The Covid curse strikes again

If 2020 was the year from hell, 2021 is turning out to be more like purgatory – a temporary version of hell which we hope will end sometime but don’t know when. As the end of 2021 moves into view, it is beginning to feel very much like a year ago: After a summer during which infection rates fell, a new Covid variant has popped up and case numbers are sharply on the rise as we head into winter. The surge in case numbers is especially big in Europe (perhaps less the case in the UK where case numbers have been elevated for the past three months) and the discovery of the Omicron strain has raised a lot more questions than the scientific community currently has answers. New restrictions on social gatherings are being put in place and forecasters are beginning to edge down their economic growth projections for the winter months, which is bad news for those institutions that have already produced their year-ahead outlooks and spent the past few weeks marketing them to clients.

Global case numbers suggesting there have so far been 268 million Covid infections can be taken with a huge grain of salt, especially when they indicate that China has reported less than 100,000 positive cases versus 10.6 million in the UK – a country with a population just 5% of the size. European data are likely to be more accurate given the rigorous testing procedures in place across the continent: they point to almost 86 million cases since February 2020 with a quadrupling in the last 12 months.

Germany has led the way in tightening restrictions, with significant curbs on the unvaccinated who will have to contend with curtailed access to restaurants, cinemas, leisure facilities and many shops. This was described by outgoing Chancellor Angela Merkel an act of “national solidarity.” The new Chancellor Olaf Scholz backs a policy of mandatory vaccinations, although this has yet to go through parliament. Indeed, it is notable that the proportion of the German population vaccinated against Covid currently stands at a relatively low 71%, versus 75% in the UK; 77% in France and Italy and 82% in Spain. In response to the threat posed by Omicron, the British government earlier this week implemented what it called ‘Plan B’, carefully avoiding the word lockdown. This entails reintroduction of working from home guidance; the use of facemasks in “most public indoor venues” and a requirement to show a Covid pass in a number of venues, depending on the number of people present and whether it takes place indoors or outdoors.

The Covid policy tracker, published by the Blavatnik School of Government at Oxford University, shows that the restrictions index jumped sharply in Germany and is now back to levels last seen in January (chart). Such a sharp jump has not yet been seen in the UK, although it is likely to edge up over the next few days as the Plan B measures take full effect. A comparison of the political response in the UK and Germany shows considerable differences in approach. Germany has acted quickly and the political consensus is in favour of action to restrict the spread of Covid. But there is mounting political resistance in the UK to further restrictions, driven in part by the defiant libertarian streak which is present in the governing Conservative Party. The Plan B legislation may indeed only pass through parliament thanks to the political opposition which has said it will support the measures.

This is not to say that there are not legitimate concerns about the damage that lockdowns do to the economy. Of course, we do not yet know what the full impact of the Omicron variant will be but the evidence suggests that it is the most transmissible variant to date. Case numbers look set to rise sharply across Europe and the government responses are unlikely to leave the economy unscathed. Even before the latest concerns about the Omicron variant, the UK economy had lost considerable momentum. GDP in October rose by just 0.1% m/m taking the annualised 3-month growth rate down to 3.2%. Ironically, such growth as there was in October came from output in human health activities, which grew by 3.5% m/m due mainly to a continued rise in face-to-face appointments at GP surgeries. It is a pretty strange sort of economy where growth is being driven by numbers of sick people going to see their doctor. It is still possible that output will get back to pre-Covid levels by Q1 2022, as the BoE projected in November, although this will depend on the extent of any anti-Covid measures.

Omicron has muddied the likely monetary policy response ahead of the BoE’s final MPC meeting of the year on Thursday. After considerable criticism that the BoE had led analysts up the garden path by not raising interest rates last month, it was widely believed that it would do so in December. That expectation has faded and rates are tipped to remain on hold next week. Given the uncertainty surrounding the economic situation, that would seem to be a prudent move. The consensus GDP growth projection for 2022 has slipped from 5.6% in August to 5.1% last month and the likelihood is that it will dip further (for the record, my own projection looks for a growth rate in the range 4% to 4.5%). There are many who believe that high inflation warrants monetary tightening. However this is to miss the cause of the recent inflation spike which is the result of supply chain difficulties. Tighter monetary policy today will do nothing to tackle this problem although once some of the Covid-related uncertainty passes there is a case for modest policy tightening.

Markets appear to be taking the view that the Omicron variant will slow economic activity rates and thus cool some of the inflationary pressures. That is not what happened a year ago when the emergence of the Delta variant made these problems worse rather than better. This is a reminder that one of the bigger dangers we face is complacency. The Omicron variant represents a new strain rather than a new disease, so the threat is perceived to be lower than it was in March 2020. That may be true but it may turn out to be wrong if the transmissibility rate is so much higher and the virus mutates yet again. Public health experts are thus warning that we once again need to deploy the toolbox developed in 2020, which entails significant economic disruption.

Quite how long we can go on doing this depends on the duration of the Covid pandemic. Based on the evidence derived from this paper, the average duration of global pandemics over history is around 6 years. It is not an edifying thought that we are barely two years into the Covid outbreak.

Go north or don't go at all

The recent news that the UK government has cancelled the extension of its planned high speed rail line (HS2) to cities in the north of England should not really surprise anyone. Expanding what is essentially nineteenth century technology at great expense in the twenty first century was always a controversial policy option. Naturally there was a political angle to this and called into question the government’s commitment to levelling up regional inequalities. But whilst the UK clearly does suffer from significant regional inequality issues, a bigger question is whether investment in railways is a good way to address them.

A historical perspective on British railways

The railway network has been at the centre of the political debate on transport for decades. In the wake of WW2 the government nationalised the dilapidated network as a prelude to a significant investment programme to phase out steam. In the 1960s, the (in)famous Beeching Report advocated slashing the network to eliminate the least profitable lines in the face of rising competition from road transport. This was duly acted upon and the UK rail network today is less than half the length of 60 years ago (incidentally, the cuts did nothing to restore the network to profitability). The UK is not alone, of course, in slashing its rail network: The track length in Germany, France and Italy is currently between 60% and 70% of its historical peak. Arguably, however, the UK went too far.

I have long believed that the Beeching approach to managing the rail network was a huge forecasting mistake since it assumed that then-current trends would continue indefinitely (before anyone wants to talk about the shortcomings of economic forecasting I should point out that Beeching was a physicist not an economist). To illustrate the folly of extrapolation, by 2019 the annual number of UK railway passenger journeys had surged to its highest level since 1923, representing a figure almost three times the modern-day low recorded in 1982 (chart 1). Anyone who regularly travelled by train prior to March 2020 will be aware of the extent to which trains were frequently overcrowded. On an international comparative basis the UK rail network is the most intensely used in Europe. Although the total number of passengers carried on German railways in 2019 was 60% higher than that of the UK, the German network is more than twice the size. On a passenger miles per km basis the UK figure is 78% higher (chart 2).

Assessing the pros and cons of extending the network

The consensus of academic opinion is that railways contribute considerable benefits to the economy’s productive potential, including alleviating congestion on the road network and facilitating the development of clusters of economic activity. They also cut CO₂ emissions and reduce the number of casualties on the transport network relative to what would happen were the journeys to be made by road. Congestion reduces the efficiency of the network which has an associated economic cost and there are studies which attempt to put a price on it (see this study, which looks at London). Whilst we can be sceptical of the exact numbers, inefficient networks undoubtedly have an impact at the margin by adversely affecting productivity and business location decisions.

When making the case for HS2 it is therefore important to assess the costs of the investment against the benefits. To get a handle on the financial costs, it was initially suggested in 2010 that to build a high-speed line between the cities of London and Birmingham (a distance of 215 km) would cost around £20bn. More than a decade on, and after considerable political and economic wrangling, the cost of this phase is estimated to have doubled to around £45bn. It was further proposed to extend the network northwards in two phases: one running a further 114km north-west to Manchester and the other an additional 190km towards Leeds (this is the part that has been shelved). Costs have spiralled accordingly. 

The previous estimate put the cost of building the network at £55.7bn: the latest official estimate is a cost between £72bn and £98bn. Even after allowing for inflation, that represents an increase of up to 60%. The cost-benefit ratio has already halved to around 1.2 - a figure that classifies the project as low value for money on the Treasury's classification scale - implying that a 20% rise in costs will make this a marginal project at best. The benefits of HS2 are dominated by time savings. Around half of the transport benefits (and over 40% of the total network benefits) are derived from time savings. It is expected that HS2 will cut the journey time between London and Birmingham from 81 to around 52 minutes when (if) the line opens between 2029 and 2033 (as projected) and reduce the London to Manchester journey time from 127 to 67 minutes. In the view of many laypeople, these are relatively small time savings compared to the costs.

The respected transport economist Stephen Glaister, who I first heard dismiss the economics of HS2 in a lecture almost a decade ago, recently wrote a report which sounded a sceptical note. He wrote that “it will inevitably be a financial loss-making enterprise, with the taxpayer filling the funding gap, with those resources having to forgo alternative uses.” That is not necessarily a reason for not undertaking the investment but he further noted that “an appraisal of the likely effects of the Covid-19 pandemic on the demands for travel and hence on the finances or economic benefits of the scheme has not been published.” In addition, he was a lot more cautious regarding the assumptions on carbon emissions than the project’s proponents. Glaister also referenced the 2006 Eddington Transport Study which concluded that economic returns from high-speed rail in the UK are unlikely to be as large as for investment in some alternative projects. In Glaister’s words, “in England, unlike in some parts of the European mainland or China, the revenue and other benefits of high speed are limited because the major cities are relatively close to one another and … there has been strong competition from established, medium speed and high frequency railways.”

With the costs of the first stage of the project having spiralled, it is hardly surprising that the government has suddenly got cold feet about further extending HS2. It is equally unsurprising that political leaders in the north feel that they have been short-changed by a government that promised not to ignore the provinces. Indeed, if the government had been serious about levelling up in the first place, it should have followed the recommendation of the National Infrastructure Commission which suggested that connectivity between the northern cities was a higher priority than HS2.

High-speed can work - the Italian example

It is sometimes hard to escape the view that British politicians want a high-speed network because other countries have successfully introduced them and the French TGV system is often cited as a model for Britain to copy. But Italy provides a better role model where last month Alitalia ceased flight operations after years of financial underperformance, driven in large part by the fact that its domestic business was being undercut by the rail network. According to a 2019 report by Trenitalia, passenger numbers on its high-speed trains soared from 6.5 million in 2008 to 40 million in 2018. On the lucrative route between Rome and Milan, 69% of those travelling between the two cities went by train whilst the share of those travelling by air fell from 26% in 2015 to below 20% in 2018.

The distance between Rome and Milan is 570km which means that a fast train can compete with air travel. This is double the distance between London and Birmingham which nobody in their right mind would ever want to fly. However, London to Edinburgh is a distance of 650km where a fast rail service would be competitive vis-à-vis flying. Whilst time savings will be derived on the first half of the journey to Manchester, these are insufficient to do in the UK what was achieved in Italy. The key takeaway in my view is that building a long distance high-speed network that can compete with air travel, thus leading to a reduction in carbon emissions, would have positive social benefits. However, there are better ways to spend £98bn than a relatively short stretch of high-speed rail that looks increasingly like a vanity project. These funds could provide up to 150 new hospitals, for example, or be invested in green electricity options. The message is thus extend north, or not at all.

Control and who has it

Over the last couple of years I have expressed concerns at the UK’s mounting governance problem in which the government has failed on numerous occasions to adhere to the standards expected of it, arguing that this undermines the rules-based economic system in which we operate. Equally, I have been puzzled at the lack of cut-through with the wider public. But in the last week there have been signs that the issue is beginning to generate wider public concern. Quite how pivotal this will turn out to be remains to be seen but it does feel highly significant.

The Paterson case

The issue was triggered by the Owen Paterson affair (here for an overview). For those not following the minutiae of British politics – and who can blame you? – Paterson was an MP who was found guilty by the parliamentary Standards Committee of having “breached the rule prohibiting paid advocacy.” In other words accepting money from outside sources to lobby government – something which is expressly prohibited under parliamentary rules. His original punishment was a 30-day suspension from the House of Commons which under the circumstances seemed like a minor slap on the wrist. However, Paterson protested his innocence, arguing that the system was not fit for purpose although surprisingly no MPs had seen fit to bring up this problem before.

What was shocking was that the government then backed a parliamentary motion to suspend the current process and review the system of investigating breaches of the parliamentary code by MPs, which would have let Paterson off the hook. They did this by whipping MPs (instructing them to vote in line with the government’s wishes) to override the findings of the Standards Committee. 242 Tory MPs backed the motion (6 voted against and 111 abstained), apparently on the understanding that those who did not support the government’s line would find their constituencies at the back of the queue when it came to doling out funding.

Like no comparable issue in recent years, this generated a huge backlash with even traditionally sympathetic newspapers such as the Daily Mail crying foul. Even the most ardent Conservative supporters found it hard to stomach what came across as an attempt by MPs to change the rules in order to protect one of their own, despite the fact that the due process found Paterson guilty of the charges he faced. Consequently, the government swiftly executed a U-turn after claiming that “this isn’t about one case but providing members of parliament from all political parties with the right to a fair hearing.” This is nonsense and everybody knows it. But as a result the 242 MPs who risked the ire of their constituents were left high and dry by the government’s about-turn.

Symptomatic of a wider problem

Whilst there have been numerous financial scandals in British politics in the past (see here for a list) what differentiates this issue is that the government sought to subvert due process. It is part of a developing pattern which has gained momentum during Boris Johnson’s time in office. In 2019 his government attempted to prorogue parliament in order to shut down dissent over Brexit. In 2020, it backed legislation that was a flagrant breach of international law. The prime minister also kept the Home Secretary, Priti Patel, in place despite the fact she was found to have breached the Ministerial Code. Those Tory MPs who voted in line with the government’s wishes may reflect on Johnson’s handling of the DUP, upon whom his government initially relied for a parliamentary majority prior to the 2019 election, whose position regarding the impact of Brexit on Northern Ireland was totally ignored when it no longer suited Johnson’s interests.

It is ironic that this furore blew up during Johnson’s hosting of COP26 where the world’s media must have been somewhat bemused to be told that the UK is "not remotely a corrupt country." On the basis of research carried out by Transparency International (TI) there is some truth to that statement (strange as it may seem). Ten years ago, TI launched a report which it defined as a ‘health check’ for the UK. Since it was published the UK has acknowledged some of the criticisms and has improved its performance in the TI corruption perception index, moving up from 17^th place in 2011 to 11^th. Yet one line from the report remains true today: “it is correct to say that in some areas of UK society and institutions, corruption is a much greater problem than recognised and that there is an inadequate response to its growing threat.”

Indeed, there is a sense that something is not right in the corridors of power. A joint investigation by openDemocracy and The Sunday Times found that in the past seven years, every former Conservative party treasurer who has contributed £3 million to the party has been offered a seat in the House of Lords. The analysis by openDemocracy suggests that the odds of so many major Tory donors in the UK population all ending up in the House of Lords is equivalent to winning the National Lottery 12 times in a row. Even if we accept that such dubious practices are less of an issue in the House of Commons and that the Paterson case was a rare example, there has been a corrosion of political standards (cf the list of examples above). Perhaps this can be traced back to the Brexit referendum when the Leave campaign blatantly misrepresented the facts without sanction, and secured their end goal.

Brexit opened up a whole new can of worms

A pattern has emerged whereby the government is determined not to be constrained by the institutional framework in the pursuit of its policies, and will only back down if ordered by the courts or if it plays exceptionally badly with the electorate. Thus, nobody cared sufficiently about the Patel case to make an issue of it, nor was the double-crossing of the DUP likely to cost many votes. By contrast the attempt to prorogue parliament was enough of a big deal that the Supreme Court was forced into a ruling. A test of the government‘s new-found principles will be whether it feels sufficiently bold to try and force through former Daily Mail editor Paul Dacre as the next head of the media regulator Ofcom despite him being found “not appointable” by the interview board when he applied for the job earlier this year.

One of the supreme ironies in all this is that Brexit was sold as a way for the British electorate to take back control – whatever that meant. Yet large parts of the electorate are increasingly concerned at policies being enacted in their name. Voters might have been given their say on whether the UK should remain in the EU but they have had no subsequent input on the form of Brexit (the general elections of 2017 and 2019 cannot be regarded as true plebiscites on Brexit as they conflated a number of issues). The quality of governance also appears to be deteriorating. For example, the extent of shady deals agreed between government and its favoured suppliers in the early stages of the Covid pandemic represented a degree of insider dealing that is simply not tolerated in the financial services industry.

All of this should worry those who care about democratic accountability and the rule of law upon which the economy is based. Sometimes it takes an outsiders eye to uncover the truths that many at home are unable or unwilling to see. This excellent essay by ARD’s London bureau chief, Annette Dittert, does just that. She points out that the inherent contradictions within Brexit, which is an ideological project offering no steer on how Britain can use its new-found sovereignty, has forced Johnson to turn his back on reality merely to keep the plates spinning. In so doing, he has been forced to ride over democratic norms and in the process is showing the British constitution for what it is: A beautiful illusion that only ever worked “so long as everyone wanted to hold onto it.”

The good news is that the UK has a strong institutional framework which has so far stood firm in the face of a political onslaught. But as the experience of Hungary and Poland shows, it is quite easy for a determined government to override it. That should be a lesson to us all.