is any consistency to the performance of the forecasters. I have been running my league table for at least a quarter of a century and, while I cannot promise to go back that far, I should be able to provide a running order for the past three3, five5 and 10 years. Watch this space.
For this year, consensus forecasts for the economy — as compiled by the Treasury each month — have been remarkably stable in recent months, despite the many political twists and turns.

They are for economic growth of 1.5%, a touch stronger than last year, and for inflation to head down to its official target rate of 2% (from 2.3% now) by the end of the year. Unemployment surprised on the downside last year and is expected to hold broadly steady at 4.1% of the workforce.

Britain’s balance of payments is expected to remain significantly in the red, with a deficit similar to last year, which I estimate to have been £85bn. I shall return to that in a moment. As for interest rates, the general expectation is that they will edge higher, with at least one, and possibly two, quarter-point increases from the current 0.75% level. Government borrowing is expected to edge up to about £33bn for the 2019-20 fiscal year, from £31bn in 2018-19.

These forecasts seem perfectly fair. I should say, as you have probably already noticed, that they are conditional on the prime minister getting something close like to her EU withdrawal agreement through the House of Commons and (though you would not describe anything related to Brexit as being smooth)) an orderly Brexit being achieved. This is despite the government’s stepping up its no-deal preparations. I: it cannot be long, amid the controversial chartering of ferries, before a minister invokes the little ships of Dunkirk.

On this basis, Samuel Tombs of Pantheon Macroeconomics predicts growth this year slightly better than the consensus, at 1.6%,; an unemployment rate of 3.9%; and inflation coming down to 1.8%. He thinks there will be a bounce in business investment if there is a deal, as do the chancellor and Bank of England governor (thoughI am a little sceptical). He also sees scope for a significant appreciation in the pound, to $1.40 and €1.27, from $1.26 and €1.11 now, partly on the back of a rise in Bank rate to 1.25%.

Narrowly second among the forecasters last year, the Office for Budget Responsibility (OBR), suffers from the disadvantage of not being able to update its published predictions as regularly as others,. Its latest forecast, at the end of October, was also for 2019 growth this year of 1.6%, and below-target inflation of 1.8%, and an unemployment rate of 3.7%. If my top two forecasters are to do as well this year as last, it will be by being more optimistic than the consensus.

All this assumes, as noted, an orderly Brexit. I cannot remember a time when the outlook for the economy has been so dependent on what happens in the first three months of the year. If we get over the Brexit line on March 29 Brexit line in a pragmatic and sensible way, prospects for the economy will not, by any measure, be great — we will still do worse over time than we would have done by staying in the EU — but they will not be terrible.

A no-deal Brexit, as I have rehearsed here on a number of occasions, is a very different kettle of fish. The OBR has drawn comparisons with the three-day week of 1974, when the economy recorded its biggest post-war quarterly fall of nearly 3%. Tombs, while stressing that a “calamitous” no-deal Brexit is highly unlikely, thinks it would lead to a slump in sterling, higher inflation, emergency measures from the Bank and a significant hit to growth. It is hard to argue with that.

There is an element of all this that it is worth dwelling on. There was a brief moment, after sterling’s sharp post-referendum fall, when it was possible to be optimistic about one aspect of the rebalancing of the economy, — the balance of payments current account deficit. Indeed, I wrote as much here.

It was, I am afraid, a short-lived hope. The current account deficit narrowed from an all-time record of £103bn in 2016 to £68bn in 2017, but it widened again last year. The latest figures we have, for the third quarter of 2018, showed a deficit of £26.5bn. As a percentage of gross domestic product, the deficit, 4.9%, is bigger than at the time of the Opec oil crisis of the 1970s or the Lawson boom of the late 1980s.

That matters, or it could. If you have a current account deficit, then you require offsetting capital inflows. Maintaining those inflows will be a challenge with any form of Brexit. Mark Carney once referred to Britain relying on the “kindness of strangers”, but strangers can be a hard-headed lot.

Keeping the capital flowing into Britain under a no-deal scenario would be likely to involve a significantly lower pound, allowing foreigners to buy up UK assets, including businesses, at bargain-basement prices, and/or higher interest rates. The balance of payments, which has not featured much in the recent economic debate in recent years, could yet return to bite us.

That depends, as I say, on what happens in the next three months, and whether our politicians steer clear of what would be a monumental blunder. Forecasters are assuming they will. Let’s hope that they are right.

Sunday, December 30, 2018
A good year for 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 to accompny this article is also in The Sunday Times.

So we get ready to say goodbye to a year that, in the end, was a disappointing one. Much of that disappointment relates to the global economy. Back in January it was possible to look at a world economy firing on all cylinders, with strong growth in North America, Asia, the emerging world and, most surprisingly, Europe.

It appeared, at long last, that the world was shaking off the doleful influence of the financial crisis, and that the hangovers, financial and fiscal, had finally gone away. A couple of years of global growth very close to the pre-crisis norm of 4%, with world trade also on the up, appeared to be in prospect.

Sadly, it has not turned out like that. Growth has not collapsed but it has disappointed, closer to 3.5% rather than 4%. We end the year with worries on the increase and the optimism of a year ago taking a back seat. Countries most exposed to world trade, such as Germany, have been caught in the downdraft, ending the year with growth slowing and business confidence weak,

As Charles Dumas of T S Lombard put it in a recent report: “The global slowdown seems to have started in mid-2018, and shows the now decisive importance of emerging markets to the world economy. China and other emerging markets account for 40% of world GDP and their slowdown led to a sharp mid-year reduction in world trade growth … In Europe, export dependence led to a negative third quarter GDP change in Germany and Italy.”

Why the disappointment? High on the agenda are two separate developments in America; Donald Trump’s trade wars and the decision by the Federal Reserve, America’s central bank, to raise interest rates four times during the year, with the last coming earlier this month.

Trump’s tariffs, initially on steel and aluminium but then extending into a more general trade war with China, nipped in the bud a promising recovery in world trade. And, as economists warned, protectionism turned out to be bad for growth.

The Fed, which felt emboldened enough to raise rates for the ninth time since the crisis, and at a faster pace than before, attracted Trump’s ire. But, in its efforts to keep US inflation under control, was also in the vanguard of what was a significant monetary policy reversal. After years of stimulus, via ultra low interest rates and quantitative easing (QE), central banks shifted into reverse gear. Even the European Central Bank ended its QE.

What about Britain? Economic forecasters would be the first to acknowledge that they have good years and bad ones. Most had a couple of bad years around the time of the financial crisis, mainly because even when it was under way, they underestimated how bad its impact on growth would be.

The referendum, in contrast, was expected to have a bigger short-term negative effect on growth than turned out to be the case, although the broad impact on the economy of Britain’s vote to leave over the past 2½ years has turned out close to expectations.

2018 was one of the good years for forecasters. Though the world economy turned out to be a touch disappointing, predictions of UK growth were downbeat, and were right to be so. At an estimated 1.4%, the current consensus, growth was very close to what was expected by the majority of forecasters at the beginning of the year.

Growth was expected to be disappointing, and it has been, ranking as the weakest year since the crisis. Though we have to wait a little while for the final figures – and even then they are subject to revision – the economy struggled.

The story of the economy was one of Brexit - and again there was more optimism on that a year ago than there is now - and of other more traditional factors. The Beast from the East which ended the winter hit growth quite hard, while the hot summer and a surprising World Cup showing from the England team enhanced the bounce in the third. The fourth quarter looks to have seen a return to the very slow growth of earlier in the year; just 0.1% or 0.2%.

Economists mainly got growth right and they were also correct in anticipating a fall in inflation, as the effects of sterling’s sharp post-referendum fall pass through. Inflation was 3% at the end of last year and was down to 2.3% last month.

That has meant, with a strengthening of wage growth to its best in 10 years, a crossover between earnings and inflation, so resuming real wage growth, currently around 1%. This was not enough, however, to rescue a grim year for retailers who, despite a Black Friday boost in November, have found 2018 to be the toughest year in a long time,

The labour market performed well in another respect, with continued if slightly slower growth in employment, and a further drop in unemployment. The 4% unemployment rate seen during the year was the lowest for decades.

What else happened? The Bank of England raised interest rates, taking Bank rate to 0.75%, and thus br4eaking above 0.5% for the first time since March 2009. Philip Hammond took advantage of some favourable forecast revisions from the Office for Budget Responsibility to fund the National Health Service’s 70th birthday present and a cut in income tax via raising the personal allowance. But a change in the treatment of student loans by official statisticians will add significantly to the measured budget deficit.

So who got closest to the story of 2018 with their forecasts? I am pleased to announce that we got two perfect tens this year on my scoring system, two forecasters who got growth, inflation, unemployment, the balance of payments and interest rates as close to completely correct as it is possible to be.

One was Pantheon Macroeconomics, in the form of its chief UK economist Samuel Tombs. His tone about Britain’s economy has been downbeat since the referendum and in 2018 he called it correctly. Congratulations to him.

It is also pleasing to record that the Office for Budget Responsibility (OBR), the government’s fiscal and forecasting watchdog, which has a huge influence in framing others’ forecasts for the economy, also did very well, again scoring 10 out of 10. For the OBR this will be somewhat bitter-sweet. It would be the first to admit that its forecasts for public borrowing, one of its main functions, have been too pessimistic over the past couple of years. A recognition of that enabled Hammond to splash the cash in November. Government borrowing has never been one of the measures I have used to judge the forecasts, however, because the time to do that is after the end of the fiscal year in April, not at the end of the calendar year.

It is only fair to report that many other forecasters did well this year, the number of eight and nine scores being higher than on average. Economic forecasting comes in for a lot of flak, but it did well in 2018.

At the other end of the scale to Tombs and the OBR sits the Liverpool Marco Research Group of Patrick Minford, now a professor at Cardiff University but previously at Liverpool. He is perhaps the most prominent Brexit-supporting economist. Optimism on the impact of the referendum vote did not serve him well this year or, it should be said, in 2017.

Sunday, December 23, 2018
Confidence zapped as no-deal worries return
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 be great to report that we are ending the year on an upbeat note, with uncertainty banished and confidence riding high. Unfortunately, and though I don’t want to spoil anybody’s festive fun, neither of those things are true.

According to the closely-watched GfK consumer confidence index, which has been running since the 1970s, households are ending the year “on a pessimistic note”, with confidence lower even than in the immediate aftermath of the referendum. Though this did not prevent them taking advantage of Black Friday bargains last month, they are downbeat about prospects for their own financial situation, and markedly so about the outlook for the economy. Confidence has not been this low for five years.

Business confidence, meanwhile, is also in the doldrums. On some measures, including the ICAEW (Institute of Chartered Accountants in England and Wales) index, it is it at is lowest since the financial crisis. On others, such as the Federation of Small Businesses’ index, it is at a seven-year low.

It is not hard to see why. Business groups have been at best lukewarm and in some cases openly hostile about the proposals set out in the government’s immigration white paper, of which more below.

More worryingly for business, many thought that talk of a no-deal Brexit, which as I described here recently as madder than any number of mad things you can think of – I left out George the Third – had been safely buried. But, like the many-headed hydra or the black knight in Monty Python’s Holy Grail it will not lie down, and is revived on almost a daily basis, usually by spivs or failed politicians.

The fact that the government has stepped up its no-deal preparations, and is allocating £2bn to government departments and putting 3,500 troops on standby, has added to the concern. Though Downing Street continues to insist that the prime minister’s deal will prevail, if it was certain it would not have embarked on these preparations.

Such is the weird mood that people cannot make up their minds whether the latest phase of the EU’s no-deal preparations would make a disruptive Brexit slightly less disruptive or are an attempt to stitch this country up.

The measures, which will extend equivalence for some financial products, allow flights between the UK and EU and allow UK hauliers to carry goods into the EU for nine months, are intended to minimise the effects on the 27 of the abrupt exit of the 28th. They do not make a no-deal Brexit any less silly.

The disadvantages of a no-deal Brexit are many and large. It would not, as constitutional experts have assured me, absolve Britain of the responsibility for most, an d probably all, of the £39bn “divorce bill”, unless this country wants to start its new era as a pariah state which leaves without paying. We do not, as many continue to exasperatingly claim, trade with the rest of the world on “WTO terms”. We trade on the basis of agreements and arrangements, negotiated by the EU, which are superior to basic World Trade Organisation terms, and which we probably could not carry over in the event of a no-deal Brexit.

The idea of a “managed no-deal” is also a fiction. As Tim Durrant of the think tank the Institute for Government wrote after the EU announced its measures: “The EU has made clear it is not willing to negotiate a so-called managed no deal – it will take temporary unilateral measures to mitigate the impact of no deal on EU businesses and citizens. They are not planning for the UK to retain “the terms of any transition period”, which is a key component of the withdrawal agreement – so there is no “managed glide path” available, where the UK keeps the transition and reneges on the rest of the prime minister’s deal.”

In the City, the probability of a no-deal Brexit has been raised; Berenberg, a bank, has just raised it from 10% to 20%, the same as for Theresa May’s withdrawal agreement getting through the House of Commons, but lower than the 25% probability Berenberg puts on Brexit not happening at all.

It is good, therefore, that business has risen up against the danger of no-deal, with five business organisations, the British Chambers of Commerce, the CBI, the EEF, the Federation of Small Businesses and the Institute of Directors, writing a joint letter last week of their “horror” at the parliamentary process and the rising risk of a no-deal Brexit on which, they warned, “there is simply not enough time to prevent severe dislocation and disruption”. A no-deal Brexit, of course, does long-term damage as well as carrying serious short-term risks.

The last word on no-deal should go to Sir Ivan Rogers, Britain’s former ambassador to the EU and an expert the government would have done well to keep on board in the past two years. As he put it, in a recent lecture at Liverpool University: “Because so-called ‘WTO rules’ deliver precisely no continuity in multiple key sectors of the economy, we could expect disruption on a scale and of a length that no-one has experienced in the developed world in the last couple of generations.”

And, he added: “Markets continue to react … as if something must turn up and that “no deal” is a virtually unimaginable scenario for politicians professing to be serious, to contemplate. That risk has therefore been seriously underpriced for a year or more, because we are dealing with a political generation which has no serious experience of bad times and is frankly cavalier about precipitating events they could not then control, but feel they might exploit.”

If no-deal is the worry as we end 2018 and move into the uncertainties of 2019, what about immigration? The government’s white paper, like the prime minister’s EU withdrawal agreement, has managed to earn the disapproval of just about everybody.

Migration Watch, the pressure group devoted to cutting immigration, is worried about a proposal which would allow unskilled and low-skilled workers to come to Britain for up to a year. Businesses are concerned that they will be faced with much higher levels of bureaucracy when recruiting workers from overseas, and that the ready supply of EU migrant workers is over, particularly for jobs paying less than £30,000 a year.

They have a point. The white paper itself envisages negative net migration, an overall outflow, of EU workers between 2021 and 2025, at a cost of up to £4bn for the public finances (they are net contributors). The EEF warns that employers will have to pay “thousands of pounds to cover the cost of visas, the immigration skills charge and the health surcharge for new EU workers”. This is no bonfire of red tape.

The National Farmers Union warns that the new 12-month visa system will be “highly disruptive”. The Institute of Directors says the white paper can be realistically viewed as a work in progress.

All fair comment. But, to also be fair, the white paper is confused because it is the product of a government in a state of confusion, and it could have been a lot worse. The 100,000 annual net migration figure has been dropped, the 12-month visa scheme was better than expected and overseas graduates and those with higher qualifications will be able to stay for 6-12 months to find employment. It did not do much for confidence, but it could have been worse.

Sunday, December 16, 2018
Something needs to turn up to lift our feeble growth rate
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 be easy at this moment to despair. Political stability is something we usually take for granted in this country; governments acting in the national interest and most politicians supporting them in that aim. It is one of the hidden but important components of economic stability and success.

But Brexit, as well as casting a long shadow over business and the economy, is breaking British politics. The Tories, who once described themselves as the party of business, are now fatally divided and have done much to damage business over the past three years. The prospect of a coming to power of Labour, also badly divided, is regarded with barely-disguised horror by many people I come across.

When President George H W Bush died recently, he was described as the last of the greatest generation, those who had served in the second world war and then devoted themselves to public service. In Britain, we have a different and far-from-great generation of politicians, too many of whom think they are still fighting the second world war, though they would probably have been spared on the grounds of flat feet, and know little of public service.

We should not despair too much. An old Treasury hand reminded me the other day that we do get through these things, however difficult and intractable they seem at the time. As a fully signed-up member of the “something will turn up” school, this is a view I happily endorse, though the fact that neither of us could quite see the way through the current mess was a touch worrying.

In this spirit of looking beyond the current turmoil I will not dwell this week on the pall that has descended on the economy with markedly weaker fourth quarter growth figures (though a surprisingly sprightly labour market) and a moribund housing market. Exasperation and uncertainty are the dominant sentiments among business people as we head towards the year-end.

Instead it is time, as promised, to look forward, and there is a good excuse to do so. I have not yet written about the IPPR economics prize, under the auspices of the Institute for Public Policy Research. The prize money, totalling £150,000, is underwritten by John Mills, the founder of JML, and is the world’s third biggest economic prize after the Nobel (the Bank of Sweden award) and the Wolfson prize.

I like the idea of prizes like this. They remind us of a time when solving problems like longitude, as John Harrison’s marine chronometer helped do in the 18th century, could be facilitated by the offer of a prize. There is a modern version of the longitude prize running now, awarded to scientists for their work on tackling the problem of antibiotic resistance.

The IPPR prize consists of a main award of £100,000, runners-up prizes totalling £25,000 and a separate £25,000 prize for under-25s. Initial 5,000 word submissions are due in by Sunday January 6; offering an opportunity to fill in the downtime over Christmas. They should be sent, not to me, but to EconPrize@ippr.org.

The aim is straightforward, if ambitious. The prize will be awarded to the best proposal for raising Britain’s sustainable growth rate from its current 1.5% to between 3% and 4%. The judging panel will be headed by Stephanie Flanders and will include, as well as Mills, of Lord John Eatwell of Cambridge University, Dame Helena Morrissey, head of personal investing at Legal & General and Shriti Vadera, chair of Santander UK.

Many economists would say that achieving a sustainable growth rate of 3% to 4% for Britain is a much harder task than anything Harrison faced 300 years ago. Though growth touched a little more than 3% on a quarterly basis just over three years ago, it has since slowed to half that, at best, with the risks to the downside we all know about.

Though growth regularly exceeded 3%, sometimes by a wide margin, in the “golden age” for the world economy between 1948 and 1973, doing so on 14 occasions, sightings of 3%-plus growth have become rarer. The last annual growth rate above 3% was in 2005, one of only three this century. Britain’s average growth rate in the 21st century has been 1.8%, including the big recession of 2008-9, a percentage point below the 2.8% average in the second half of the 20th century.

How could higher sustainable growth be achieved? I disagree fundamentally with Mills, a lifetime Brexiteer, that it should be via what he describes as a competitive exchange rate strategy. A lower pound is not a route to permanently stronger growth. If currency devaluation and depreciation were the keys to growth, Britain would be a world champion.

He does, however, set out some useful parameters about what else is needed. One of the most depressing recent comparisons, produced by the Office for National Statistics, was that over the 1997-2017 period Britain had the lowest investment, combining private and public, of any of the 30-plus OECD (Organisation for the Economic Co-operation and Development) countries. Raising Britain’s investment rate from 16% to 26% of gross domestic product, split between high technology private investment and infrastructure, would transform Britain’s prospects.

To boost growth, you need to be at the cutting-edge, and in important respects Britain is not. Another comparison, from the International Federation of Robotics, highlighted recently by the CBI, showed this country lagging near the bottom of the global league table for take-up of manufacturing robots. On a comparable basis – robots installed per 10,000 employees – South Korea and Singapore are miles ahead, with six or seven times the number of robots in Britain, followed by Germany and Japan.

This appears to be part of a more general problem with technology. A study by the management consultants McKinsey, highlighted by Be the Business, the organisation devoted to raising productivity, found that take-up of customer relations management (CRM) and enterprise resource planning software, is much lower in the UK than, for example, Germany. In too many small end medium-sized businesses, in particular, technology is something to be feared, not embraced.

There are other things we should be doing, again highlighted by Be the Business. If management quality in domestically-owned firms could be raised to the level of that in foreign-owned firms operating in Britain, their performance, and that of the economy would improve. Similarly, family-owned firms tend to lag behind others. Britain has a longer tail of poorly-performing businesses than competitor countries.

There is no magic bullet. Raising the growth rate, if it could be achieved, would be through a cocktail of factors including stronger demand, more investment, better skills, better management and so on.

I nevertheless await the IPPR prize process with interest, and the ideas it attracts. £150,000 is a decent amount of money in anybody’s book. Nobody would seriously expect anybody to come up with something that doubles the growth rate, even though that was Donald Trump’s election pledge in America two years ago (he won’t). But anything that raised Britain’s growth rate even a smidgen is worth at least £150,000 of anybody’s money.

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.