I robot, you taxman

When in 1940 Isaac Asimov wrote the first in a collection of stories which was later published as “I, Robot” he could barely have dreamed how far we would advance in the subsequent decades. One of the biggest economic and social challenges of the coming years will be how to deal with the rapid surge in automation which threatens to destroy jobs on an unprecedented scale. Will we find alternative means of employment? Or will we be cast aside as the second machine age (as Brynjolfsson and McCaffee so memorably called it) gains pace?

I have long been fascinated by the application of computers to automate routine tasks and recall a lecture I attended more than 30 years ago when I was introduced to the concept of artificial intelligence. AI had first surfaced in the 1950s when computer applications were developed which could perform fairly routine tasks very well – and indeed, in some cases better than humans. But the difficulties in getting computers to think and act like humans had been underestimated and by the mid-1970s interest started to languish. By the time I became acquainted with the subject, interest had been rekindled by so-called expert systems which utilised programs based on ‘if-then’ rules rather than highly structured procedural programming. A new wave of AI was kicked off in the 1990s by improvements in computing power and advances in deep learning technology, which is a statistical technique designed to allow systems to learn from observational data. By 1997, the world chess champion, Garry Kasparov, was being beaten by a machine and by 2011 IBM’s Watson computer was able to beat human contestants in the TV general knowledge quiz Jeopardy!

There are a number of different strands to the technological revolution incorporating software and hardware innovations which have fuelled concerns that many of us will be replaced by a machine in the not-too-distant future. Indeed, much of the talk today is of how far technology will advance in the coming years with apparently simple skills such as driving now able to be replicated with a high degree of accuracy by machines, That said, a reasonable degree of accuracy is not yet good enough – machines will have to do as well as, or better than, humans in order to displace them. But with 3.5 million people in the US alone employed driving trucks, that is a lot of workers who could potentially be displaced. It is against this backdrop that Bill Gates recently suggested that a tax should be levied on robots in order to safeguard the jobs of humans.

One of the motivating notions behind the idea is that those with access to capital, who employ robots in the first place, would be enriched at the expense of those whose jobs are displaced. The idea is thus to levy a tax in order to reduce inequality. Another motivation is that since it takes decades for the full impact of a major technological revolution to work through, the imposition of a tax will slow the widespread adoption of automation rather than stop it in its tracks, thus giving the workforce time to adjust.

Whilst these are laudable aims, there are serious difficulties involved in imposing a robot tax. The most obvious problem is that it impedes innovation. Imagine where we would be today if the automobile had been taxed to the hilt in order to preserve the jobs of horse carriage drivers. But the sheer range of jobs which can be automated suggests that new technology threatens to displace workers not seen on a scale since the start of the industrial revolution – and even then, displaced agriculture workers were able to find jobs in the rapidly growing urban areas. A bigger problem is that it is difficult to differentiate between technologies that substitute for labour and those which complement it. The introduction of the personal computer in the 1980s had a dramatic impact on the world of work but this has not prevented the numbers of people in employment in the US and UK reaching record highs. A combination of human effort and new technology has facilitated a whole new range of jobs that were previously unimaginable.

So if taxing robots is not necessarily practical, is there anything else we could do? The blogger and economist Noah Smith suggests introducing a wage subsidy for low-paid workers – perhaps by cutting payroll taxes – which will raise the cost advantages of human labour versus capital. Another suggestion might be to distribute capital income more widely by using tax revenue to buy assets (real and/or financial) and distribute the profits to the wider population. The idea is that this gives citizens a stake in society and allows them to share in the profits generated by the new robot labour force.

Although this idea may be anathema to those who believe in ever smaller government, and that the displaced will have to find new ways to compete in a new technological world, the reality is that the pace of change may be too rapid for many. Indeed, unless we start to think about ways to cope with the problem today, modern industrial societies could be overtaken by events. And if we think people are dissatisfied today, wait until they are replaced by machines, with no hope of finding a new job. It could make the Trump/Brexit revolution seem like a picnic.

Taking Europe's temperature

For all that many of the claims made by the UK Brexiteers are absurd, there is a rising tide of dissatisfaction across the whole of Europe towards the EU. This is a danger of which politicians and bureaucrats in Brussels must surely be aware. After all, the evidence comes from the European Commission’s own Eurobarometer survey. The survey, which is conducted biannually, has shown that since late-2011 more than 50% of respondents have registered a lack of trust in the EU whereas prior to the onset of the financial crisis in 2008, distrust levels were running at significantly less than 40%.

Ironically, there are seven countries above the UK in the latest Eurobarometer survey indicating high levels of EU distrust. Perhaps not surprisingly Greece tops the list with 78% of respondents expressing dissatisfaction. Worryingly, given the proximity of the French presidential election, France is in third place with 65% whilst Italy is sixth at 58%. The UK’s 56% dissatisfaction reading is only slightly ahead of Germany (53.2%) which also happens to be around the EU average (53.9%).

However, it is one thing to be dissatisfied with the status quo – it is another thing for voters to opt for departure as has happened in the UK. In a bid to assess the degree of Euroscepticism, perhaps we ought to pay closer attention to the degree of optimism shown by voters towards the future of the EU, on the basis that those who are the most pessimistic are the most likely to want to leave. Here, the picture is slightly different. On the whole, EU citizens show a moderate balance of net optimists (53%, if we exclude those expressing no opinion). But again, Greek citizens show the greatest degree of hostility with only 32% recording optimism regarding the future, whilst the French are in third place (42%) with the Brits fourth (44%).

On the basis that French optimism levels were lower than those of the UK even before the Brexit vote, this suggests that we should take the threat of Marine Le Pen more seriously than we are today. Although the generally accepted view is that Le Pen has no chance of winning the second round, there is a danger that too many pundits are looking back at 2002 and arguing that a coalition will form to stop the Front National (FN) winning the presidency at any cost – just as happened to her father. This view, which is expressed both in France and abroad, might be a touch complacent. Marine Le Pen is not the antagonistic figure that her father was (indeed, still is even in his eighties). If Le Pen continues to hammer home the message that the EU is the root cause of many of France’s ills, she may well run her challenger far closer than the expected 60-40 defeat that the polls currently predict. This is not to say she will win, but if the result is a close run thing, it does suggest that the FN is likely to be a force to be reckoned with in the years to come and that their popularity may not necessarily peak in 2017.

In any case, what has changed since 2002 is that immigration policy is far higher on the list of voter concerns than it was 15 years ago. The Eurobarometer survey indicates that at the EU level it is far and away the biggest concern, followed by terrorism issues, whilst the economic situation trails in a poor third. French voters apparently believe that unemployment is the biggest single domestic issue with immigration some way behind. If the FN manages to convince voters that the EU is partially responsible for the lack of jobs, it will only bolster their standing in the polls.

What is perhaps most concerning for politicians across the continent is that the degree of dissatisfaction which began to take hold in 2008 is gaining momentum. There is little doubt that the economic crisis of 2008, which morphed into a full-blown Greek debt crisis in 2010, has been badly handled. Greek voters are resentful that they have been forced to accept austerity whilst voters in other EMU countries are less than keen to continue providing support. The apparent inability of the EU to defend its borders, with the result that huge numbers of immigrants from the Middle East and North Africa have entered Europe, has also caused resentment. The German government’s policy of throwing open its doors in 2015 is widely perceived to have exacerbated the problem because it has raised tensions in other countries on the transit route that were not consulted.

All this is happening at a time when Europe lacks leaders unable to sell a vision of what the EU can achieve. At least in the days of Kohl and Mitterrand we knew the direction in which Europe was travelling even if not everyone agreed. Without strong leadership, the EU as we know it is doomed – at best to irrelevance, at worst to further fragmentation. The Eurobarometer surveys make it clear what EU citizens are concerned about. But is anyone in Brussels listening?

Brexit: The cost of divorce

One of the motivations advanced by Brexit supporters for the UK to leave the EU is that it will be able to save billions of pounds each year in budget contributions which can be put to more profitable use at home. But it is becoming increasingly clear that the UK will not be able to reduce its EU budget contributions as quickly as many Brexiteers believe. Indeed, it is increasingly likely that the EU negotiating team will announce that settling the UK’s account will be the key item on the EU’s list of negotiating points once the Article 50 legislation is triggered. Moreover, it may decide that it will not discuss matters such as trading arrangements, which is the UK’s number one priority, until agreement on this issue has been reached. I can imagine the spluttering outrage from the UK press already.

Various estimates have been bandied about but the consensus is increasingly homing in on a range between €40bn and €60bn, which equates to around 4 to 6 years of current net contributions. In order to understand where this figure comes from, I am indebted to a paper (here) by the FT’s Alex Barker, which breaks the costs down into their constituent parts.

According to Barker, the UK’s obligations can be broken down into three main areas: legally binding contributions to which Britain has already signed up; pension contributions and contingent liabilities that would only become payable in certain circumstances. It is far from clear of the extent to which the UK will actually be liable for financial contributions after departure. Some form of agreement is likely on areas such as project commitments which have been made but not yet paid for. But a considerable chunk of the EU’s outlays form cohesion payments designed to reduce regional income inequalities, which have so far only been promised and will not become budget commitments until the 2020s.

Barker makes a very insightful observation when he notes that the EU’s budget differs hugely from the system of accounting used in UK public finance discussions. The EU splits its accounts into commitments and payments, in which the former measures what the EU plans to spend on a particular project whilst the latter represents what it actually pays in a given period. This is a political workaround to balance out what the EU wants to spend against what its members are willing to pay. By contrast, the UK operates on an accruals basis whereby payments appear on the budget only when they are actually made, and future plans only include what the government actually intends to commit. Under the British system, the government cannot commit to paying something which is not already budgeted for. The balance between actual and planned commitments on the EU budget is expected to reach €241bn by 2018, of which the UK’s share would be €29-36bn according to Barker’s calculations.

The next biggest item on the agenda is existing structural fund commitments. These appear as a liability on the EU accounts which in Brussels’ view must be paid. By end-2018, the EU’s commitments are expected to total €143bn, of which the UK will be on the hook for between €17 and €22bn. It is unlikely that the UK will be able to dodge much of this bill. But the most contentious part of the exit bill will undoubtedly be pension payments to EU officials. The EU operates an unfunded defined benefits scheme with liabilities of almost €64bn. Barker quotes Eurostat calculations which suggests that “in 2014, the average retirement benefit was €67,149 a year” which is a very comfortable sum. Whilst the UK might offer to cover the pension costs of British nationals working for EU institutions, the Commission will almost certainly argue that officials of all nationalities worked on behalf of all EU members. As a consequence, the UK will be liable for a pension bill of between €7.5bn and €9.5bn.

Allowing for other small liabilities, and the offsetting impact of the UK’s share of EU assets, we arrive at the likely bill of between €40bn and €60bn. Barker’s paper outlines the legal issues in some detail and interested readers are advised to have a look. In summary, the UK is likely to argue that it cannot be held liable for unfunded commitments if the EU chose to live beyond its budgetary means, and thus should not be required to pay for the gap between commitments and payments. However, it has always struck me as odd that the UK argued that the “international law principle of equitable division” would be applied in the event that Scotland voted to leave the Union in 2014 whereas today it is trying to get away with paying as little as possible.

Whilst the question of the Brexit bill is a matter for negotiators (not to mention accountants and lawyers), the British public has not yet been made aware of the fact that it will have to pay a hefty price to leave. It is not as simple as ceasing payments upon exit as we enter a land of milk and honey. Apparently, around 42% of marriages in the UK end in divorce. Every one of those people knows that aside from the emotional issues involved, there is a hard reckoning to be had as assets and liabilities are divided up. This is exactly what will be involved in the Brexit negotiations. They did not tell us anything about this during the referendum campaign, but watch out for a press backlash coming to a tabloid near you as we discover that divorce is costly, protracted and often bitter.

Rationality, not greed, trumps fear

The evidence of recent days suggests that financial investors are more inclined to take the risk of investing in emerging markets rather than the developed world. It is not exactly a new phenomenon: After all, the hunt for yield has been a recurrent theme of financial investing for much of the past eight years. But what is different today is that the EM universe is less stable than it was once perceived to be.

Non-agricultural commodity producers have suffered badly as the price boom of recent years appears to have come to an end. The election of President Trump, which threatens a round of US protectionism, will do nothing to help countries which depend on exporting to the west. Rising US interest rates, and the upward pressure this will impose on the dollar vis-à-vis EM currencies, will raise debt servicing costs. Moreover, the impact of rapid growth in raising wages in many EMs has reduced their competitive advantage at a time when many companies are looking to shorten their global supply chains. 

The travails of the BRICS countries are symbolic of all that has changed in recent years. Brazil has laboured under the burden of a corruption scandal that has seen the president replaced and the economy fall into recession. Russia suffers from sanctions imposed in the wake of the Crimea incursion – an event which has been exacerbated by the decline in energy prices. India is the one exception to the general trend, although even here the strange decision to demonetise large parts of the economy points to a government capable of following economically harmful policies which will impact on growth this year. Chinese growth has slowed sharply, although the much-feared boom and bust is not immediately apparent. 

Meanwhile South Africa – which does not deserve to be mentioned in the same league as the other BRICS countries – is being hammered by falling commodity prices and exceptional economic mismanagement. We can also add in Turkey for good measure, another market previously viewed positively by investors, which has undergone radical political change since last year’s coup attempt and where the government’s exertion of even more pressure on a nominally independent central bank has done nothing to support investor confidence. 

Faced with all of these problems, why are investors even contemplating going back to these markets? First of all, many EMs are cheap following the sharp collapse in key emerging currencies in the wake of the 2013 taper tantrum, so it is still possible to find value if investors are prepared to take the risk. But perhaps what has prompted investors to look further afield is the fact that the stability which traditionally favoured developed markets is being eroded by the rise of populist politics. The unity of the EU is threatened by Brexit, and faced with a lack of returns and mounting political uncertainty in continental Europe, it may pay to look beyond the safe haven trade for the time being. Indeed, the Trump rhetoric has not proven to be as damaging to EMs as was feared in November. It may yet prove to be the case, in which case fund flows will reverse, but there is simply no point in hanging around waiting for an event which may take years to materialise – if indeed it does so at all.

But perhaps the crucial point is that there appears to be evidence that growth in EM economies is beginning to pick up. The Institute for International Finance last week reported that its EM growth tracker in January pointed to the fastest rate of monthly activity growth since June 2011. As emerging markets increasingly become bigger consumers rather than simply exporters of low cost goods to the west, they will continue to gain in importance.

A report published a couple of years ago by PwC (here) highlighted that current trends in demographics, capital investment, education levels and technological progress suggest that by 2050, seven of the world’s top 10 economies will be what we currently describe as emerging economies. According to the report, those with the greatest growth potential are those with demographics on their side. Thus, India is projected to grow by an average of 5% per annum between 2014 and 2050 to propel it to second place in the global standings on a PPP-adjusted basis whilst Nigeria can grow at a rate of 5.5% per year to take it into the world top 10. We should always take such projections with a grain of salt, but they do make the point that there is a huge degree of untapped potential in many of these countries: population size alone suggests that Indonesia, Nigeria and even Pakistan have the potential to become significant economies.

What all economies require to grow rapidly, however, is institutional stability. If they cannot achieve stable government, many of the big EM economies will remain stuck in low gear. But whilst in the next few years we may not see the stellar growth across the EM universe which characterised the period 2002-2012, these economies continue to offer great catch-up potential. Investors ignore them at their peril.

Blair's Brexit beef

Yesterday’s intervention by former PM Tony Blair (here for full speech) calling for a rethink of the Brexit decision was both spot on and deeply troubling. On the one hand he perfectly nailed the hypocrisy of the case for leaving the EU – like Nick Clegg, I agreed with every single word – and calls for “a time to rise up in defence of what we believe”. Yet this was the same prime minister who failed to listen to the majority of the people when involving Britain in a highly unpopular war in Iraq. It also starkly highlights the lack of opposition to a government which appears bent on “Brexit at any cost”, as the party he used to lead slavishly follows the Conservatives in ramming through Article 50 (we can debate that another time). Yet it is somewhat troubling to hear a politician who was criticised for being part of the metropolitan elite arguing against the “will of the people.” I am reluctantly forced to concede that although his message is the right one, Blair is not the right man to deliver it and as a consequence it will not be heard.

Looking through the speech, there is nothing there that I have not pointed out over the past four years. But it is worthwhile quoting Blair who noted, “What was unfortunately only dim in our sight before the referendum is now in plain sight. The road we’re going down is not simply Hard Brexit. It is Brexit At Any Cost … How hideously, in this debate, is the mantle of patriotism abused … nine months ago both she [the PM] and the Chancellor, were telling us that leaving would be bad for the country, its economy, its security and its place in the world.  Today it is apparently a ‘once in a generation opportunity’ for greatness. Seven months ago, after the referendum result, the Chancellor was telling us that leaving the Single Market would be – and I quote – ‘catastrophic’. Now it appears we will leave the Single Market and the Customs Union and he is very optimistic.” 

He went on to point out that “This jumble of contradictions shows that the PM and the Government are not masters of this situation. They’re not driving this bus. They’re being driven …  We will trigger Article 50 not because we now know our destination, but because the politics of not doing so, would alienate those driving the bus. Many of the main themes of the Brexit campaign barely survived the first weekend after the vote. Remember the £350m a week extra for the NHS?” 

On the substantive issue of immigration, Blair pointed out “of the EU immigrants, the PM has recently admitted we would want to keep the majority, including those with a confirmed job offer and students. This leaves around 80,000 who come looking for work without a job. Of these 80,000, a third comes to London, mostly ending up working in the food processing and hospitality sectors. It is highly unlikely that they’re ‘taking’ the jobs of British born people in other parts of the country.”

Predictably, Blair’s comments were met with opprobrium from large sections of the press and from pro-Brexit MPs, with the lovable Iain Duncan Smith telling Sky News that "He seems to have forgotten what democracy is about. Democracy is about asking people a question and then acting on it.” Personally, I always thought it was about rational debate and respecting the fact that other people are allowed to hold different opinions, whilst being free to change one’s mind. But the frothing-at-the-mouth brigade doesn’t do rationality. Clearly, I am a fake news dupe!

The Frankfurter Allgemeine Zeitung also called it right in an article published yesterday: “In Great Britain, an era is coming to an end: 38 years characterised by a firm belief in liberalism and an open market economy, which began on 4 May 1979 when Margaret Thatcher moved into Downing Street ended – as it is becoming ever more clear – on 23 June 2016.” The article went on to say that although Theresa May is less alarming than Donald Trump, her economic programme is equally contradictory. “Her free-market rhetoric sounds hollow. It is not convincing when she praises economic openness and globalization as Britain's future and at the same time laments the openness of the British labour market.”

Two days before the House of Lords is due to reconvene to debate the Article 50 bill that was supported in parliament by an opposition whose MPs are more concerned about keeping their seats than debating the national interest, we should not pin our hopes on major changes. The most tragic thing about the whole affair is that EU membership is being used as the scapegoat for decades of policy failures by governments of all hues, in much the same way as traditional American values of decency and tolerance have been subverted by rage against the status quo. It is nothing short of a revolution.

But revolutions succeed or fail depending on the extent to which a coalition of interest groups is able to come together “including elite groups and the middle class[1].” For example, the Iranian revolution of 1979 succeeded in overthrowing the government but set the country’s progress back years as the educated middle class left in droves. In the UK debate, large swathes of the popular press are in favour of Brexit, which is an important constituent. But their support can be fickle. Business generally does not support it, and the much-despised “elite” is not onside, so there is no sense of a broad coalition forming in the UK. It is going to be a bumpy ride, and much as Iain Duncan Smith, Nigel Farage et al might wish for it, people are not simply going to shut up and accept the result.

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[1] Dix(1984) ‘Why Revolutions Succeed & Fail’, Polity, Vol 16,  pp. 423-446

Keep the hands off the stash

They say that we live in a cashless society. The same cannot be said for India. On 8 November, the prime minister gave just four hours’ notice that 500 and 1,000 rupee notes would no longer be legal tender. People were told they could deposit or exchange their old notes at banks until 30 December, and new 500 and 2,000 rupee notes would be issued. This dramatic move was designed to flush shadow economy transactions out into the open in a bid to curb tax evasion. Given that these notes made up 86% of all cash in circulation, this has clearly led to more short-term disruption than necessary.

Official figures from the Reserve Bank of India suggest that as of January, currency in circulation with the public was almost 43% below year-ago levels. This does not bode well for overall economic growth: The IMF has lopped one percentage point off its 2017 growth projection, with the October forecast of 7.6% having been recently downgraded to 6.6%. According to the IMF, the disruptions which forced people to queue outside banks to exchange their notes and the simple shortage of cash resulting from the switchover, will curb consumption in the early part of 2017. It is fairly certain that activity will subsequently recover and before too long India will be able to regain its crown as the “fastest growing major economy” (it might still hold onto this position, depending on what happens in China in 2017). Nonetheless, the episode highlights how an apparently capricious decision of this nature can have far reaching consequences.

One of the prerequisites of money in a modern economy is that it acts as a stable source of value and medium of exchange. At a stroke the Indian government wiped out the cash holdings of those citizens who had not deposited their money in the bank, and in the process has done nothing to win the trust of those who have been disadvantaged. A bigger issue is that if we erode trust in money, we potentially erode wider trust in institutions.

In Europe, for example, the ECB has faced a battle to establish its credibility, particularly in Germany where it replaced the much-revered Bundesbank. As former European Commission president Jacques Delors pithily remarked in 1992: “Not all Germans believe in God, but they all believe in the Bundesbank.” Many people in Germany today have a problem with the monetary policy which the ECB is conducting because they see a huge explosion in the stock of money created by the central bank which they fear will ultimately lead to higher inflation. Whether they are right or wrong, only time will tell. But it is important for the ECB to win the credibility battle today or it may not survive long enough to say ‘we told you so’.

As it happens, there is a strong case for suggesting that if governments are serious about reducing the scope of the shadow economy, maybe they should withdraw all high value notes from circulation. To the extent that it is pretty easy to transport large quantities of cash in 1,000 Swiss franc notes or the 500 euro note without carrying a huge volume, the authorities are concerned about their use in illegal transactions. As a neat little paper by Peter Sands points out (here), the equivalent of one million dollars  in cash weighs just 2.2 kg in the highest denomination euro note whereas it weighs 10kg in the highest denomination  US dollar bills. Precisely for this reason, the ECB is to stop issuing the 500 euro note next year.

But in contrast to the ECB, which has given plenty of warning, the Indian authorities gave virtually none. As a way to crack down on the shadow economy and other avoiders of tax, it may well be highly effective. But if it leads to a sharp decline in economic activity with consequences for tax revenue, it may turn out to be counterproductive. Moreover, the government rather strangely decided to phase out the 1,000 rupee note and replace it with a 2,000 rupee note. It is not exactly what the authorities elsewhere would advocate in the fight against shadow activity. But given recent experience, those who might be tempted to hold any of their untaxed income in rupees in future may think again. It will thus be interesting to see whether it ultimately boosts demand for gold – the ultimate safe haven during times of uncertainty.

Paying the price for good health

The Institute for Fiscal Studies released its annual Green Budget publication earlier this week (here). It is intended as a comprehensive assessment of the challenges facing the UK government as it prepares to unveil its official budget (scheduled this year for 8 March). It is certainly comprehensive – the report extends to 312 pages. However, one thing particularly jumped out at me: In the chapter on health and social spending, the authors showed that over the period 1955-56 to 2015-16, real health spending in the UK grew at an average rate of 4.1% per year whereas over the period 2009-10 to 2014-15, real spending increased by just 1.1% per annum (see chart).

We should keep this in perspective: Under the previous Labour government, real spending increased at a rate of 5.9% per year, so some degree of slowdown was required. Indeed, this huge surge in outlays was designed to raise health spending as a proportion of national income towards the average levels of health spending in other western European countries – a target which was not achieved. On a per capita basis real health spending has remained roughly unchanged since 2010 although the ageing of the population, which raises the share of elderly people, means that the per capita numbers are slightly misleading.

Nonetheless, the government can claim that it has abided by its manifesto commitment to protect the National Health Service from the cuts in other public services. But at a time when the strain on the NHS is greater than ever before, the government (irrespective of political persuasion) is going to have to face up to some uncomfortable truths on the provision of health care. Part of the problem stems from the fact that although health spending has been spared the worst of the cuts, the social welfare bill has been slashed, having fallen by 1% in real terms since 2009-10. Faced with a lack of options, people are being forced to turn to the NHS for help which it is not designed to provide, which in turn impairs its ability to meet its other targets.

Professor Sir Bruce Keogh, medical director of NHS England, highlighted in a newspaper interview two years ago (here) that the lack of local services such as district nurses, beds in community hospitals and mental health support were key factors behind the rising strain on front line health services. It is not as though the government is unaware of the problem. The Times reported in December that Chancellor Philip Hammond wanted to raise the funds allocated to social welfare provision but was overruled by the prime minister. It further suggested that the issues facing social welfare are “a political problem exacerbated by political cynicism,” following the stymying of cross-party efforts to find a solution to the problem by former Chancellor George Osborne before the 2010 election.

On the basis that the NHS in England expects to face a cash shortfall of up to £30bn by 2020, what can be done to plug the hole? Unpalatable though it may sound, a simple option would be to raise taxes. A rise of 1% in the basic rate of income tax would provide £4.5bn of additional revenue by 2019-20, according to the Treasury’s ready reckoner. Bearing in mind that the basic rate today, at 20%, is the lowest in decades (40 years ago it stood at 30% and it was last cut in 2008 from 22%), this is not the worst option. A 2% rise in the higher rate of tax would yield a further £2.0bn. The government could also raise national insurance contributions which are, after all, designed to fund social welfare provision. A 1% rise in employee contributions would raise almost £4.3bn and a similar increase in employer contributions would generate £5.1bn. But the real kicker is the government’s planned cuts in corporation tax rates. Each 1% reduction in the standard rate costs £2.4bn in revenue, and with the government planning to cut the standard rate from 20% today to 17% by 2020, this will cost £7.2bn in revenue. If corporate taxes are left unchanged and the other tax hikes are implemented, this would get us two-thirds of the way towards covering the health spending shortfall.

These are, of course, static calculations. Employers will create fewer jobs if payroll taxes rise which will result in less revenue than these numbers suggest. However, they illustrate that UK governments will at some point have to begin squaring the circle.  The 30 year period during which governments have cut taxes whilst promising world class public services are over.

Nobody likes to pay higher taxes of course (least of all me). Thus the other unspoken possibility is to introduce some form of charges in order to encourage rationing. One option might be to introduce an initial charge for doctor’s visits with subsequent visits incurring no such penalty. The British Medical Association reckons that there are around 340 million consultations per year; over 90% of this contact is with local general practitioners and the average member of the public sees a GP six times a year. Running through the maths, GPs see 51 million different people per year. Imagine that the first GP consultation per year was charged at £10 with subsequent ones free (with suitable exemptions for the very young and the very poor) – which is the equivalent of three pints of beer per year or 12 pints of milk – this would yield £0.5bn per year in user charges.

Whilst this is not a huge amount in the grand scheme of things, it might be the direction in which we are forced to travel. As we all know, demand for health care is near-infinite, and unfortunately we need to find ways to fund this demand as our population ages and the pressure on the system mounts. But are our governments brave enough to face up this unpalatable truth? It certainly won’t win votes but it might help to preserve the health services.

The haze of regulation

Having posted previously on the subject of incentives (here), and how important it is to ensure they are set correctly in order to avoid unintended consequences, the recent spate of warnings regarding pollution levels in London over the winter months brought the issue to mind once again. There are many contributory factors to high pollution levels in urban areas with climatic conditions exacerbating the problems caused by central heating systems and wood burners (one of the recent scapegoats). But one of the factors rising up the worry list in London is the problem caused by emissions from diesel engines (see chart).

Ironically, it is not long ago since diesel engines were hailed as the great new clean technology which would save us from the choking carbon dioxide emissions of petrol engines. Beginning in the early-1980s, UK excise duties on diesel were set lower than those on petrol, though since the late-1990s they have remained the same as those on unleaded fuel. From a fuel consumption perspective diesel engines are more efficient than their petrol equivalents, so even if the duty per litre is the same, the tax paid per mile (or kilometre) travelled is lower for diesel than for petrol. Successive governments were happy to encourage the switch to diesel engines because – we were told – they emit less carbon dioxide than petrol, and this switch was seen as one of the arrows in the quiver designed to reduce CO₂ emissions in line with international agreements. Unfortunately, diesel engines emit more nitrogen oxides and small particulate matter, which is even worse for human health than CO₂. Moreover, the evidence appears to suggest that their average CO₂ emissions are no better than petrol engines.

The chemistry associated with the burning of diesel is not new. So how is it that governments across Europe have encouraged this trend? According to the academics Cames and Helmers (here) one argument is that “the European oil industry co-initiated the shift to diesel cars in the 1980s and 1990s in order to find outlets for middle distillates” which had collapsed as natural gas displaced heating oil as a fuel used in electricity generation. In addition, the increased use of nuclear power for generating purposes further increased the downward pressure on distillate demand.  Whatever the reason, across most European countries, diesel cars received favourable tax treatment at the expense of petrol-engined cars. If governments were indeed using the switch as a cover to promote the need to reduce CO₂ emissions it was at best misleading, and if the claims advanced by Cames and Helmers are true, it points to collusion between the interests of the oil industry and government.

This goes back to the point I made recently (here) about how there is evidence to suggest that interest groups can have undue influence over government policy which may not always be in the best interests of voters. Perhaps the most egregious example of this is the policy towards obesity in the western world. It has become accepted wisdom that the problem is caused by too much fat in the diet. However, as long ago as 1972, a scientist called John Yudkin wrote a book claiming that there is a clear correlation between the rise in heart disease and a rise in the consumption of sugar, and questioned whether there was any causal link between fat and heart disease. But the food industry struck back, led by a scientist called Ancel Keys who – aided and abetted by the sugar industry – proceeded to discredit Yudkin’s work. However, the work spearheaded in recent years by prominent scientists such as Robert Lustig, suggest that Yudkin had been right all along.

This was not a simple academic spat: It was an issue of fundamental scientific importance with implications for human health. It also highlights the problem that if a particular interest group funds research which is unequivocally accepted by government, and is used as the basis for public policy, there is an incentive to distort the research to ensure the desired outcome. I am not endorsing the claims of Cames and Helmers with regard to the influence of the oil industry. But the very fact that it has been hinted at indicates that the line between genuine scientific research and that conducted for ulterior motives is at best blurred.

As it happens, European countries have a pretty good track record in preventing dodgy research from slipping through the net – think of the good work done by the drug regulatory authorities. However, it is crucial that these high standards are maintained, which is something else for the UK government to think about as it embarks upon Brexit. And as the diesel and sugar episodes remind us, it is also important to think about the longer-term effects of today's policy choices. Failure to think long-term can - quite literally - be fatal.

Not your father's world

This is a post which I considered very carefully before deciding to publish. I certainly do not “do” conspiracy theories – they have often struck me as the paranoid delusions of people who cannot accept that the world works differently to how they would like. I struggle with the idea that the world is run by a secret cabal of men (for that is how they are normally portrayed in James Bond films) sitting in some glamorous location making decisions which affect the lives of the little people. Nor do I buy the idea that the likes of the Bilderberg Group are trying to subvert the democratic process in the western world. But I was recently brought up short by a couple of articles by people who I have long regarded as sane commentators. 

The first was by George Monbiot, an environmentalist and political activist. I have to confess that I have not always been a fan of his work, believing for many years that he hugely exaggerated his stance on many positions. But I was impressed with his intellectual honesty in reversing his position on nuclear power and I now take him much more seriously, even if I don’t always agree with what he writes. However, the article, published in The Guardian (here) took a cogent look at how so-called "dark money" – used to fund organisations involved in political advocacy without disclosing where it comes from – has a huge impact on the way in which government policy is shaped.

In particular, he focused on the activities of one Dr Liam Fox MP, who is a prominent supporter of Brexit and currently Secretary of State for International Trade. In 1997, Fox founded Atlantic Bridge, described as an educational organisation designed "to bring people together who have common interests [and] ... defend these interests from European integrationists who would like to pull Britain away from its relationship with the United States.” In 2007, a sister organisation was set up in the US with affiliations to the American Legislative Exchange Council (ALEC), described by Monbiot as "perhaps the most controversial corporate-funded thinktank in the US" and which has extremely close ties to the Trump administration (see Monbiot’s article for the detail). After registering as a charity in 2003, the UK arm of Atlantic Bridge was dissolved in 2011 after the Charity Commission concluded that it was "not evident that [it] had advanced education" and "may lead members of the public to call into question its independence from party politics.”

Monbiot convincingly makes the case that Fox has consistently blurred the lines between the public interest and his own personal interests. However, by being tasked with the job of securing trade deals with other countries, Fox is ideally placed to lead the way in securing a UK trade deal with the US.  But as has been pointed out numerous times before, any trade deal will be on terms which put US interests ahead of those of Britain. As Monbiot put it, “European laws protecting the public interest were portrayed by Conservative Eurosceptics as intolerable intrusions on corporate freedom. Taking back control from Europe means closer integration with the US. The transatlantic special relationship is a special relationship between political and corporate power. That power is cemented by the networks Liam Fox helped to develop.”

You may or may not agree with this view, but whilst it is plausible, Monbiot has “form” and we know where he stands on the political spectrum. But the blog post by Tony Yates, professor of economics at Birmingham University and which made some similar points, comes from someone who in my experience does not consistently advocate a particular political stance (here) Yates points out that many of the grievances which led to the Brexit result "have been stoked and crafted ruthlessly. The vortex is stoked and our descent into it is piloted in the name of the ‘will of the people’.  But in fact the journey is in the service of the populist-controllers who have managed to sell the people the bad policies.  What do they get out of it?  Publicity, gratification, media careers, control over policies that affect the net worth of companies they and their associates are connected with."

Precisely because I regard Yates as a rational commentator is the reason why his argument hits with such force. Regular readers will know that I have consistently questioned how the policies of Trump – or the UK government with regard to Brexit – serve the economic interests of their respective electorates. If both the US and UK governments are pursuing policies designed to benefit a small group of individuals, we are in more trouble than I thought. I will leave it to the political scientists to assess the impact on the democratic process. More worrying from an economic perspective is that the international institutions upon which our security and prosperity have been built for 70 years are under threat. I have noted previously (here) that the parallels with the 1930s are more worrying than people care to admit, and historians will tell you that despots come to power riding a wave of popular support to impose policies which impoverish their countries. Whilst Trump may not be a despot, and Theresa May is certainly not, they both lead governments whose policies are economically harmful. 

Perhaps we are all being a little bit jumpy in the wake of the political upheavals of the last year and wiser heads will soon prevail, such that by the end of the year we will all wonder what the fuss was about. Or maybe, as Yates wrote, the failures of current policies "can be sold as a success, whose ill effects are blamed on simply not punishing the imaginary villains enough.  And the next round follows." This is not my father’s world. It’s my grandfather’s.

Trading places

I spent this evening at a seminar organised by the National Institute of Economic and Social Economic Research (NIESR) at which they outlined their latest economic view and some of the associated research topics. One of the presentations, by Monique Ebell, looked at NIESR's ongoing research into Free Trade Agreements and how the UK is likely to fare post-Brexit.

The worrying conclusion was that leaving the European Single Market (ESM) is going to impose significant costs, irrespective of whatever deal the UK signs with other countries. This is due to the fact that the ESM is a deep and comprehensive trade agreement which is designed to reduce non-tariff barriers, whereas conventional FTAs do little to tackle this problem. And because they are generally aimed at trade in goods, they do little to stimulate services trade which is an important issue for the UK.

NIESR used conventional gravity models to estimate the impact of post-Brexit trade flows. Such models approximate bilateral trade flows between two countries by employing the ‘gravity equation’, derived from Newton’s theory of gravitation. The idea is that just as planets are attracted to each other in proportion to their sizes and proximity, so too are countries. Relative size is determined by GDP, and economic proximity is determined by trade costs – the more economically ‘distant’ the greater the trade costs. Gravity models suggest that relative economic size attracts countries to trade with each other while greater distances weaken the attractiveness.

The empirical results suggest that if the UK were to leave the ESM and impose WTO rules, as Theresa May has threatened, this would lead to a long-term reduction of around 60% in UK trade with the EU compared to what would otherwise take place. Swapping ESM rules for an FTA used by the EU in trade with third party countries would produce a smaller, but still significant, reduction of 45% in UK-EU trade. There would be a modest offset if the UK could replace WTO rules with some form of FTA with the BRICS or Anglophone countries, but it would in no way be enough to fully compensate for the losses.

As it currently stands, leaving the ESM will make the UK significantly less well off. Indeed, NIESR's calculations indicate that swapping the current EU trading arrangements for WTO rules will cut GDP by around 2.3% over the longer term (5-10 years). This is rather smaller than the numbers suggested by the Treasury prior to the referendum, but it is likely there would be significant second round effects which I reckon could produce a long-term decline somewhere in the region of 5%.

We should, of course, be careful of the spurious precision attached to such estimates. But they support the view that leaving the safety of the ESM, which is one of the most integrated international trading markets in the world, will leave the UK poorer than it needs to be. And it is for this reason I continue to believe that the gamble taken by David Cameron in holding the referendum in the first place, and the comments made by Theresa May in her speech two weeks ago, represent steps which are not in the UK's national interest.

If conventional FTAs suggest that the gains from trade with third countries will be outweighed by the losses resulting from a loss of access to the ESM, might it be possible to devise ways to narrow the losses? Obviously, one way would be to replicate the features of the ESM which make it so successful, by reducing non-tariff barriers. But this would involve efforts to improve economic integration in any new trade deals, which in turn would require greater regulatory harmonisation, though this is precisely one of the things which the electorate (narrowly) rejected last June.

Ironically, on a day when the proportion of MPs voting in favour of the Article 50 bill (81.4%) was greater than the proportion of the electorate voting for Brexit (51.9%), the government has still given us no indication that it understands the risks which it is taking with the UK's economic future. Moreover, the fact that the EU is expected to present the UK with a significant exit bill, likely to be in the region of £40-60 bn, suggests that it will take at least five years to recover from the initial financial hit (so much for saving money by leaving, eh Nigel?). Thus, even if Brexit does not cause the damage that is feared, in order to come out ahead the new arrangements would require the UK to get a bigger growth boost than the current arrangements can deliver. Let's just say I am not hopeful.