House of Sad

Every now and then I like to go off-piste and look at issues in the world of football, partly because it interests me but also because it is an area ripe for economic analysis (bear with me on this, there is some economics in here). A couple of years ago, I looked at the financial position of Newcastle United, the club I support. I reluctantly concluded that although the financial model adopted by the owner Mike Ashley was condemning the club to mediocrity, this was consistent with a strategy in which the owner had no incentive to spend huge sums of money for no guaranteed reward. However, this was inconsistent with the demands of fans who want to see the club spend money in order to challenge for trophies, rather than simply making up the numbers. Perhaps the relationship between owner and fans can be seen as a principal-agent problem in which the owners’ actions on behalf of the club impact directly on the fans. 

The news earlier this year that a Saudi Arabian consortium was interested in buying the club was welcomed by fans who hoped that it would allow Newcastle to challenge for trophies on the domestic, and perhaps even European, stage. The group included Saudi Arabia's sovereign wealth fund PIF thus making a direct link to the Saudi government whose record on human rights is, to say the least, questionable. This posed an ethical dilemma for me. Obviously I want my club to be successful which would have been enabled by the funds PIF has at its disposal. Against that I am uncomfortable with the links to a government deemed by Amnesty International as repressive. As it happens, the dilemma was resolved yesterday when the consortium withdrew its bid for the club.

It appears that the Premier League (PL) had dragged its feet in applying the “fit and proper person” test to the prospective owners and 17 weeks after the bid was submitted, the consortium simply lost patience. Quite rightly the PL wanted to determine the precise links between the consortium and the Saudi government. It needed assurances about who would have control (who is the beneficial owner), where funding would come from and who would appoint the board. In the absence of clarification, the PL’s rules prevented it from sanctioning the deal. On the surface, you might think that this was a case of good governance in action. But the PL – and indeed the English Football League, which governs lower leagues in England – has a murky record. Consider these examples:

1. In 2003 the PL welcomed Roman Abramovich's takeover of Chelsea FC with open arms. Not once did they publicly ask how he obtained his money. Nor did they raise the issue of money laundering, despite the fact that any business funded by funds of dubious provenance is a classic money laundering risk.
2. In 2005 the PL was quite happy to allow the Glazers to purchase Man Utd, despite the fact they loaded the club with huge debts in the process. Those debts are currently valued at £0.5bn – almost 0.8% of the annual gross value added generated in Manchester.
3. The PL welcomed Thaksin Shinawatra as the buyer of Man City in 2007. Thaksin, being a former PM of Thailand who was deposed in a coup, is the sort of politically exposed person whom people in finance are warned to treat carefully in any financial dealings. Thaksin then sold the club to the Abu Dhabi Investment Group, owned by a member of their royal family. The club was recently charged with breaching UEFA's financial fair play regulations (and dubiously acquitted), yet we did not hear anything from the PL on the issue.
4. If it is Saudi involvement the PL is concerned about, there seem to be no worries that Sheffield United are owned by a Saudi prince who recently won a court ruling that he could purchase a 50% stake in a club reputedly worth £100m for just £5m. 
5. Lower down the leagues, the football authorities claim to have a 'fit and proper' person test. Yet Wigan Athletic was last month declared bankrupt just four weeks after it was sold to a Hong Kong based consortium.
6. The travails of recently-promoted Leeds Utd can partly be laid at the PL's door. They raised no eyebrows when in the early-2000s the owner borrowed against future revenues to load up the club with debt, predicated on the basis it would regularly qualify for the Champions League. It didn’t and predictably Leeds went bankrupt. It then went through a series of owners which culminated in the farce whereby Massimo Cellino took control in 2014 only after winning a challenge to the Football League's attempt to block him. Cellino was later banned for financial irregularities before being allowed to return to his post. You almost couldn’t make it up.

I could go on. Fans of football clubs with long pedigrees such as Blackpool and Portsmouth can tell similar tales of woe in which unscrupulous owners managed to take over clubs before subsequently ruining them. On the basis of their past record of "anything goes" there are calls for the PL to be more open about why they put obstacles in the way of the Saudi takeover, without ever explicitly saying they failed the ownership test. Has it discovered a moral conscience, in which case I fully expect that this won't be the last occasion that club takeovers are blocked? Or is it because the Saudis have blocked the PL from taking legal action against the broadcaster beoutQ for illegally streaming matches whilst simultaneously blocking the PL’s licensed broadcaster in the Middle East?

In effect, football is being run along casino capitalism lines: The very behaviour which voters condemned banks for undertaking prior to the Lehman’s bust is alive and well in football. It has been well established in finance that self-regulation does not work – there is always an incentive for someone to game the system to their advantage. The same is true in football club ownership. To the extent the owner is running a business, there needs to be a systematic set of rules which proscribe what owners can do and penalties which are consistently applied in the event they are broken. Football’s regulators could do worse than learn from the financial regulators, which have been open and transparent about what institutions can and cannot do, and which crack down hard on miscreants. There should also be a separation of the financial incentives of the PL and those of the top clubs. Regulators are there to regulate, not to get rich on the back of those they are meant to oversee.

My favourite quote from the book by Simon Kuper and Stefan Szymanski Why England Lose … (aka Soccernomics) is “just as oil is part of the oil business, stupidity is part of the football business.” But it should not be this way. If football people want to be treated as the professionals they say they are, the sport needs to be regulated properly. Not run in the capricious manner which benefits the rich owner at the expense of the less well-off fan.

The new debt normal - just like the old one

A lot of newsprint has been devoted to the prospect of a huge rise in public debt in the wake of the Covid-19 recession with the most frequent question being “who is going to pay?” My answer is always the same: we are. This is debt incurred in the name of taxpayers, and it is their tax contributions which will ultimately be required to pay it down. But – and this is the crucial point – it will not happen anytime soon. Indeed, economies tend to pay down debt a lot more slowly than it is accumulated because, as I noted in a recent post, governments have an infinitely long life span which allows them to charge future generations for debt accumulated in the past.

A case in point is the debt accumulated by the UK in the wake of World War II. It was only in 2006 that Britain repaid the last portion of the debt it owed to the US and Canada. The US loaned USD4.33bn to Britain in 1945, while Canada loaned USD1.19 bn in 1946. Ultimately the UK paid back USD7.5bn to the US and USD2 bn to Canada, implying an annual average rate on the combined debt of almost 1%. In effect, my generation was paying off debt incurred following a conflict that took place long before I was even born. Moreover, even with such a low effective interest rate, the UK still repaid an amount which was almost double the original principal. This should act as a cautionary tale for those who believe that economies can afford not to worry about how much they borrow at a time of ultra-low interest rates.

It is fascinating to look back over more than 200 years of public debt data in the IMF’s Historical Public Debt database to see how countries’ debt profiles have changed. Indeed many countries have registered debt-to-GDP ratios above 200% at some point with the UK the stand-out example, posting a ratio close to 270% in 1946.  But even the now fiscally rigorous Dutch recorded a debt ratio of almost 250% in the 1830s and got close to these levels again in the late-1940s. France, which ended World War I with a debt ratio close to 240% was able to reduce it to 15% by the mid-1960s. These examples demonstrate that it is possible to eliminate high debt burdens without triggering domestic inflation, as Germany did in the 1920s, or default as many Latin American countries have tried over the past 40 years. As chart 1 illustrates, across a sample of industrialised countries debt levels are quite some way below their historical peaks, suggesting there may a bit of fiscal space to take on more debt. At the very least, it is likely that they can live with high debt levels for some time without having to take the axe to the public sector.

The key to long-term debt reduction – as I have noted on numerous previous occasions – is the fiscal solvency condition which suggests that so long as nominal (real) GDP growth exceeds the nominal (real) interest rate on debt, the debt ratio can be reduced whilst still running a primary deficit. As Nick Crafts points out in this nice blog post the UK was able to reduce the debt ratio from over 250% of GDP in 1948 to just over 60% within 25 years despite running a primary deficit averaging 2.3% of GDP which resulted from the expansion of the welfare state. As Crafts points out, “low interest rates, low unemployment, rapid economic growth and tolerance for higher taxation all played a role” in driving down the debt ratio. The idea that society was tolerant of higher taxes is an interesting one and with many suggestions as to how the government can find new ways to raise taxes, it is a theme I plan to return to in the near future. 

The notion of higher tax tolerance runs contrary to the economic model of the last 40 years in which governments have sold the idea of a low tax economy as the best way to allow the private sector to make resource allocation decisions. It has also allowed the state to take a back seat in some key areas of public service provision (e.g. rail and electricity networks). But what the proponents of low tax fail to point out is that this model may not be the best at delivering optimal social outcomes. There is, for example, a clear negative correlation between tax receipts as a share of GDP and rates of child poverty (chart 2).

As governments begin to grapple with high debt levels, it is evident that they will have to think more creatively about revenue raising measures that do not necessarily rely on taxing the same old areas as before. When large numbers of people were in employment and governments were keen to promote investment, it made sense to tax incomes and allow tax breaks for capital. It is less clear that this holds today. And as I have noted previously, societies will have to determine what their priorities are. Scandinavian-style welfare provision is incompatible with US-style taxes. If the Covid crisis has taught us anything, it is that it may be time for an economic reset. Whether we are ready to confront the fiscal implications is another matter entirely.

How is he doing?

A year ago I posed the question “if Johnson is the answer, what is the question?” Twelve months on, the question still stands. It has been a remarkably turbulent year, what with last year’s constitutional shenanigans; a general election; Brexit and the outbreak of Covid-19. On the basis of this BBC Fact Check Johnson's record is at best checkered. He failed in his primary objective to leave the EU on 31 October ("no ifs or buts"); his position on the Irish border has been less than honest and his much-vaunted social care plan has yet to see the light of day. Being generous, Johnson’s programme has been derailed by the worst recession in 300 years. But as I noted around the time of last year’s election it is still not clear what Johnson believes in, apart from delivering Brexit – and even then, he has cynically used this cause celebre as a platform for his ambition rather than being a hardline supporter of the policy.

There have over recent months been many claims in certain areas of the media that the Johnson government is engaged in shifting the political centre of gravity to the right and it is prepared to ride roughshod over the niceties of the British constitution in pursuit of its aims. Reasonable people can agree to disagree on this point but it certainly looks as though his government has taken the old Facebook maxim to heart: “Move fast and break things.” Johnson’s actions over the last 12 months are more authoritarian than anything we have experienced in British politics in living memory. Take for example, the attempt to suspend parliament last year in a bid to deliver Brexit – subsequently overturned by the courts – and the suspension of 21 MPs from the Conservative Party for defying the government. Whatever you might think of the action, and regular readers will know I was not a fan, it was at least designed to break the parliamentary deadlock over Brexit which had paralysed the government over the preceding three years.

But the recent decision to withdraw the whip from Julian Lewis for having the temerity to run against, and beat, the government’s preferred candidate to chair the Intelligence and Security Committee (ISC) was worrying on a number of levels and it highlights many of the weaknesses at the heart of the Johnson government. First, it appears from the outside that the government was prepared to appoint a lackey to oversee the release of the highly sensitive report into Russian influence on British public life. Filling parliamentary committees with “yes” men (and women) erodes the ability of parliament to hold the government to account on matters of national importance. Second, the government’s preferred candidate, Chris Grayling, does not have a strong track record of delivering. As The Economist noted last week, there is a dearth of talent in government because MPs are subject to “a Brexit purity test” which acts as a barrier to many competent people. Third, the fact that the government managed to lose a rigged election to the ISC calls into question its general competence to deliver on some of the bigger issues it will have to face (notably Brexit). Finally, the fact that the ISC report found that the government had not even bothered to investigate allegations of Russian involvement – whether true or not – points to remarkable complacency on matters of national importance.

In a week when the UK and EU warned that little progress has been made towards signing a trade deal by year-end and there is no prospect of a trade deal with the US, the risks to the UK economy are mounting. As it happens, I still believe that the UK and EU will sign some form of trade agreement before 31 December for to do otherwise would be a major policy failure that the government cannot afford. But in terms of international economic relations, the government appears to have a dwindling circle of friends following its decision to cut Huawei out of the 5G network and this week’s spat with Russia. When the government claimed that Brexit would allow the UK to forge its own path, nobody imagined it would be quite this alone on the world stage.

During his tenure as London Mayor Johnson was noted for being a hands-off leader, preferring to delegate the hard thinking to a group of trusted advisers. At the heart of Johnson’s administration is his chief adviser Dominic Cummings who is a man in a hurry to get things done. Cummings appears indispensable to the Johnson project – after all, his clear breach of the Covid-19 lockdown guidelines would in most circumstances have seen him removed from office. For anyone interested in understanding Cummings, his views and modus operandi, I heartily recommend this BBC documentary (Youtube link here). I am uncomfortable with the media attention Cummings generates, and the picture that is painted of a guy who controls the heart of government (a view I hope is untrue). My impression is that Cummings is an iconoclast who wants to make radical changes to the way in which Britain is governed. Whilst he is clearly persuasive and articulate, I do not get the sense that he has thought through the longer-term implications of his ideas. In short, he is a campaigner rather than a man who follows through. 

I can see why this appeals to Johnson, who is a fantastic campaigner in his own right and always looking for the next idea to sell. But this is not how the hard work of governance is conducted. If politics is the art of the possible, a sensible strategy is to adopt a small number of ambitious but achievable goals rather than trying to do too many things at once. Arguably it is this rush to do too much that has forced the government to crack down on those who get in the way of it achieving its goals. However it creates the impression of unstable government in which a small, unchanging, group of people are driving the agenda.

Johnson won a handsome majority at the December election on the promise of getting Brexit done and creating opportunities for those voters outside the London bubble who perceive they have been left behind. The UK may have left the EU but Brexit is far from done, and the government has its work cut out to deliver on its promises now that Covid-19 has turned the economic landscape upside down. Johnson has had a difficult year, and not all the problems are of his own making. But too many are, and if he fancies another term as Prime Minister, he will have to change his approach to government.

Greatest hits

For most of the last 40 years I have listened to politicians misrepresenting fiscal issues. In the 1980s the Thatcher government in the UK talked about “living within our means”, treating the government budget constraint as if it were a household. This never made any sense because whilst households have a finite lifespan, governments – in theory – do not which raises their borrowing capacity because they can repay debt on a multi-generational basis. A decade ago, George Osborne adopted a similar approach, arguing that if the UK government did not rein in its budget deficit it would suffer similar fiscal consequences to Greece. Never mind the fact that UK debt levels were lower, or the fact the UK had an independent monetary policy or indeed that it issued debt in a currency which it controlled.

For the present we appear to have put the need for wearing a fiscal hair shirt behind us. Instead politicians like to boast of their fiscal largesse, even though a large segment of the public is increasingly asking who will pay for it. Ultimately, it is the tax payer although not necessarily the current generation. But just as politicians have overdone the fiscal rectitude in the past, so they may be guilty of exaggerating their largesse today. At the end of June, Boris Johnson announced a plan to spend £5bn on infrastructure which was portrayed as a “new deal” along the lines of Franklin D Roosevelt’s 1930s plan. It was, of course, nothing of the sort. FDR’s plan amounted to a splurge equivalent to around 40% of US GDP at the time whereas Johnson’s equates to around 0.2% of UK GDP. The BBC Fact Check team looked at the details of Johnson’s speech and concluded that large parts of the plan merely involved allocating funds that had previously been announced.

Chancellor Rishi Sunak, who has performed creditably during the crisis, did come up with a more substantive plan in his Summer Statement last week. His plan to provide additional support of £30bn (1.4% of GDP) included a Job Retention Bonus which promised a subsidy to employers for each furloughed employee they retain until end-January 2021; a package of measures to help the hospitality sector and a housing Stamp Duty holiday. There are many reasons why the package is badly targeted: A subsidy of £1000 per employee will not do much to dissuade employers from making job cuts and it also runs the risk that taxpayers will foot the bill for workers who would otherwise have been re-employed anyway. A Stamp Duty holiday will be of most benefit to those in the south east of England where house prices are highest, which is not exactly consistent with the government’s plan to level up the economy by helping those regions which have fallen behind. Yet for all that, we do have to give the Chancellor credit for pulling out all the stops after a decade in which fiscal policy has been relegated to the back burner.

The plan came too late to be fully incorporated into this week’s Fiscal Sustainability Report (FSR) from the OBR. Nonetheless, it dutifully ploughed through the fine details and found that the Chancellor has been even more generous than he admitted. The OBR pointed out that the Treasury “’has so far approved £48.5 billion of additional expenditure on public services’, of which £32.9 billion had not previously been announced.” On my maths, this implies a fiscal boost equivalent to almost 3% of GDP.

For those with the time to browse it, the FSR was an excellent, sober overview of the current problems facing the UK economy and how it might perform in future (chart 1). The scenario set out in April always felt a little rushed – understandably – but having had time to reflect on events, the OBR set out three possible long-term scenarios. The central case looks for output to get back to pre-recession levels by end-2022, which is achievable although I fear it could take a bit longer. In this scenario, the deficit balloons out to 16% of GDP this year before falling back to 4.6% by fiscal 2024-25 with the debt-to-GDP ratio remaining above 100%.

Indeed it is the long-term implications of the economic crisis which are particularly interesting.  A debt ratio in 2025 of around 100% is far lower than in the late-1940s when it went above 250%. A combination of favourable demographics, rapid growth and low interest rates allowed the ratio to halve between 1947 and 1957 and it halved again within the next 15 years. We are unlikely to see such a rapid reduction this time around unless there is a miraculous transformation in the potential growth rate. Indeed, the OBR’s central case scenario suggests that based on assumptions for demographics, pensions and health care spending, the debt ratio will rise to 320% on a 50 year horizon (chart 2). Whilst we should not take the figures at face value, they do highlight that in the absence of counteracting measures the debt ratio is not going to decline anytime soon and the OBR’s illustrative calculations suggest that fiscal tightening of around 2.9% per decade will be required to get the debt ratio back to 75% over a 50-year span.

All of this is, of course, subject to a huge degree of uncertainty and it is purely an illustrative scenario. But the point is made that even in the absence of COVID-19, the UK (and indeed all industrialised countries) face major fiscal challenges. Governments will have to make major decisions about what kind of debt levels they are prepared to tolerate and what level of services they can realistically provide. Societies as a whole will have to make decisions about how much tax they are prepared to pay. Whilst I have been an advocate for greater use of fiscal policy over the past decade, like most people I never expected to see the kind of hit to public finances which we have seen in just the last four months. In the coming years we will need a proper debate about the role of the state in the economy. Political blustering on fiscal issues will no longer suffice.