… Donald created chaos. In recent days, the Trump Administration
has imposed an immigration ban which is generating controversy around the
world, whilst today the head of the National Trade Council, Peter Navarro, publicly
accused Germany of using a “grossly
undervalued” euro to “exploit”
the US and its EU partners. Both these issues call into question the underlying
principles of the international economic and financial framework. Whilst recent
events reveal that the new Administration is not going to play by the old rules,
and we are going to have to live with it, they also display a degree of
callowness regarding how the world works.
On a wider view, businesses and investors do not like what
they have seen and heard. It is potentially the first step towards a more
protectionist world which will damage the US as much as its trading partners.
Of more concern is that the global financial system has historically worked
best when the global superpower acts in its benevolent self-interest by
maintaining access to its markets, allowing unrestricted access to its
financial markets and generating higher global incomes which benefit everyone –
corporate America included. Any sense that the system is to be gamed in favour
of the US will not end well for anyone.
Navarro’s comments in particular were worrying on many
levels, not the least of which because he is wrong. It is true that Germany is
running an excessively large external surplus which, as I have pointed out in a
previous post (here),
does put undue strain on the workings of EMU. But ironically, a higher surplus
ought to put upward pressure on the currency, rather than weaken it. After all,
it is not as if the whole of Germany’s surplus is solely generated at the
expense of other EMU members. Moreover, the perceived weakness of the euro is
due more to ECB asset purchases than to any deliberate action on Germany’s
part, something which has been strongly opposed by the German contingent at the
ECB (notably Bundesbank President Weidmann, who has been a vociferous critic of
QE).
An excellent article in The Economist a couple of weeks ago
noted that “there are reasons to be
worried about the head of Donald Trump’s new National Trade Council” (here).
In particular, The Economist notes that Navarro’s view that unbalanced trade is
responsible for a slowdown in US growth since 2000 is simply “dodgy economics.” It goes on to suggest
that Navarro “seems to think that once
they [China] comply with global trade rules, the trade deficit will close and
manufacturing jobs will return to America’s shores … This is a fantasy. When
manufacturing production moves overseas and then returns, productivity has
usually risen in the interim; so far fewer jobs come back than left.”
Navarro’s views on the EU are equally wrong-headed. He said
in a recent FT interview that “The
unequal treatment of the US income tax system under biased WTO rules is a
grossly unfair subsidy to foreigners exporting to the US and a backdoor tariff
on American exports to the world that kills American jobs and drives American
factories offshore.” Whatever else it might be doing, Europe is not
stealing US manufacturing jobs. It might be getting more of its share of US corporate
taxes than the government would like but there is a simple solution to that –
cut the corporate tax rate, which is amongst the highest in the industrialised
world.
But perhaps what is most worrying of all – and it was
highlighted by a number of below the line commentators on the FT website, who
are a pretty savvy bunch – is that the US government appears to be trying to drive
a wedge between EU nations by highlighting the fact that Germany is “exploiting”
other European partners. Certainly, it seems to have a preference for
negotiating bilateral deals with the intention of (as one commentator put it) “the destruction of the EU, by peeling one
nation at the time from the EU, till the whole thing collapses.” That might
be a bit over the top but it is a common theme.
Even more worrying from a UK perspective, as the inestimable
Gideon Rachman noted in the FT yesterday, is that “the election of Mr Trump has transformed Brexit from a risky decision
into a straightforward disaster (here).” I have long believed that the main risk Trump poses to the UK is that
many of his policies may well not be in the UK’s national interest. As Rachman
put it, “If Britain had voted to stay
inside the EU, the obvious response to the arrival of a pro-Russia
protectionist in the Oval Office would be to draw closer to its European
allies. Britain could defend free-trade far more effectively with the EU’s bulk
behind it … As it is, Britain has been
thrown into the arms of an American president that the UK’s foreign secretary
has called a madman”.
When a man who wants to build a wall on the southern US
border to keep out Mexicans; who wants to ban immigrants from one of the most
tolerant and open societies in the world and who threatened to jail his
political opponent, thinks Brexit is a good idea we really need to think again!
As the Ancient Greek storyteller Aesop wrote, “A doubtful friend is worse than a certain enemy. Let a man be one thing
or the other, and we then know how to meet him.”
Tuesday 31 January 2017
Sunday 29 January 2017
Don't forget about Grexit
It is somewhat ironic that the phrase Brexit is heard far more frequently these days than Grexit, despite the fact that the latter was long viewed as the more likely event to happen. Although the Greek issue has not been anywhere near the top of investors’ agenda over the last eighteen months, the problems have not gone away. We were reminded of this recently when an IMF report was leaked to the Financial Times, which concluded that without relief, Greece faces an “explosive” surge in its debt burden which will raise the debt-to-GDP ratio from somewhere around 180% today to over 250% by 2060.
It is evident that the current policy mix is simply not working. Imposing more austerity on Greece in the hope that it will be able start repaying its debts anytime soon, is nothing more than delusional. Already the economy is suffering from what can only be described as a depression with economic output around 30% below levels recorded at the start of 2008. And the more output is depressed, the less likely it is that the economy will be able to generate the revenue to ease the fiscal situation. This is, of course, not news. Most economists see no way out of the debt trap into which Greece has sunk. But the EU continues to believe that more of the same medicine needs to be applied, which of course is nonsense.
Such is the IMF’s disquiet over the situation that there is a real threat it will not participate in the next round of the Greek bailout package, as it believes this is simply to throw good money after bad. But if it were not to participate this would put Germany in an awkward position because it has insisted on IMF participation, largely because it does not trust its fellow EU partners to sustain the pressure on Greece to reform. Moreover, with crucial elections scheduled this year in the Netherlands, France and Germany, the window of opportunity to agree the next stage of the bailout package appears to be closing without the IMF’s support.
We have been through this Greek tragedy on a number of occasions, with the fraught summers of 2012 and 2015 still very fresh in the memory. The good news is that at least the Greek economy is not contracting further and it is posting a primary surplus (i.e. excluding debt interest payments). But this has only been achieved at great cost to the economy and people of Greece, and it cannot be sustained on the multi-year horizon that the EU desires. There are some things that the Greek government could do, of course. For one thing, it could ensure that citizens pay the taxes which they owe, which amongst other things would involve a clampdown on the shadow economy which some academic estimates suggest equates to 25% of official GDP estimates – the highest in the EU. The IMF adds that Greece also needs pension reform and should impose a safety net to help those most affected by the recent crisis.
But this is in many ways to miss the point: All this should have been done years ago. Indeed, my own estimates, produced in a 2014 paper, reckoned that even if the government had taxed only 25% of shadow activity starting in 1999, this would have been sufficient to reduce the debt burden by 40% of GDP and would have put the economy in a much better starting point when the crisis finally struck.
However, we are where we are, and the issue now is where do we go from here? For the last five years I have advocated substantial debt relief. Without it, the problems Greece has faced will not only recur but they will get worse. It is questionable whether other EMU partners will allow such relief. But rather than writing off debt completely, as is often suggested, perhaps one thing that could be considered is the establishment of a sinking fund. This would allow Greece to transfer a substantial proportion of its debt to an off-balance sheet fund which has no designated repayment date. In this way, Greece can focus on the remaining debt (whether it be half, or two-thirds) and not have to worry about the rest. It can set aside modest amounts, as and when finances allow, in order that over a multi-decade (or even multi-century) horizon, the debt burden is gradually run down. After all, it is a strategy which worked for the UK in the eighteenth century.
Alas, few investors will buy undated Greek consols, so the fund would have to be guaranteed by a body such as the ECB. But this would lay it open to the charge of monetary debt financing which is expressly prohibited by the Maastricht Treaty. Alternatively the IMF could step in, but given disquiet about its current role, that seems unlikely. But something must be done – and soon. If German public opinion further turns against granting aid to Greece, Grexit will once more become a reality.
Indeed, with Brexit now being set in motion, perhaps EMU members will be less willing to provide the support to maintain the integrity of monetary union than they were even two years ago. For all its tricky relationship with the EU, the UK is after all a net contributor to the budget and questions will be raised about why support is being provided to those which do not bring as much to the party. But if EMU countries wish to preserve their currency union, they will have to start thinking outside of the box or it will go the way of all such unions.
Wednesday 25 January 2017
Rules are rules
All social and economic systems are based on rules. Some are
necessary, some merely irksome, but they are all designed with a purpose in
mind. All advanced societies live by a code designed to preserve social order,
which is a prerequisite for economic advancement. Anarchic systems tend not to
last long.
I was struck by this thought yesterday, following the UK Supreme Court’s ruling that parliament must be allowed to vote before the Article 50 legislation triggering Brexit is enacted. There are those who may disagree with the court’s ruling. Others may question whether it was necessary that the whole episode should have required legal involvement in the first place. After all, it would have been simple enough for the government to have acquiesced to demands for a vote, whilst preparing a pared down bill which parliament would find very difficult to reject – something that the government will now have to do anyway. But it is important to recognise that under English law, the courts exist to enact the law which is designed in parliament. The judgment handed down yesterday made it clear that the Supreme Court has no wish (or indeed, power) to rule on whether Brexit is a good or bad thing for the UK. It merely ruled that legislation put in place by parliament can only be repealed by parliament.
It was thus extraordinary to hear Iain Duncan Smith, a prominent eurosceptic MP – indeed a former leader of the Conservative Party – say in a radio interview: “There’s also the issue about who is supreme – Parliament or a self-appointed court ... I’m disappointed they've tried to tell Parliament how to run its business. They've stepped into new territory where they've actually told Parliament not just that they should do something but actually what they should do. I think that leads further down the road to real constitutional issues about who is supreme in this role.”
Rarely, if ever, have I heard a more crass statement from a British politician. It demonstrates a lack of understanding of how the UK judicial process works, which in itself is worrying from a lawmaker. As the writer of The Secret Barrister blog noted on Twitter “There's no issue about who is supreme between Parliament and Supreme Court. It’s Parliament. The Court expressly did not tell Parliament how to run its business. It clarified what it could not do unilaterally. The Supreme Court is not self-appointed. It was established by Parliament by section 23 of the Constitutional Reform Act 2005.” My own reaction was to question in what way a parliament, that his government wanted to be kept out of the process in the first place, was being told how to act? And the irony must have escaped him that somehow allowing parliament to demonstrate its sovereignty was a means of taking control that surely his Brexit campaign had been about all along?
But this goes to the heart of a deeper economic, and indeed social, problem. There is often a fundamental misunderstanding of the rules which are in place; why they are in place and the consequences of not adhering to them. To give a simple economic example, many people know that the Maastricht Treaty of 1992 specified that members of the single currency should ensure that their public deficit on an annual basis be kept below 3% of GDP. Fewer people know that this apparently arbitrary figure is based on the desire to stabilise the long-term debt-to-GDP ratio at 60% under the assumption that nominal GDP grows at a rate of 5% per annum (60% x 5% = 3%). Fewer still realise that if GDP growth slows, governments have to run an even tighter fiscal stance to stabilise the long-run debt ratio at 60%. Thus if growth were to permanently slow to 4%, this would require maintaining a deficit ratio of 2.4% (60% x 4% = 2.4%). Alternatively, governments will be required to run higher debt limits (a 3% deficit limit and 4% growth would allow governments to stabilise debt ratios only at 75% of GDP). Either way, the 3% deficit threshold has become an article of faith to be adhered to at all times, even though it is no longer appropriate in the current low growth environment.
As it happens, the consequences of failing to adhere to the fiscal targets are not particularly dramatic. But the fact that they are believed to be so has prompted EMU countries to embark upon a damaging round of fiscal austerity. The consequences of IDS’s failing to understand the nature of the English legal system are manifestly more worrying. Like a series of Chinese whispers, they are repeated until they become an article of faith which begins to undermine the basis of the legal framework and erodes trust in experts and institutions. This is how post truth societies emerge and gives rise to the series of untruths (or alternative facts) upon which the case for Brexit was made.
They say that rules exist for the obedience of fools and the guidance of wise men. But both fools and wise men need to know why the rules are there in the first place, or we all end up looking like fools.
I was struck by this thought yesterday, following the UK Supreme Court’s ruling that parliament must be allowed to vote before the Article 50 legislation triggering Brexit is enacted. There are those who may disagree with the court’s ruling. Others may question whether it was necessary that the whole episode should have required legal involvement in the first place. After all, it would have been simple enough for the government to have acquiesced to demands for a vote, whilst preparing a pared down bill which parliament would find very difficult to reject – something that the government will now have to do anyway. But it is important to recognise that under English law, the courts exist to enact the law which is designed in parliament. The judgment handed down yesterday made it clear that the Supreme Court has no wish (or indeed, power) to rule on whether Brexit is a good or bad thing for the UK. It merely ruled that legislation put in place by parliament can only be repealed by parliament.
It was thus extraordinary to hear Iain Duncan Smith, a prominent eurosceptic MP – indeed a former leader of the Conservative Party – say in a radio interview: “There’s also the issue about who is supreme – Parliament or a self-appointed court ... I’m disappointed they've tried to tell Parliament how to run its business. They've stepped into new territory where they've actually told Parliament not just that they should do something but actually what they should do. I think that leads further down the road to real constitutional issues about who is supreme in this role.”
Rarely, if ever, have I heard a more crass statement from a British politician. It demonstrates a lack of understanding of how the UK judicial process works, which in itself is worrying from a lawmaker. As the writer of The Secret Barrister blog noted on Twitter “There's no issue about who is supreme between Parliament and Supreme Court. It’s Parliament. The Court expressly did not tell Parliament how to run its business. It clarified what it could not do unilaterally. The Supreme Court is not self-appointed. It was established by Parliament by section 23 of the Constitutional Reform Act 2005.” My own reaction was to question in what way a parliament, that his government wanted to be kept out of the process in the first place, was being told how to act? And the irony must have escaped him that somehow allowing parliament to demonstrate its sovereignty was a means of taking control that surely his Brexit campaign had been about all along?
But this goes to the heart of a deeper economic, and indeed social, problem. There is often a fundamental misunderstanding of the rules which are in place; why they are in place and the consequences of not adhering to them. To give a simple economic example, many people know that the Maastricht Treaty of 1992 specified that members of the single currency should ensure that their public deficit on an annual basis be kept below 3% of GDP. Fewer people know that this apparently arbitrary figure is based on the desire to stabilise the long-term debt-to-GDP ratio at 60% under the assumption that nominal GDP grows at a rate of 5% per annum (60% x 5% = 3%). Fewer still realise that if GDP growth slows, governments have to run an even tighter fiscal stance to stabilise the long-run debt ratio at 60%. Thus if growth were to permanently slow to 4%, this would require maintaining a deficit ratio of 2.4% (60% x 4% = 2.4%). Alternatively, governments will be required to run higher debt limits (a 3% deficit limit and 4% growth would allow governments to stabilise debt ratios only at 75% of GDP). Either way, the 3% deficit threshold has become an article of faith to be adhered to at all times, even though it is no longer appropriate in the current low growth environment.
As it happens, the consequences of failing to adhere to the fiscal targets are not particularly dramatic. But the fact that they are believed to be so has prompted EMU countries to embark upon a damaging round of fiscal austerity. The consequences of IDS’s failing to understand the nature of the English legal system are manifestly more worrying. Like a series of Chinese whispers, they are repeated until they become an article of faith which begins to undermine the basis of the legal framework and erodes trust in experts and institutions. This is how post truth societies emerge and gives rise to the series of untruths (or alternative facts) upon which the case for Brexit was made.
They say that rules exist for the obedience of fools and the guidance of wise men. But both fools and wise men need to know why the rules are there in the first place, or we all end up looking like fools.
Tuesday 24 January 2017
What would Margaret do?
Post-truth is a phrase which seems to have gained a lot of
currency in recent months. Or, as President Trump’s aide Kellyanne Conway would
have it, the new president’s press secretary did not lie about the size of the
crowd for Trump’s inauguration, he merely presented alternative facts. The presentation of alternative facts is
rather how I felt when I went back again over Theresa May’s speech last week
which contained a phrase so outrageous that the PM had to hide it in plain
sight.
To recap, May told us that the UK is leaving the Single Market. And not only that but “both sides in the referendum campaign made it clear that a vote to leave the EU would be a vote to leave the single market.” As lies, sorry alternative facts, go that is a whopper. I don’t recall anywhere on the ballot paper being asked my opinion on this. Or did I just get an alternative ballot paper? Indeed, the lobby group British Influence has launched a legal bid to force the government to separate EU membership from the question of Single Market membership. Good luck with that, as I have no wish to rake over the coals of legal challenges to the referendum once again.
But there is a wider economic point which has not been made often enough – namely, that those elements of the Conservative Party calling for an exit from the Single Market are simply ignorant of their party’s history and do not understand what they are getting rid of. A great article by Ben Chu in The Independent (here) hit the nail on the head. He argues forcefully that many Conservative MPs do not appreciate the role played by their political heroine, Margaret Thatcher, in helping to bring about the Single Market in the first place. Indeed, whilst Thatcher was no fan of a federalist EU, she understood the benefits of free trade well enough.
In assessing what Thatcher’s views on Brexit might have been, we have to weigh her views on EU unity against her economic liberalism. The great irony is that they are not mutually exclusive, as might have been thought 30 years ago. Thatcher’s famous Bruges speech in 1988 ("We have not successfully rolled back the frontiers of the state in Britain, only to see them reimposed at a European level, with a European superstate exercising a new dominance from Brussels") resonates as powerfully today as it did then (here for a link to a contemporary UK newspaper report). As The Guardian put it at the time: “Dismissing as irrelevant proposals for a European central bank, Mrs Thatcher said the EEC should remain committed to a free market economy. ‘The basic framework is there: the Treaty of Rome itself was intended as a charter for economic liberty … But that is not how it has always been read, still less applied’."
One of the key lessons from last week’s speech by Theresa May was that she wants to open up the UK and make free trade agreements with the rest of the world. The crucial bit here is “free trade.” What is it that Brexiteers think we have now? The logic of their argument is “leave the EU to get more free trade.” Our PM believes that she will get “a new, comprehensive, bold and ambitious free trade agreement” with the EU. But what if she doesn’t? The UK will then have walked out of the comfort of the Single Market in the hope of being able to get better deals elsewhere. As dumb economic gambles go, this one is up there.
Thatcher used a speech at Lancaster House in 1988 – ironically the same venue used by May – to make the point that the EU offers “A single market without barriers – visible or invisible – giving you direct and unhindered access to the purchasing power of over 300 million of the world's wealthiest and most prosperous people. ” Perhaps the EU did move too close to being the federalist state so opposed by many UK politicians. But I find it bizarre that a government which nominally extols the virtues of free trade should walk away from one of the world’s great free trade areas, in the pursuit of the chimera of better trade prospects elsewhere. And for what? Even Judas was rewarded with 30 pieces of silver.
To recap, May told us that the UK is leaving the Single Market. And not only that but “both sides in the referendum campaign made it clear that a vote to leave the EU would be a vote to leave the single market.” As lies, sorry alternative facts, go that is a whopper. I don’t recall anywhere on the ballot paper being asked my opinion on this. Or did I just get an alternative ballot paper? Indeed, the lobby group British Influence has launched a legal bid to force the government to separate EU membership from the question of Single Market membership. Good luck with that, as I have no wish to rake over the coals of legal challenges to the referendum once again.
But there is a wider economic point which has not been made often enough – namely, that those elements of the Conservative Party calling for an exit from the Single Market are simply ignorant of their party’s history and do not understand what they are getting rid of. A great article by Ben Chu in The Independent (here) hit the nail on the head. He argues forcefully that many Conservative MPs do not appreciate the role played by their political heroine, Margaret Thatcher, in helping to bring about the Single Market in the first place. Indeed, whilst Thatcher was no fan of a federalist EU, she understood the benefits of free trade well enough.
In assessing what Thatcher’s views on Brexit might have been, we have to weigh her views on EU unity against her economic liberalism. The great irony is that they are not mutually exclusive, as might have been thought 30 years ago. Thatcher’s famous Bruges speech in 1988 ("We have not successfully rolled back the frontiers of the state in Britain, only to see them reimposed at a European level, with a European superstate exercising a new dominance from Brussels") resonates as powerfully today as it did then (here for a link to a contemporary UK newspaper report). As The Guardian put it at the time: “Dismissing as irrelevant proposals for a European central bank, Mrs Thatcher said the EEC should remain committed to a free market economy. ‘The basic framework is there: the Treaty of Rome itself was intended as a charter for economic liberty … But that is not how it has always been read, still less applied’."
One of the key lessons from last week’s speech by Theresa May was that she wants to open up the UK and make free trade agreements with the rest of the world. The crucial bit here is “free trade.” What is it that Brexiteers think we have now? The logic of their argument is “leave the EU to get more free trade.” Our PM believes that she will get “a new, comprehensive, bold and ambitious free trade agreement” with the EU. But what if she doesn’t? The UK will then have walked out of the comfort of the Single Market in the hope of being able to get better deals elsewhere. As dumb economic gambles go, this one is up there.
Thatcher used a speech at Lancaster House in 1988 – ironically the same venue used by May – to make the point that the EU offers “A single market without barriers – visible or invisible – giving you direct and unhindered access to the purchasing power of over 300 million of the world's wealthiest and most prosperous people. ” Perhaps the EU did move too close to being the federalist state so opposed by many UK politicians. But I find it bizarre that a government which nominally extols the virtues of free trade should walk away from one of the world’s great free trade areas, in the pursuit of the chimera of better trade prospects elsewhere. And for what? Even Judas was rewarded with 30 pieces of silver.
Saturday 21 January 2017
Donald's rhetoric trumps rationality
I have no axe to grind regarding President Donald Trump. I
am not a fan but unlike the Brexit issue I have no skin in the game. So when I
say I don't like much of what I heard during Trump's inauguration speech, I say
it as an economist and a citizen of the world (which in Theresa May's eyes
makes me a citizen of nowhere).
I tuned in just as Trump got into full flow. But I shuddered at the passage which contained the phrases:
"We have defended other nations' borders while refusing to defend our own ... One by one, the factories shuttered and left our shores with not even a thought about the millions and millions of American workers that were left behind ... From this day forward, it's going to be only America first, America first ... Protection will lead to great prosperity and strength."
I am critical of British politicians who play the nationalist card and I am not impressed by leaders of other major nations who do the same. Imagine what the reaction in the British press would be if German politicians said similar things. But when an American president takes such a tack, we know that this could be very damaging to the world economic and political order upon which our prosperity has depended for so long.
As an economist, I question the notion that protectionism will make the US economy stronger. My immediate reaction was "has he learned nothing from long dead US politicians Smoot and Hawley?" Standard economics states that raising tariff barriers simply increases the costs to consumers who ultimately have to pay. It's the same reason I am so concerned that the UK will fail to get a deal with the EU and we have to fall back on WTO rules which raises the costs of most imports.
Yet there is an argument that this is conventional thinking and we should be approaching the problem differently. Indeed, a young journalist asked me this week if tariffs are such a bad thing. In effect, he was asking whether the pursuit of economic efficiency really is the be all and end all. Given the times in which we live, it is a question which deserves an answer. I suspect the answer lies in the extent to which they serve the national interest. The national interest in this case is not simply about the economic costs and benefits, because on these grounds there is no case. It is about taking back control – a slogan we heard so often during the Brexit referendum. Ironically, the message from Theresa May was that the UK wants more free trade, rather than less, which seems to contrast with the Trump view. Trump’s appeal is to those who believe that the pace of change has been too rapid, and my guess is that American voters might tolerate higher import tariffs for a while but ultimately realise they are economically self-defeating. But tariffs may simply have to be tried to remind a new generation of why the world has spent 70 years trying to reduce them.
Think of the US auto industry. The area around Detroit declined (as did the British Midlands) because the cars built there were more expensive and technologically inferior to those produced by the foreign competition. Domestic consumers took the view that they got better value for money by looking elsewhere. Imagine they didn't have that choice. Imagine that instead US workers continued producing cars and stayed put in Michigan. This would have reduced the internal migration of skilled workers, with the result that currently-dynamic urban areas would have grown more slowly and there would be fewer resources available to be allocated to higher value-added sectors such as tech or fracking. In short, there would have been less dynamism. If that is what the public wants, that is their choice. But as my friends on the other side of the Atlantic tell me, that is not the American way.
Then there is the problem of retaliation. If the US erects barriers, you can bet its trading partners will respond. American companies have pinned their hopes for many years on the Chinese market – whether those hopes have been realised is another matter. But they will be shut out of the world's most dynamic major market and will lose global market share as a consequence, especially if China were simultaneously to open up to the Europeans. And it is not as if the US does not have world class companies which compete globally. Microsoft, Apple, Google and Amazon have revolutionised the world, and did not arrive in their present incarnation behind tariff barriers. They depend on being able to sell around the world, and rely on global supply chains to stay competitive. Its global banks have survived the financial crisis in far better shape than their European counterparts and still play a huge role in the global financial architecture.
We should also not ignore the soft power which the US enjoys. Netflix is changing the way the world watches TV; Hollywood blockbusters are still the films most people talk about; its universities are ranked as amongst the best in the world. Moreover, the US issues the world's pre-eminent reserve currency. This should not be underestimated: Controlling access to dollar markets gives the US unprecedented economic and financial leverage.
All told, the US is in a far stronger position than Trump’s supporters believe. Admittedly, we no longer live in a world of unchallenged American power – the rise of China has seen to that. But the US has more to lose than gain if Trump really does set off down the protectionist path. We can only hope his team is less impulsive than he is.
I tuned in just as Trump got into full flow. But I shuddered at the passage which contained the phrases:
"We have defended other nations' borders while refusing to defend our own ... One by one, the factories shuttered and left our shores with not even a thought about the millions and millions of American workers that were left behind ... From this day forward, it's going to be only America first, America first ... Protection will lead to great prosperity and strength."
I am critical of British politicians who play the nationalist card and I am not impressed by leaders of other major nations who do the same. Imagine what the reaction in the British press would be if German politicians said similar things. But when an American president takes such a tack, we know that this could be very damaging to the world economic and political order upon which our prosperity has depended for so long.
As an economist, I question the notion that protectionism will make the US economy stronger. My immediate reaction was "has he learned nothing from long dead US politicians Smoot and Hawley?" Standard economics states that raising tariff barriers simply increases the costs to consumers who ultimately have to pay. It's the same reason I am so concerned that the UK will fail to get a deal with the EU and we have to fall back on WTO rules which raises the costs of most imports.
Yet there is an argument that this is conventional thinking and we should be approaching the problem differently. Indeed, a young journalist asked me this week if tariffs are such a bad thing. In effect, he was asking whether the pursuit of economic efficiency really is the be all and end all. Given the times in which we live, it is a question which deserves an answer. I suspect the answer lies in the extent to which they serve the national interest. The national interest in this case is not simply about the economic costs and benefits, because on these grounds there is no case. It is about taking back control – a slogan we heard so often during the Brexit referendum. Ironically, the message from Theresa May was that the UK wants more free trade, rather than less, which seems to contrast with the Trump view. Trump’s appeal is to those who believe that the pace of change has been too rapid, and my guess is that American voters might tolerate higher import tariffs for a while but ultimately realise they are economically self-defeating. But tariffs may simply have to be tried to remind a new generation of why the world has spent 70 years trying to reduce them.
Think of the US auto industry. The area around Detroit declined (as did the British Midlands) because the cars built there were more expensive and technologically inferior to those produced by the foreign competition. Domestic consumers took the view that they got better value for money by looking elsewhere. Imagine they didn't have that choice. Imagine that instead US workers continued producing cars and stayed put in Michigan. This would have reduced the internal migration of skilled workers, with the result that currently-dynamic urban areas would have grown more slowly and there would be fewer resources available to be allocated to higher value-added sectors such as tech or fracking. In short, there would have been less dynamism. If that is what the public wants, that is their choice. But as my friends on the other side of the Atlantic tell me, that is not the American way.
Then there is the problem of retaliation. If the US erects barriers, you can bet its trading partners will respond. American companies have pinned their hopes for many years on the Chinese market – whether those hopes have been realised is another matter. But they will be shut out of the world's most dynamic major market and will lose global market share as a consequence, especially if China were simultaneously to open up to the Europeans. And it is not as if the US does not have world class companies which compete globally. Microsoft, Apple, Google and Amazon have revolutionised the world, and did not arrive in their present incarnation behind tariff barriers. They depend on being able to sell around the world, and rely on global supply chains to stay competitive. Its global banks have survived the financial crisis in far better shape than their European counterparts and still play a huge role in the global financial architecture.
We should also not ignore the soft power which the US enjoys. Netflix is changing the way the world watches TV; Hollywood blockbusters are still the films most people talk about; its universities are ranked as amongst the best in the world. Moreover, the US issues the world's pre-eminent reserve currency. This should not be underestimated: Controlling access to dollar markets gives the US unprecedented economic and financial leverage.
All told, the US is in a far stronger position than Trump’s supporters believe. Admittedly, we no longer live in a world of unchallenged American power – the rise of China has seen to that. But the US has more to lose than gain if Trump really does set off down the protectionist path. We can only hope his team is less impulsive than he is.
Wednesday 18 January 2017
Is it just me?
Sometimes you just have to admit that you are out of tune
with the Zeitgeist. Having endured Theresa May’s speech yesterday when she set
out her vision for a post-Brexit Britain, it seems that there is little point
in engaging in rational debate. After all, nobody else seems to be interested.
Donald Trump won an election in this fashion; Boris Johnson went from being the
ex-Mayor of London to UK Foreign Secretary via a Brexit campaign and
Vladimir Putin invaded a sovereign state – the common denominator being that
all of them spun a web of lies and deceit in order to ensure that the debate
was conducted on their terms rather than the awkward reality which we used to
call facts. They say you can fool some of the people all of the time, and all of the
people some of the time. But in our post-truth world, it feels like mainstream politicians
are trying to fool all of the people all of the time.
When the PM opened yesterday’s speech with the line “A little over 6 months ago, the British people voted for change. They voted to shape a brighter future for our country. They voted to leave the European Union and embrace the world,” I had to pinch myself to ensure that I was not dreaming of the occasion when the electorate overwhelmingly rejected EU membership. When May noted that "after all the division and discord, the country is coming together," I wondered whether she had bothered to consult with Scottish MPs who clearly do not share the same desire to exit the EU.
As she went on to outline that one of the reasons why British citizens have a problem with EU bureaucracy is that “supranational institutions as strong as those created by the European Union sit very uneasily in relation to our political history and way of life,” I realised I had it all wrong. Clearly, the fact that the UK has one of the most centralised governments in Europe is a figment of my imagination. The European Economy Discussion Paper published by Charles Wyplosz in 2015 (here) citing research which showed that UK sub-central government spending as a share of total public outlays is (along with the Netherlands) the lowest in the EU, is obviously fake news.
And then it really went downhill. The UK government intends to leave the Single Market in an action which I can only describe as one of economic self-harm. But that’s OK because “we will take back control of our laws and bring an end to the jurisdiction of the European Court of Justice.” That would be the same ECJ which ruled in favour of the UK in 2012 when the ECB tried to ensure that the clearing of all euro denominated transactions should take place in the euro zone, rather than in the London financial market. May must have forgotten the court’s ruling that “the ECB lacks the competence necessary to regulate the activity of securities clearing systems as its competence is limited to payment systems alone.” A small oversight, I’m sure.
Moreover, the UK will obtain the benefit of being able to control immigration. Hoorah, I hear you cry. The woman who failed to control immigration when she was Home Secretary will be given the opportunity to do so at the expense of the UK’s economic self-interest. It is evident that the PM is happy to trade off access to the Single Market against the ability to control our borders. And if someone can enlighten me as to what the benefits of this are, please feel free to leave a comment.
As if this were not enough, the prime minister urged the EU to accommodate the UK’sdemands wishes
because not to do so would be “an act of
calamitous self-harm … Britain would not – indeed we could not – accept such an
approach. I am equally clear that no deal for Britain is better than a bad deal
for Britain.” This was translated by the headline in The Times this
morning as “Give us a fair deal or you’ll be crushed”, and by the Daily Mail as
“Steel of the new Iron Lady” as memories of the blessed Margaret were rekindled
(here if you must).
But as the eminently sensible Rachel Sylvester pointed out in The Times yesterday, May is looking at a still image of the EU when in reality it is a moving picture. She has “a two-dimensional view of the EU negotiations but she risks being skewered by her own inflexibility” as the debate regarding immigration changes across the continent. Sylvester also quoted one senior businessman who said, “They are living in a fool’s paradise. There’s still a belief that the Europeans will blink, that they need us more than they need them, and I don’t believe that for a second.”
I wrote in a note yesterday that May’s speech does not constitute a plan: It is a wish list. It is an opening gambit in a poker game where the UK does not hold many good cards. Worse, the hand is being played by a bunch of bluffers. When it comes to the crunch, the UK negotiating team will have to step up to the big league where they will learn when to fold and when to hold. Meantime, the economy (i.e. the voters) will pay the price for such arrogance. But what do I know? I am clearly thinking in the old ways and we should never let the facts get in the way of a good story.
When the PM opened yesterday’s speech with the line “A little over 6 months ago, the British people voted for change. They voted to shape a brighter future for our country. They voted to leave the European Union and embrace the world,” I had to pinch myself to ensure that I was not dreaming of the occasion when the electorate overwhelmingly rejected EU membership. When May noted that "after all the division and discord, the country is coming together," I wondered whether she had bothered to consult with Scottish MPs who clearly do not share the same desire to exit the EU.
As she went on to outline that one of the reasons why British citizens have a problem with EU bureaucracy is that “supranational institutions as strong as those created by the European Union sit very uneasily in relation to our political history and way of life,” I realised I had it all wrong. Clearly, the fact that the UK has one of the most centralised governments in Europe is a figment of my imagination. The European Economy Discussion Paper published by Charles Wyplosz in 2015 (here) citing research which showed that UK sub-central government spending as a share of total public outlays is (along with the Netherlands) the lowest in the EU, is obviously fake news.
And then it really went downhill. The UK government intends to leave the Single Market in an action which I can only describe as one of economic self-harm. But that’s OK because “we will take back control of our laws and bring an end to the jurisdiction of the European Court of Justice.” That would be the same ECJ which ruled in favour of the UK in 2012 when the ECB tried to ensure that the clearing of all euro denominated transactions should take place in the euro zone, rather than in the London financial market. May must have forgotten the court’s ruling that “the ECB lacks the competence necessary to regulate the activity of securities clearing systems as its competence is limited to payment systems alone.” A small oversight, I’m sure.
Moreover, the UK will obtain the benefit of being able to control immigration. Hoorah, I hear you cry. The woman who failed to control immigration when she was Home Secretary will be given the opportunity to do so at the expense of the UK’s economic self-interest. It is evident that the PM is happy to trade off access to the Single Market against the ability to control our borders. And if someone can enlighten me as to what the benefits of this are, please feel free to leave a comment.
As if this were not enough, the prime minister urged the EU to accommodate the UK’s
But as the eminently sensible Rachel Sylvester pointed out in The Times yesterday, May is looking at a still image of the EU when in reality it is a moving picture. She has “a two-dimensional view of the EU negotiations but she risks being skewered by her own inflexibility” as the debate regarding immigration changes across the continent. Sylvester also quoted one senior businessman who said, “They are living in a fool’s paradise. There’s still a belief that the Europeans will blink, that they need us more than they need them, and I don’t believe that for a second.”
I wrote in a note yesterday that May’s speech does not constitute a plan: It is a wish list. It is an opening gambit in a poker game where the UK does not hold many good cards. Worse, the hand is being played by a bunch of bluffers. When it comes to the crunch, the UK negotiating team will have to step up to the big league where they will learn when to fold and when to hold. Meantime, the economy (i.e. the voters) will pay the price for such arrogance. But what do I know? I am clearly thinking in the old ways and we should never let the facts get in the way of a good story.
Monday 16 January 2017
Mad world
Ahead of Theresa May’s long-awaited speech outlining the
nature of the Brexit deal which the UK government wants, the past few days have
seen a certain amount of poker playing. I was somewhat discomfited by remarks
by Chancellor Philip Hammond to the German press over the weekend, who suggested
to Welt am Sonntag that although “most of
us who had voted remain would like the UK to remain a recognisably
European-style economy with European-style taxation systems, European-style
regulation systems etc … if we are
forced to be something different, then we will have to become something
different.”
In response to a request to clarify his remarks, he noted “we could be forced to change our economic model, and we will have to change our model to regain competitiveness. And you can be sure we will do whatever we have to do. The British people are not going to lie down and say ‘too bad, we’ve been wounded’. We will change our model and we will come back, and we will be competitively engaged.”
That sounds like a threat to engage in tax competition with the EU in the event that the UK does not get the deal it wants. I know I should not be surprised by chancellors who demonstrate their economic illiteracy in public – he would not be the first after all – but this argument does not work on so many levels. First, days ahead of Theresa May’s speech, it does not strike me as a sensible policy to antagonise one of the key negotiating partners, let alone one whom the British government hopes will be sympathetic to its aims. Not surprisingly, EU politicians did not react very favourably. The new Dutch Labour party leader, Lodewijk Asscher, has already suggested that The Netherlands will block any EU trade deal with the UK unless it signs up to tough tax avoidance regulations preventing it from becoming an attractive offshore haven for multinationals.
What I found particularly interesting, however, were the below the line comments from German online newspaper readers who offered a more balanced view of the pros and cons of the Brexit debate than I get from most British newspapers. At the risk of over-simplifying the views, there is a large constituency which understands why the Brits have had enough yet also believes that the UK government is behaving irrationally. And there is also a large group which says “go if you must. It’s a pity but that is your choice and you will have to live with the consequences.”
From a domestic British perspective, Hammond’s comments make little sense. For one thing, UK policy over the past seven years has been to eliminate the fiscal deficit. Further cutting taxes is not exactly a clever way to further that aim. Moreover, the average working man (and woman) will not benefit from lower taxes. Hammond is talking about cutting corporate taxes. Reducing the tax burden on corporates – precisely the group which has been in the firing line in recent years for not paying their share of tax – does not sound as though the will of the people is being taken into account on this issue. Indeed, to the extent that at least part of the Brexit vote was triggered as a reaction to the impact of globalisation on UK regions outside the south east, a policy of attracting footloose international capital means more rather than less dependence on globalisation.
Unless the government is simply prepared to ignore the domestic fiscal constraint, cutting corporate taxes means either taxes will have to rise in other areas, or spending will have to be reduced further. And this at a time when the National Health Service is widely reported as creaking at the seams due to an ageing population, which will require additional resources to be spent simply to maintain the current level of service. We all know by now that we cannot expect Scandinavian-style public services if we are prepared only to pay US tax rates. But Hammond has simply taken a leaf out of his predecessor’s book by claiming that what the UK needs is more of the Thatcherite medicine which involves cutting taxes, public services and privatising state resources. However, as with any medicine, the more you take, the more it loses its potency. I would very much like to see some alternative policy prescriptions.
And as if matters were not bad enough, the UK’s Brexit vote has been endorsed by none other than Donald Trump – the model of policy consistency destined to end the week as US President. If Trump does what he says and cuts the UK some slack in getting a trade deal with the US, it would be a step forward. But given his problems with NAFTA, which is of great benefit to US manufacturers, why should he care about the UK?
To quote the Tears for Fears song, “I find it kinda funny, I find it kinda sad/ The dreams in which I'm dying are the best I've ever had/ I find it hard to tell you, I find it hard to take/ When people run in circles it's a very very/ Mad world”
In response to a request to clarify his remarks, he noted “we could be forced to change our economic model, and we will have to change our model to regain competitiveness. And you can be sure we will do whatever we have to do. The British people are not going to lie down and say ‘too bad, we’ve been wounded’. We will change our model and we will come back, and we will be competitively engaged.”
That sounds like a threat to engage in tax competition with the EU in the event that the UK does not get the deal it wants. I know I should not be surprised by chancellors who demonstrate their economic illiteracy in public – he would not be the first after all – but this argument does not work on so many levels. First, days ahead of Theresa May’s speech, it does not strike me as a sensible policy to antagonise one of the key negotiating partners, let alone one whom the British government hopes will be sympathetic to its aims. Not surprisingly, EU politicians did not react very favourably. The new Dutch Labour party leader, Lodewijk Asscher, has already suggested that The Netherlands will block any EU trade deal with the UK unless it signs up to tough tax avoidance regulations preventing it from becoming an attractive offshore haven for multinationals.
What I found particularly interesting, however, were the below the line comments from German online newspaper readers who offered a more balanced view of the pros and cons of the Brexit debate than I get from most British newspapers. At the risk of over-simplifying the views, there is a large constituency which understands why the Brits have had enough yet also believes that the UK government is behaving irrationally. And there is also a large group which says “go if you must. It’s a pity but that is your choice and you will have to live with the consequences.”
From a domestic British perspective, Hammond’s comments make little sense. For one thing, UK policy over the past seven years has been to eliminate the fiscal deficit. Further cutting taxes is not exactly a clever way to further that aim. Moreover, the average working man (and woman) will not benefit from lower taxes. Hammond is talking about cutting corporate taxes. Reducing the tax burden on corporates – precisely the group which has been in the firing line in recent years for not paying their share of tax – does not sound as though the will of the people is being taken into account on this issue. Indeed, to the extent that at least part of the Brexit vote was triggered as a reaction to the impact of globalisation on UK regions outside the south east, a policy of attracting footloose international capital means more rather than less dependence on globalisation.
Unless the government is simply prepared to ignore the domestic fiscal constraint, cutting corporate taxes means either taxes will have to rise in other areas, or spending will have to be reduced further. And this at a time when the National Health Service is widely reported as creaking at the seams due to an ageing population, which will require additional resources to be spent simply to maintain the current level of service. We all know by now that we cannot expect Scandinavian-style public services if we are prepared only to pay US tax rates. But Hammond has simply taken a leaf out of his predecessor’s book by claiming that what the UK needs is more of the Thatcherite medicine which involves cutting taxes, public services and privatising state resources. However, as with any medicine, the more you take, the more it loses its potency. I would very much like to see some alternative policy prescriptions.
And as if matters were not bad enough, the UK’s Brexit vote has been endorsed by none other than Donald Trump – the model of policy consistency destined to end the week as US President. If Trump does what he says and cuts the UK some slack in getting a trade deal with the US, it would be a step forward. But given his problems with NAFTA, which is of great benefit to US manufacturers, why should he care about the UK?
To quote the Tears for Fears song, “I find it kinda funny, I find it kinda sad/ The dreams in which I'm dying are the best I've ever had/ I find it hard to tell you, I find it hard to take/ When people run in circles it's a very very/ Mad world”
Sunday 15 January 2017
Crisis? What crisis?
David Miles, former Bank of England MPC member and now
professor of economics at Imperial College, this week issued a clear rebuttal (here)
of Andy Haldane’s charge that economics is in “crisis” (here).
Miles makes the point very bluntly: “If
existing economic theory told us that such events should be predictable, then
maybe there is a crisis. But it is obvious that economics says no such thing … In
fact, to the extent that economics says anything about the timing of such
events it is that they are virtually impossible to predict; impossible to
predict, but most definitely not impossible events.”
He then goes on to point out that basic economics, in which organisations act in their own best interests, explained perfectly well why the financial crisis happened. In a world in which banks knew that they would face only a limited liability for the losses they created, and where the tax system favoured debt over equity, they had every incentive to increase their leverage. He also reminded us that there is a whole literature on market failure and that economists have won the highest academic honours for “exploring the ways in which free market outcomes can sometimes generate poor results.”
Indeed, when you think about it, the record of economists in predicting economic shocks is no worse than that of seismologists in predicting earthquakes. There are various warning indicators which signal that an earthquake may be imminent but scientists cannot pinpoint accurately when they will happen, and certainly not months or years in advance. Or, as Miles put it, “any criticism of “economics” that rests on its failure to predict the crisis is no more plausible than the idea that statistical theory needs to be rewritten because mathematicians have a poor record at predicting winning lottery ticket numbers.”
As I have noted on numerous previous occasions, economics is not a predictive discipline so we are forced to do the best we can in order to meet the demand for predictions of future economic activity. And unfortunately, despite the best efforts of former UK Chancellor Gordon Brown to abolish boom and bust, we are faced with the problem of simultaneously trying to predict the amplitude and frequency of an economic cycle which is not regular. It can shift abruptly, which leads to structural breaks in our model-based forecasts. If there is a “crisis” in economics it is that too much mainstream policy analysis focuses on the central case outcome, which becomes a binary choice as to whether the forecast in question was attained. This raises a question of whether a forecast for 2% GDP growth in any given year is “wrong” if it turns out to be 2.2%. It is a pointless exercise to strive for that sort of precision, which raises the question of how far away we are allowed to be from the central case before our prediction is deemed “wrong”.
In fairness the likes of the BoE have long maintained that it is the distribution of risks around the central case which is important (and many others are now catching on). By defining the probability distribution around the central case we then have some idea of the plausible range of outcomes. But we have to accept that economics cannot predict the point at which the steady state switches from one condition to another, in much the same way that quantum physicists cannot determine with any precision the degree to which certain pairs of physical properties of a particle can be known. In other words, we cannot forecast structural shifts.
But one of the things that economics can do is to figure out how behaviour will change once the structural shift has occurred. Forecasters may not have incorporated the crash of 2008 into their central case (I will expound on some of the reasons why on another occasion) but expectations adjusted quite quickly thereafter. It was treated as a structural break with profound consequences for near-term growth, and consensus GDP growth numbers were revised down sharply thereafter, as indeed were expectations for central bank policy rates. Seismologists may not always be able to predict when the earthquake will strike but they know what the consequences will be when they do
He then goes on to point out that basic economics, in which organisations act in their own best interests, explained perfectly well why the financial crisis happened. In a world in which banks knew that they would face only a limited liability for the losses they created, and where the tax system favoured debt over equity, they had every incentive to increase their leverage. He also reminded us that there is a whole literature on market failure and that economists have won the highest academic honours for “exploring the ways in which free market outcomes can sometimes generate poor results.”
Indeed, when you think about it, the record of economists in predicting economic shocks is no worse than that of seismologists in predicting earthquakes. There are various warning indicators which signal that an earthquake may be imminent but scientists cannot pinpoint accurately when they will happen, and certainly not months or years in advance. Or, as Miles put it, “any criticism of “economics” that rests on its failure to predict the crisis is no more plausible than the idea that statistical theory needs to be rewritten because mathematicians have a poor record at predicting winning lottery ticket numbers.”
As I have noted on numerous previous occasions, economics is not a predictive discipline so we are forced to do the best we can in order to meet the demand for predictions of future economic activity. And unfortunately, despite the best efforts of former UK Chancellor Gordon Brown to abolish boom and bust, we are faced with the problem of simultaneously trying to predict the amplitude and frequency of an economic cycle which is not regular. It can shift abruptly, which leads to structural breaks in our model-based forecasts. If there is a “crisis” in economics it is that too much mainstream policy analysis focuses on the central case outcome, which becomes a binary choice as to whether the forecast in question was attained. This raises a question of whether a forecast for 2% GDP growth in any given year is “wrong” if it turns out to be 2.2%. It is a pointless exercise to strive for that sort of precision, which raises the question of how far away we are allowed to be from the central case before our prediction is deemed “wrong”.
In fairness the likes of the BoE have long maintained that it is the distribution of risks around the central case which is important (and many others are now catching on). By defining the probability distribution around the central case we then have some idea of the plausible range of outcomes. But we have to accept that economics cannot predict the point at which the steady state switches from one condition to another, in much the same way that quantum physicists cannot determine with any precision the degree to which certain pairs of physical properties of a particle can be known. In other words, we cannot forecast structural shifts.
But one of the things that economics can do is to figure out how behaviour will change once the structural shift has occurred. Forecasters may not have incorporated the crash of 2008 into their central case (I will expound on some of the reasons why on another occasion) but expectations adjusted quite quickly thereafter. It was treated as a structural break with profound consequences for near-term growth, and consensus GDP growth numbers were revised down sharply thereafter, as indeed were expectations for central bank policy rates. Seismologists may not always be able to predict when the earthquake will strike but they know what the consequences will be when they do
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