There is an increasing sense that many of those people who promoted
the Brexit cause last year are beginning to back away from their position. Two
days ago I reported the comments by the director of the Vote Leave campaign who
suggested that leaving the EU might turn out to be an “error.”
One of the few economists to support Brexit, Andrew Lilico, noted yesterday on Twitter
that “I'm much more pessimistic about Brexit myself since the General Election.It's the Election that changed that.”
My response to that is that the election only changes the tactics of the negotiations
but the strategy of Brexit itself was – and is – misguided. Finally, Treasury
officials are said to have written an unpublished paper challenging the
Department for International Trade to prove it can line up free-trade
agreements with non-EU countries that can outweigh the loss of European trade
associated with leaving the customs union.
Frankly, it is all beginning to look like the car crash which
I warned it would be all along. Far too many of those responsible for setting
the Brexit bonfire alight in the first place departed the scene pretty quickly
when they realised the magnitude of the task ahead. Nigel Farage has resorted
to his role as a sniper from the sidelines; Boris Johnson and Michael Gove backed
out of their prime ministerial challenges when it became evident that neither
of them was likely to win and David Cameron (at whose door much of the blame
should be laid) lectures the government about austerity from his well-paid
position on the international lecture circuit. The fact that apart from David
Davis, nobody in government appears willing to take ownership of Brexit, speaks
volumes. It is hard to believe that nobody in government did not see any of
this coming – the economics profession warned long and loud – but given the
apparent level of disorganisation within government and the civil service, you
do have to wonder.
With the Article 50 clock ticking and no indication of
progress on the things which matter to business, they are increasingly having
to make their own arrangements. The financial services industry in particular
is not going to wait around for government to make a decision. It looks
increasingly likely that the passporting arrangements which allow EU banks to
conduct cross border business, will be a casualty of the UK decision to
withdraw from the Single Market. Foreign banks operating in London will in
effect be treated as third country institutions and thus have to apply for a
banking licence to continue operations.
It takes up to 12 months to go through the application process for a banking licence, and around six
months to conduct the preparatory work. The head of the Financial Conduct Authority
today called on the government to clarify before year-end what form of transitional
arrangements will be put in place to allow financial services to continue
operating. But it really does need to act fast: On the basis that the UK will
leave the EU in March 2019, as things currently stand this means that banks will
have to begin their preparations this autumn.
Many banks are simply not going to wait around. Deutsche
Bank is reported to be ready to relocate many of the banking books currently operated
out of London back to Frankfurt, and they are not alone. Three Japanese
institutions, Daiwa, Nomura and Sumitomo, are applying for licences to operate
businesses in Frankfurt and some big US institutions are reported to be raising
their German headcount. This is the business end of Brexit – jobs which might
otherwise have remained in London will be transferred elsewhere. Banks, in
particular, could find themselves on Brexit day unable to conduct business in
the EU if they do not make plans now.
Whilst at present the numbers discussed publicly are small,
the concern is that this could mark the thin end of a bigger wedge. The City of
London contributed 11.5% of total government tax receipts in fiscal 2015-16,
and business not conducted in London and jobs transferred elsewhere represents
tax revenue which does not flow into the UK government’s coffers. In Philip Hammond’s
words, voters did not vote to make themselves poorer by backing Brexit. But at
a time when the government is under pressure to ease back on austerity, allowing high value added
business to slip away because government cannot get its act together will end
up doing just that.
Thursday, 6 July 2017
Tuesday, 4 July 2017
Getting our facts right
A few weeks ago I was involved in a debate with a young
analyst who refused to believe that exchange rates are driven by factors other
than trade deficits (not current accounts, simply the flow of trade in goods).
After fruitless attempts to try and engage in some form of intellectual debate,
only to be met each time with the stock response “I disagree,” I simply shut
down the conversation. This is not my preferred mode of interaction – far from
it. We learn from discourse and I like to think I am open to changing my mind
on various issues if the facts prove I was wrong.
It was in this vein that I read with interest a blog piece by Noah Smith entitled “Is economics a science?” "Real" scientists would treat the question with contempt and indeed I never try to claim that it is. But what economics tries to do is measure and draw inference from observation. In that respect it employs scientific methods even if it does not always result in scientific conclusions. One reason why the theory and practice differ so much is that the logical economic answer is not always politically acceptable. Economics also has deep philosophical roots which colour the prior beliefs of many practitioners. Indeed, one of Adam Smith’s noted works - admired by many on the political right - was a Theory of Moral Sentiments published 17 years before the Wealth of Nations. It is perhaps these philosophical underpinnings which explain why adherents to the Austrian school of economic thought, which also derives from a branch of philosophy, eschew empiricism in favour of a priori deduction in order to reach a conclusion.
I could not help thinking during the Brexit debate last year that many of the leading Brexiteers were adherents of free market economics of the kind espoused by the Austrian school. It therefore does not surprise me that many of their arguments were not backed up by empirical analysis. I have also been struck by the apparent shift in tone of those who 12 months ago supported Brexit. Only today, the campaign director of Vote Leave, Dominic Cummings, admitted that “in some possible branches of the future leaving will be an error” (let me correct you there, Dominic. In pretty much all branches of the future leaving will be an error). Cummings appears to be directing much of the blame for this on the way it has been handled by Downing Street. Personally, I prefer the explanation that those responsible for promoting the cause did not do their homework and failed to think through the implications of their actions. In other words, they adopted a very unscientific approach.
However, we also have to be very careful when making arguments based on data alone. One of the issues which the academic world is currently very concerned about is the accuracy and replicability of much (non-economic) scientific work. Only last week, the president of the Royal Statistical Society, Professor Sir David Spiegelhalter, pointed out that public trust in scientific conclusions is being undermined by a “failure to adhere to good scientific practice and the desperation to publish or perish.” As Spiegelhalter points out, most scientists do not overtly falsify their data, but they sometimes play fast and loose with statistical inference (credit should also go to The Economist for having made this point repeatedly in recent years).
Aside from problems arising from the accuracy of results, economics suffers from another problem due to the quality of the underlying data. Although I do believe that economic statisticians are free from political bias, economic data often suffer from sample bias due to the fact that it is constructed by drawing population inferences from a relatively small sample. It is often an approximation to reality at best. A case in point is UK labour force data, where a tightening of the criteria for benefit eligibility means that many people whose fitness for work is questionable, have been reclassified as part of the labour force. UK immigration data are also not fit for purpose either, despite the fact that they form a key element in the government’s Brexit strategy (amongst other reasons, because the UK does not require migrants to register after arrival, the figures are compiled from the International Passenger Survey, which has numerous methodological shortcomings).
But for all that, a debate based on some form of data is always more informed than one based purely on belief and supposition. As the Canadian academic Marshall McLuhan pointed out, “a point of view can be a dangerous luxury when substituted for insight and understanding.” A year on from the Brexit referendum, that rings all the more true.
It was in this vein that I read with interest a blog piece by Noah Smith entitled “Is economics a science?” "Real" scientists would treat the question with contempt and indeed I never try to claim that it is. But what economics tries to do is measure and draw inference from observation. In that respect it employs scientific methods even if it does not always result in scientific conclusions. One reason why the theory and practice differ so much is that the logical economic answer is not always politically acceptable. Economics also has deep philosophical roots which colour the prior beliefs of many practitioners. Indeed, one of Adam Smith’s noted works - admired by many on the political right - was a Theory of Moral Sentiments published 17 years before the Wealth of Nations. It is perhaps these philosophical underpinnings which explain why adherents to the Austrian school of economic thought, which also derives from a branch of philosophy, eschew empiricism in favour of a priori deduction in order to reach a conclusion.
I could not help thinking during the Brexit debate last year that many of the leading Brexiteers were adherents of free market economics of the kind espoused by the Austrian school. It therefore does not surprise me that many of their arguments were not backed up by empirical analysis. I have also been struck by the apparent shift in tone of those who 12 months ago supported Brexit. Only today, the campaign director of Vote Leave, Dominic Cummings, admitted that “in some possible branches of the future leaving will be an error” (let me correct you there, Dominic. In pretty much all branches of the future leaving will be an error). Cummings appears to be directing much of the blame for this on the way it has been handled by Downing Street. Personally, I prefer the explanation that those responsible for promoting the cause did not do their homework and failed to think through the implications of their actions. In other words, they adopted a very unscientific approach.
However, we also have to be very careful when making arguments based on data alone. One of the issues which the academic world is currently very concerned about is the accuracy and replicability of much (non-economic) scientific work. Only last week, the president of the Royal Statistical Society, Professor Sir David Spiegelhalter, pointed out that public trust in scientific conclusions is being undermined by a “failure to adhere to good scientific practice and the desperation to publish or perish.” As Spiegelhalter points out, most scientists do not overtly falsify their data, but they sometimes play fast and loose with statistical inference (credit should also go to The Economist for having made this point repeatedly in recent years).
Aside from problems arising from the accuracy of results, economics suffers from another problem due to the quality of the underlying data. Although I do believe that economic statisticians are free from political bias, economic data often suffer from sample bias due to the fact that it is constructed by drawing population inferences from a relatively small sample. It is often an approximation to reality at best. A case in point is UK labour force data, where a tightening of the criteria for benefit eligibility means that many people whose fitness for work is questionable, have been reclassified as part of the labour force. UK immigration data are also not fit for purpose either, despite the fact that they form a key element in the government’s Brexit strategy (amongst other reasons, because the UK does not require migrants to register after arrival, the figures are compiled from the International Passenger Survey, which has numerous methodological shortcomings).
But for all that, a debate based on some form of data is always more informed than one based purely on belief and supposition. As the Canadian academic Marshall McLuhan pointed out, “a point of view can be a dangerous luxury when substituted for insight and understanding.” A year on from the Brexit referendum, that rings all the more true.
Sunday, 2 July 2017
Helmut Kohl's legacy
A memorial service was held in Strasbourg yesterday for
former German Chancellor Helmut Kohl, who died on 16 June. Whilst his death
briefly made headlines in the British press, coverage of what was in effect a
European state funeral barely made a splash on this side of the channel. That
says a lot about the way the British media thinks of European issues. Kohl was,
after all, praised across the continent for being the lead architect in the
construction of the EU – an institution which the British electorate rejected
12 short months ago.
Politically, Kohl was a unifier: In addition to his role on the European stage, he will forever be remembered as the Chancellor who reunited Germany. But as the German media has highlighted, one of the great ironies is that he never managed to unify his family: Even in death, he remained estranged from his two sons. Nor, despite the eulogies, did he share Angela Merkel’s vision, particularly with regard to the handling of the euro crisis. Kohl was a historian with no interest in economics. His was the politics of the grand vision, regardless of the cost. Very few politicians of the post-war era would have attempted a project as ambitious as German reunification. But no reputable economist agreed with the decision to convert the Ostmark to the Deutschmark at a rate of 1:1 which gave East Germans a short-lived income boost but which later wiped out the eastern economy.
Many German economists also believe that his push to introduce the euro was badly handled. The decision to introduce a pan-European currency without the appropriate leadership structure in the EU, and without a body to direct common political and economic policies for the euro zone, means that the single currency effectively remains little more than a glorified fixed income mechanism. It was created on the basis of the competitive situation which prevailed in the 1990s, and the pain associated with maintaining competitiveness was always going to require significant domestic adjustment: Even the European Commission was clear about this in the mid-1990s. As Die Zeit put it, “a currency union was created that only worked when the sun shone. And when a storm, in the form of a financial crisis, came along, Mr. Kohl’s peace project became the nucleus of the largest European crisis since the war.”
Undoubtedly, Kohl’s solution to the Greek debt crisis would have been to dip deeper into German pockets to find a financial solution. It might even have worked – for a while. But it does not detract from the fact that there are significant faults in the construction of monetary union which need to be fixed. Although Kohl was not honest with his own electorate about the costs of monetary union – living in Germany at the time, I was acutely aware of that – we cannot pin all the blame for the euro zone’s ills on his shoulders. Politicians in other countries signed up willingly to the euro without realising that their own economies would have to bear a far greater share of the adjustment burden than Germany.
The election of Emmanuel Macron as French President has been hailed across the continent as a chance to rebuild the Franco-German axis that drove the European project forward during the 1980s and 1990s. Macron has proposed a common fiscal policy, a joint finance minister and the completion of banking union, and surprisingly he has been given a sympathetic hearing in Berlin. But we cannot so easily turn back the clock to the halcyon days of Kohl and Mitterrand. The world has changed, with the rise of Asia having permanently altered the global economic landscape. Nor is it so certain that the people of Europe today share the vision for their continent which Kohl espoused. His was a vision rooted in the past, designed to ensure that the horrors of the first half of the twentieth century could not be repeated. That was, and is, a laudable goal. But the survey evidence suggests that European electorates remain sceptical of the need for further integration.
Europe in early 1995, after Kohl’s fourth election victory, felt like a good place to be. The EU was a smaller, more manageable institution with just 15 members. It was moving towards convergence at a pace which felt comfortable and although progress towards a single currency was ongoing, there were widespread doubts that it would be operational by 1999. It felt more like a warm and fuzzy aspiration which made the federalists feel good yet was far enough away not to worry the sceptics too much. In my view, that was Kohl’s real achievement: He led the horse to water. It is unfortunate that the purity of the water did not match up to expectations.
Politically, Kohl was a unifier: In addition to his role on the European stage, he will forever be remembered as the Chancellor who reunited Germany. But as the German media has highlighted, one of the great ironies is that he never managed to unify his family: Even in death, he remained estranged from his two sons. Nor, despite the eulogies, did he share Angela Merkel’s vision, particularly with regard to the handling of the euro crisis. Kohl was a historian with no interest in economics. His was the politics of the grand vision, regardless of the cost. Very few politicians of the post-war era would have attempted a project as ambitious as German reunification. But no reputable economist agreed with the decision to convert the Ostmark to the Deutschmark at a rate of 1:1 which gave East Germans a short-lived income boost but which later wiped out the eastern economy.
Many German economists also believe that his push to introduce the euro was badly handled. The decision to introduce a pan-European currency without the appropriate leadership structure in the EU, and without a body to direct common political and economic policies for the euro zone, means that the single currency effectively remains little more than a glorified fixed income mechanism. It was created on the basis of the competitive situation which prevailed in the 1990s, and the pain associated with maintaining competitiveness was always going to require significant domestic adjustment: Even the European Commission was clear about this in the mid-1990s. As Die Zeit put it, “a currency union was created that only worked when the sun shone. And when a storm, in the form of a financial crisis, came along, Mr. Kohl’s peace project became the nucleus of the largest European crisis since the war.”
Undoubtedly, Kohl’s solution to the Greek debt crisis would have been to dip deeper into German pockets to find a financial solution. It might even have worked – for a while. But it does not detract from the fact that there are significant faults in the construction of monetary union which need to be fixed. Although Kohl was not honest with his own electorate about the costs of monetary union – living in Germany at the time, I was acutely aware of that – we cannot pin all the blame for the euro zone’s ills on his shoulders. Politicians in other countries signed up willingly to the euro without realising that their own economies would have to bear a far greater share of the adjustment burden than Germany.
The election of Emmanuel Macron as French President has been hailed across the continent as a chance to rebuild the Franco-German axis that drove the European project forward during the 1980s and 1990s. Macron has proposed a common fiscal policy, a joint finance minister and the completion of banking union, and surprisingly he has been given a sympathetic hearing in Berlin. But we cannot so easily turn back the clock to the halcyon days of Kohl and Mitterrand. The world has changed, with the rise of Asia having permanently altered the global economic landscape. Nor is it so certain that the people of Europe today share the vision for their continent which Kohl espoused. His was a vision rooted in the past, designed to ensure that the horrors of the first half of the twentieth century could not be repeated. That was, and is, a laudable goal. But the survey evidence suggests that European electorates remain sceptical of the need for further integration.
Europe in early 1995, after Kohl’s fourth election victory, felt like a good place to be. The EU was a smaller, more manageable institution with just 15 members. It was moving towards convergence at a pace which felt comfortable and although progress towards a single currency was ongoing, there were widespread doubts that it would be operational by 1999. It felt more like a warm and fuzzy aspiration which made the federalists feel good yet was far enough away not to worry the sceptics too much. In my view, that was Kohl’s real achievement: He led the horse to water. It is unfortunate that the purity of the water did not match up to expectations.
Tuesday, 27 June 2017
Central banks face an inflation dilemma
Over the course of recent weeks there has been a shift in
the message communicated by monetary policy makers. The monetary authorities on
the other side of the Atlantic have long been ahead of their European
counterparts, with the Fed having raised rates four times since December 2015
and three times in the last six months. But it has now gone further and
announced in mid-June that it “expects to
begin implementing a balance sheet normalization program this year, provided
that the economy evolves broadly as anticipated.” A week prior to that the
ECB changed its assessment of the balance of economic risks to “balanced” rather than “tilted to the downside” whilst only last
week, Norges Bank removed its previous guidance that interest rates could be cut this year. Also this month, the
Bank of England only narrowly voted to hold rates at their all-time low of
0.25% with three members of the Monetary Policy Committee pushing for a 25 bps
rate hike.
The narrowness of the BoE vote came as a surprise with the dissenters concerned that inflation had overshot relative to expectations, reaching a four year high last month, at the same time as the margin of spare capacity in the economy has clearly diminished. My initial reaction to this reasoning was that it was flawed: Inflation has surged largely because of the impact of currency depreciation and so long as this does not impact markedly on inflation expectations, which leads to faster wage growth, the BoE may simply have to swallow the problem. Indeed, with wage growth slower today than before the EU referendum, higher interest rates at a time of falling real wages will not do anyone any favours. That said, with the unemployment rate close to the BoE’s estimate of the NAIRU, such concerns are understandable.
My own view is that the uncertainties surrounding Brexit will suffice to keep UK inflation expectations in check for some time to come. Indeed, across much of the industrialised world, it is proving difficult to drive up inflation: In both the US and euro zone inflation is struggling to reach the central bank’s 2% target – a trend which will not be helped by the recent decline in oil prices which has supported headline inflation in the past year. Although central banks have a mandate to control inflation, and in many cases have to meet particular targets, it is difficult to explain to the wider public that there is no automatic link between price growth and interest rates – just as there is not, and never has been, one between inflation and money supply growth, despite the best efforts of many politicians and (some) economists to convince us otherwise. As if we needed proof, consider the case of Japan where despite running a balance sheet equivalent to 90% of GDP – almost four times that of the Fed, ECB or BoE – inflation has only exceeded the BoJ’s 2% target for three months during this century (once we strip out the distortionary effects of consumption taxes, see chart).
The narrowness of the BoE vote came as a surprise with the dissenters concerned that inflation had overshot relative to expectations, reaching a four year high last month, at the same time as the margin of spare capacity in the economy has clearly diminished. My initial reaction to this reasoning was that it was flawed: Inflation has surged largely because of the impact of currency depreciation and so long as this does not impact markedly on inflation expectations, which leads to faster wage growth, the BoE may simply have to swallow the problem. Indeed, with wage growth slower today than before the EU referendum, higher interest rates at a time of falling real wages will not do anyone any favours. That said, with the unemployment rate close to the BoE’s estimate of the NAIRU, such concerns are understandable.
My own view is that the uncertainties surrounding Brexit will suffice to keep UK inflation expectations in check for some time to come. Indeed, across much of the industrialised world, it is proving difficult to drive up inflation: In both the US and euro zone inflation is struggling to reach the central bank’s 2% target – a trend which will not be helped by the recent decline in oil prices which has supported headline inflation in the past year. Although central banks have a mandate to control inflation, and in many cases have to meet particular targets, it is difficult to explain to the wider public that there is no automatic link between price growth and interest rates – just as there is not, and never has been, one between inflation and money supply growth, despite the best efforts of many politicians and (some) economists to convince us otherwise. As if we needed proof, consider the case of Japan where despite running a balance sheet equivalent to 90% of GDP – almost four times that of the Fed, ECB or BoE – inflation has only exceeded the BoJ’s 2% target for three months during this century (once we strip out the distortionary effects of consumption taxes, see chart).
There are numerous reasons why inflation today is much lower
than during previous periods when prevailing economic circumstances were
similar. A much more globalised economy, in which value chains stretch across
international borders has been one of the key factors holding down price
inflation over the past decade. This has been accompanied by technological
change which has depressed wage expectations. In effect, the pricing power of
labour has been reduced as wages are increasingly set according to
international conditions rather than those in local labour markets. Moreover,
as the BIS reminds us in a message that too many economists often overlook, “wage growth is not necessarily inflationary: whenever it is supported
by productivity gains, it will not lead to rising production costs.” And as
I never tire of pointing out, although the UK’s productivity record has been
dismal since the great financial crisis, it has still been stronger than real wage
growth.
In an environment where the link between the domestic economy and wages has weakened, this makes it difficult for central banks to justify raising rates based on the threat of more rapid potential wage growth. But low interest rates have contributed to the asset bubble which has forced – or perhaps facilitated – investors to take risks in order to generate faster rates of return. Some form of monetary tightening is thus desirable. It is for this reason that the BoE today announced that it will raise banks’ countercyclical capital buffer – a measure of mandatory additional capital holdings – from zero to 0.5%, with a view to raising it to 1% in November in a bid to curb excess credit growth.
I must confess to some mixed feelings on the situation we now find ourselves in. On the one hand, central banks are concerned about the impacts of low interest rates on credit and asset price growth. Yet on the other, they wish to ensure financial stability which appears to be at odds with the current loose monetary stance. The case for higher rates based on price inflation or wage growth is weak. But there is an argument to suggest that the wider impacts of running a loose monetary policy require some tightening. For the moment, the likes of Norges Bank and the ECB can get away with merely talking about it. The BoE fiddles around the edges by adjusting macroprudential measures. But before long, they may all be forced to follow the Fed – everyone does in the end.
In an environment where the link between the domestic economy and wages has weakened, this makes it difficult for central banks to justify raising rates based on the threat of more rapid potential wage growth. But low interest rates have contributed to the asset bubble which has forced – or perhaps facilitated – investors to take risks in order to generate faster rates of return. Some form of monetary tightening is thus desirable. It is for this reason that the BoE today announced that it will raise banks’ countercyclical capital buffer – a measure of mandatory additional capital holdings – from zero to 0.5%, with a view to raising it to 1% in November in a bid to curb excess credit growth.
I must confess to some mixed feelings on the situation we now find ourselves in. On the one hand, central banks are concerned about the impacts of low interest rates on credit and asset price growth. Yet on the other, they wish to ensure financial stability which appears to be at odds with the current loose monetary stance. The case for higher rates based on price inflation or wage growth is weak. But there is an argument to suggest that the wider impacts of running a loose monetary policy require some tightening. For the moment, the likes of Norges Bank and the ECB can get away with merely talking about it. The BoE fiddles around the edges by adjusting macroprudential measures. But before long, they may all be forced to follow the Fed – everyone does in the end.
Friday, 23 June 2017
(Un)happy anniversary
They say that time flies as you get older. That must make me
positively ancient, as I can so vividly recall the events of 23-24 June 2016 as
if it were yesterday. I am referring, of course, to the EU referendum. The effects of
that vote have been socially and politically profound, and although the
economic impacts have so far been modest they will make their presence felt
over time.
For a vote which was designed to heal divisions within the Conservative Party over Europe, it was a catastrophic failure. It still threatens to tug at the unity of the UK: even though the pressure for a second independence referendum in Scotland has diminished in the wake of the election, it has not gone away completely and the position of Northern Ireland within the union may be called into question in the longer term, even though a split appears unlikely in the near future. There is a clear split between the aspirations of younger and older generations, as evidenced by voting patterns last June and again in the recent general election. And the intervening twelve months have done nothing to lessen the differences of opinion between those who wish to leave the EU and those who wish to stay. In short, the referendum resolved nothing – as I never thought it would. Indeed, I have always believed that whatever the outcome, the UK would remain semi-detached members of the EU and I stand by that view today.
Regular readers of these pages (and thanks to you all for sticking with it) will know that my anger at the Brexit issue is less about the result itself than about the lies used by self-serving politicians to serve their own ends, aided and abetted by sections of the media which have an ideological agenda. Politicians simply invented economic facts which to me is unacceptable (the most famous of which was the claim that leaving the EU would allow the government to direct an additional £350 million of extra resources per week to the NHS). They lied on immigration by failing to point out that more than half of the immigrants into the UK over the past decade came from non-EU countries, where the UK has control over its borders (they omitted to mention that a large number of these non-EU immigrants were students who support British universities).
But the biggest lie of all was that the EU needed the UK more than it needed the EU and that the EU27 would beg to do a deal which would give us exactly the same conditions as we enjoyed previously, but with extra flexibility to do great deals with non-EU countries. None of these assertions was backed up by evidence. Indeed, the only economic study showing evidence in favour of Brexit was based on assumptions so heroic it makes Superman look like a coward (notably the idea that the EU would be forced to halve the levels of protection on imports from outside the bloc – see here for further detail).
The likes of Boris Johnson, Nigel Farage, Michael Gove, Daniel Hannan and Matthew Elliott portrayed themselves as economic liberators who could lead the UK to the sunny uplands of a brighter economic future. I note that none them studied economics or business and only Farage has any claim to a business career. Nor is there a scientist amongst them who appears to recognise the value of hard evidence. On the basis that the dictionary definition of treason is “the crime of betraying one's country”, those who promoted the economic case for Brexit are closer to traitors than liberators.
As for where we go from here, that is all still up in the air. The government has been forced to backtrack on many of its initial Brexit positions. Theresa May herself was nominally a Remainer who appears to have become a champion of hard Brexit; parliament was originally to be denied a vote on the terms of the Brexit deal once it had been agreed with the EU27 (now it will be allowed a vote); the government also initially planned to invoke Article 50 without a parliamentary vote but was forced by the courts to do so and a suggestion that that companies would have to publish figures on their number of foreign workers was also quickly dropped. Add in the fact that only this week the UK quickly caved in to EU demands on the sequencing of the Brexit negotiations, and large parts of the government’s manifesto did not make into the Queen’s Speech (meaning that it will not be enacted during this parliamentary term), and you have to wonder how many other red lines will be crossed.
A survey published in The Times this morning (here for an overview ) suggests that a 58% majority wants a deal in which the UK continues to have free access to trade with the EU whilst allowing EU citizens the right to live and work in the UK. Only 42% preferred the alternative of full control over immigration but British businesses having no access to the EU single market. This was actually the choice we were faced with a year ago, only it was not put this way. Bottom line: There is no appetite for a hard Brexit, and it is becoming increasingly apparent that the government misread the message delivered by the electorate last year, which I maintain was more a howl of rage than a desire to pull up the drawbridge.
My preferred solution is that the UK does not leave the EU at all. I don’t wish to sound like a disaffected Remoaner but it is not impossible that if the negotiations drag on for a decade or more, resulting in a second referendum given that many people will have forgotten why the UK voted to leave in the first place, the generational shift in the electorate may produce a different result. The sensible strategy from the EU’s perspective would thus be to offer a deal in 2019 which the UK finds unacceptable but be willing to extend the negotiating period indefinitely. If Theresa May’s government wishes to do a deal more quickly than that (and it does) I suggest that the EU offers the UK access to the single market at a price which is lower than that which it currently pays but with correspondingly reduced rights. Indeed, I have made this point before but have since read that the German government takes a similar view.
As for where we will be in a year’s time, I suspect not much further forward. If the EU plays hardball on the Brexit bill and the UK refuses to back down, the clock will be running down without any tangible sign of progress on the trade deal which the UK so badly wants. This is all so unnecessary because it’s self-inflicted and was predictable all along. For those who led the Brexit campaign, I say only this: Judgement Day is coming.
For a vote which was designed to heal divisions within the Conservative Party over Europe, it was a catastrophic failure. It still threatens to tug at the unity of the UK: even though the pressure for a second independence referendum in Scotland has diminished in the wake of the election, it has not gone away completely and the position of Northern Ireland within the union may be called into question in the longer term, even though a split appears unlikely in the near future. There is a clear split between the aspirations of younger and older generations, as evidenced by voting patterns last June and again in the recent general election. And the intervening twelve months have done nothing to lessen the differences of opinion between those who wish to leave the EU and those who wish to stay. In short, the referendum resolved nothing – as I never thought it would. Indeed, I have always believed that whatever the outcome, the UK would remain semi-detached members of the EU and I stand by that view today.
Regular readers of these pages (and thanks to you all for sticking with it) will know that my anger at the Brexit issue is less about the result itself than about the lies used by self-serving politicians to serve their own ends, aided and abetted by sections of the media which have an ideological agenda. Politicians simply invented economic facts which to me is unacceptable (the most famous of which was the claim that leaving the EU would allow the government to direct an additional £350 million of extra resources per week to the NHS). They lied on immigration by failing to point out that more than half of the immigrants into the UK over the past decade came from non-EU countries, where the UK has control over its borders (they omitted to mention that a large number of these non-EU immigrants were students who support British universities).
But the biggest lie of all was that the EU needed the UK more than it needed the EU and that the EU27 would beg to do a deal which would give us exactly the same conditions as we enjoyed previously, but with extra flexibility to do great deals with non-EU countries. None of these assertions was backed up by evidence. Indeed, the only economic study showing evidence in favour of Brexit was based on assumptions so heroic it makes Superman look like a coward (notably the idea that the EU would be forced to halve the levels of protection on imports from outside the bloc – see here for further detail).
The likes of Boris Johnson, Nigel Farage, Michael Gove, Daniel Hannan and Matthew Elliott portrayed themselves as economic liberators who could lead the UK to the sunny uplands of a brighter economic future. I note that none them studied economics or business and only Farage has any claim to a business career. Nor is there a scientist amongst them who appears to recognise the value of hard evidence. On the basis that the dictionary definition of treason is “the crime of betraying one's country”, those who promoted the economic case for Brexit are closer to traitors than liberators.
As for where we go from here, that is all still up in the air. The government has been forced to backtrack on many of its initial Brexit positions. Theresa May herself was nominally a Remainer who appears to have become a champion of hard Brexit; parliament was originally to be denied a vote on the terms of the Brexit deal once it had been agreed with the EU27 (now it will be allowed a vote); the government also initially planned to invoke Article 50 without a parliamentary vote but was forced by the courts to do so and a suggestion that that companies would have to publish figures on their number of foreign workers was also quickly dropped. Add in the fact that only this week the UK quickly caved in to EU demands on the sequencing of the Brexit negotiations, and large parts of the government’s manifesto did not make into the Queen’s Speech (meaning that it will not be enacted during this parliamentary term), and you have to wonder how many other red lines will be crossed.
A survey published in The Times this morning (here for an overview ) suggests that a 58% majority wants a deal in which the UK continues to have free access to trade with the EU whilst allowing EU citizens the right to live and work in the UK. Only 42% preferred the alternative of full control over immigration but British businesses having no access to the EU single market. This was actually the choice we were faced with a year ago, only it was not put this way. Bottom line: There is no appetite for a hard Brexit, and it is becoming increasingly apparent that the government misread the message delivered by the electorate last year, which I maintain was more a howl of rage than a desire to pull up the drawbridge.
My preferred solution is that the UK does not leave the EU at all. I don’t wish to sound like a disaffected Remoaner but it is not impossible that if the negotiations drag on for a decade or more, resulting in a second referendum given that many people will have forgotten why the UK voted to leave in the first place, the generational shift in the electorate may produce a different result. The sensible strategy from the EU’s perspective would thus be to offer a deal in 2019 which the UK finds unacceptable but be willing to extend the negotiating period indefinitely. If Theresa May’s government wishes to do a deal more quickly than that (and it does) I suggest that the EU offers the UK access to the single market at a price which is lower than that which it currently pays but with correspondingly reduced rights. Indeed, I have made this point before but have since read that the German government takes a similar view.
As for where we will be in a year’s time, I suspect not much further forward. If the EU plays hardball on the Brexit bill and the UK refuses to back down, the clock will be running down without any tangible sign of progress on the trade deal which the UK so badly wants. This is all so unnecessary because it’s self-inflicted and was predictable all along. For those who led the Brexit campaign, I say only this: Judgement Day is coming.
Wednesday, 21 June 2017
Austerity: A local government perspective
Austerity has been very much in the UK public eye over
recent weeks. It was a major topic during the election campaign but the tragic
fire at Grenfell Tower, where the final death toll has not yet been confirmed, has
thrown the issue into stark relief. Moreover, this is not just an
austerity-related issue because it raises questions regarding inequality, the
like of which we have not heard in the UK for many years.
There is certainly mounting anger at the circumstances in which this awful disaster took place. The Royal Borough of Kensington and Chelsea (RBKC) is, after all, one of the richest parts of London which in turn is significantly richer than the rest of the country. The argument runs that the poor people in North Kensington – the part of the borough perceived to be less salubrious – were ignored in a way that their richer counterparts elsewhere in the borough were not. There is, in some quarters, an attempt to pin blame on the Conservative Party for their stewardship of the economy which promoted the cost cutting culture which allowed the tragedy to take place. Without wishing to delve too deeply into the politics of this extremely sensitive issue, it is certainly worth looking more closely at the issue of local government financing to shine some light on the difficulties of running a local authority in the current hostile fiscal climate.
In fiscal year 2010-11, central government funded 76% of local authority (LA) spending. Since then the value of the transfer has fallen by 32% and the share of local spending funded from Westminster has fallen to 57% (chart). By way of compensation, local authorities are now allowed to retain a higher proportion (50%) of what they collect locally in the form of business rates (a levy on local businesses). Nonetheless, total LA spending has fallen by almost 10% over the last six years. Across the country as a whole, the budget for 2016-17 imposed the largest cash reduction on education services compared to 2015-16 (£765 million) whilst the biggest proportional reduction fell on highways and transport services (-10.6%).
Matters are not going to get any easier in the years ahead: By 2020, the government has committed to phase out its transfer to local government, which will be compensated by the fact that local authorities will be able to keep 100% of business rates revenue. As it currently stands, only 12.3% of revenue is derived from business rates. Even assuming this doubles by 2020, this will in no way be enough to compensate for the elimination of the central government grants, which will still be required to fund 45% of local spending unless there is a correspondingly huge decline in total outlays. For this reason, the system which gives protection to those authorities with lower levels of business rate income looks likely to be heavily utilised. Nonetheless, given this difficult backdrop, it is hardly surprising that local government spending is being slashed.
Although it is the smallest of London’s 32 boroughs, RBKC’s gross outlays in 2016-17 amounted to £680 million. On a net basis, the borough’s net spending undershot its budget by around 4% (£8.2million) in fiscal 2016-17, and the accounts show that in each of the last two fiscal years, the borough has recorded a surplus on the Housing Revenue Account (£12.2 million in 2016-17 and £19.6 million in the previous year). On the basis of these numbers, this appears to be a LA which has put the squeeze on. For comparative purposes, I looked at the accounts of the City of Newcastle partly because they are similar in scale to those of RBKC, and also because the leader of Newcastle council, Nick Forbes, was one of the first to advocate cutting frontline services in the wake of the London-imposed fiscal squeeze. Interestingly, the Newcastle HRA showed an even bigger surplus in 2015-16 than RBKC of over £26 million.
Undoubtedly, local authorities will say that these surpluses are ring-fenced and will be used in future for housing related activity. So they should: local councils are, after all, non-profit organisations. But in the wake of the Grenfell Tower fire, there are those who question why the likes of Newcastle are making a net return of 22% on their local housing activities. However, life is not so simple. The reason why councils run an HRA surplus is that their finances are subject to a whole host of other regulations imposed on them by central government and part of the surplus reflects precautionary saving. They have far less autonomy than is believed even in cases like this where they nominally control the budget.
However, there is a much wider issue at stake here. Whilst we spend a lot of time fretting about general public finances in the UK, we devote relatively little time to looking at local finance issues. But we should, because it is primarily at the local level that we consume public services. We see austerity all around us at the local level: A library closure here, a request to buy extra school textbooks there. It all adds up to a very stretched system.
There is no doubt that over the last 30 years, local authorities have been subject to a considerable amount of central government influence which has allowed them to deflect blame for much of their actions onto Westminster. Indeed, it is only recently that they have been given any autonomy to hold onto the revenue they generate locally. Whilst it is true that decisions taken in London have forced local authorities to squeeze local spending, as they gain an increased degree of control over local revenue generation they will be able to break free of some of these constraints. In return, they will have to be held increasingly accountable for their actions. It will no longer be enough to say that the frequency of household refuse collections has been reduced to fortnightly thanks to central government decisions. More importantly, the prevention of disasters such as those occurring in West London will increasingly be viewed as the responsibility of local, rather than central government.
There is certainly mounting anger at the circumstances in which this awful disaster took place. The Royal Borough of Kensington and Chelsea (RBKC) is, after all, one of the richest parts of London which in turn is significantly richer than the rest of the country. The argument runs that the poor people in North Kensington – the part of the borough perceived to be less salubrious – were ignored in a way that their richer counterparts elsewhere in the borough were not. There is, in some quarters, an attempt to pin blame on the Conservative Party for their stewardship of the economy which promoted the cost cutting culture which allowed the tragedy to take place. Without wishing to delve too deeply into the politics of this extremely sensitive issue, it is certainly worth looking more closely at the issue of local government financing to shine some light on the difficulties of running a local authority in the current hostile fiscal climate.
In fiscal year 2010-11, central government funded 76% of local authority (LA) spending. Since then the value of the transfer has fallen by 32% and the share of local spending funded from Westminster has fallen to 57% (chart). By way of compensation, local authorities are now allowed to retain a higher proportion (50%) of what they collect locally in the form of business rates (a levy on local businesses). Nonetheless, total LA spending has fallen by almost 10% over the last six years. Across the country as a whole, the budget for 2016-17 imposed the largest cash reduction on education services compared to 2015-16 (£765 million) whilst the biggest proportional reduction fell on highways and transport services (-10.6%).
Matters are not going to get any easier in the years ahead: By 2020, the government has committed to phase out its transfer to local government, which will be compensated by the fact that local authorities will be able to keep 100% of business rates revenue. As it currently stands, only 12.3% of revenue is derived from business rates. Even assuming this doubles by 2020, this will in no way be enough to compensate for the elimination of the central government grants, which will still be required to fund 45% of local spending unless there is a correspondingly huge decline in total outlays. For this reason, the system which gives protection to those authorities with lower levels of business rate income looks likely to be heavily utilised. Nonetheless, given this difficult backdrop, it is hardly surprising that local government spending is being slashed.
Although it is the smallest of London’s 32 boroughs, RBKC’s gross outlays in 2016-17 amounted to £680 million. On a net basis, the borough’s net spending undershot its budget by around 4% (£8.2million) in fiscal 2016-17, and the accounts show that in each of the last two fiscal years, the borough has recorded a surplus on the Housing Revenue Account (£12.2 million in 2016-17 and £19.6 million in the previous year). On the basis of these numbers, this appears to be a LA which has put the squeeze on. For comparative purposes, I looked at the accounts of the City of Newcastle partly because they are similar in scale to those of RBKC, and also because the leader of Newcastle council, Nick Forbes, was one of the first to advocate cutting frontline services in the wake of the London-imposed fiscal squeeze. Interestingly, the Newcastle HRA showed an even bigger surplus in 2015-16 than RBKC of over £26 million.
Undoubtedly, local authorities will say that these surpluses are ring-fenced and will be used in future for housing related activity. So they should: local councils are, after all, non-profit organisations. But in the wake of the Grenfell Tower fire, there are those who question why the likes of Newcastle are making a net return of 22% on their local housing activities. However, life is not so simple. The reason why councils run an HRA surplus is that their finances are subject to a whole host of other regulations imposed on them by central government and part of the surplus reflects precautionary saving. They have far less autonomy than is believed even in cases like this where they nominally control the budget.
However, there is a much wider issue at stake here. Whilst we spend a lot of time fretting about general public finances in the UK, we devote relatively little time to looking at local finance issues. But we should, because it is primarily at the local level that we consume public services. We see austerity all around us at the local level: A library closure here, a request to buy extra school textbooks there. It all adds up to a very stretched system.
There is no doubt that over the last 30 years, local authorities have been subject to a considerable amount of central government influence which has allowed them to deflect blame for much of their actions onto Westminster. Indeed, it is only recently that they have been given any autonomy to hold onto the revenue they generate locally. Whilst it is true that decisions taken in London have forced local authorities to squeeze local spending, as they gain an increased degree of control over local revenue generation they will be able to break free of some of these constraints. In return, they will have to be held increasingly accountable for their actions. It will no longer be enough to say that the frequency of household refuse collections has been reduced to fortnightly thanks to central government decisions. More importantly, the prevention of disasters such as those occurring in West London will increasingly be viewed as the responsibility of local, rather than central government.
Tuesday, 20 June 2017
Brexit: Same stuff, different day
The UK’s Brexit negotiations may have kicked off
yesterday but there is a depressing inevitability to it all. We know that the UK’s
negotiating position is weak, and despite what David Davis’ demeanour suggested
beforehand, he has already been forced to concede on the question of sequencing
(and how many other positions will he have to retreat from before the summer is
out?). We know that Brexit will be economically damaging. We know that the
British government does not actually know what it wants. And we also know that
it does not have a mandate to pursue the hard Brexit which the Conservatives set
out in their manifesto. Apart from that, everything is hunky dory.
At least Mark Carney’s Mansion House speech this morning contained a thinly veiled jibe at Boris Johnson’s pre-referendum suggestion that his policy on Brexit is similar to his policy on cake (“My policy on cake is pro having it and pro eating it”), with Carney suggesting that “Before long, we will all begin to find out the extent to which Brexit is a gentle stroll along a smooth path to a land of cake and consumption.” Carney and the rest of the economics profession know that there is no cake at the end of this particular road.
He also implied that the idea of putting up trade barriers, which could be the result of failure to reach a Brexit agreement, was a bad idea. In his words, “Bank of England research estimates that up to one half of the post-crisis productivity slowdown could be related to the deceleration in global trade growth.” He argued that a liberalisation of services trade could be very much of benefit to the UK, given its specialisation in this area. In particular, Carney highlighted the importance of financial services: “One million people across this country work in financial services. The industry contributes 7% of output and pays taxes that cover almost two thirds of the cost of the NHS.” He did not need to say explicitly that failure to deliver a deal on financial services was a bad idea – his audience was way ahead of him – and it was a nice touch to link it to the hot topic of NHS funding.
But already there is pushback from continental Europe. London-based banks are being asked by the EU regulator to be more explicit about their plans for dealing with customers in the EU27, and only today ECB executive board member Benoît Cœuré backed the European Commission’s call for a new set of rules to govern euro clearing. Cœuré reiterated the view that the ECB, as the central issuer of euros, should be responsible for the clearing of euro transactions and not central banks outside the region. I warned in 2015 that this was likely to happen in the event of Brexit. Having failed in 2011 to force euro clearing to be conducted on the continent, after (ironically) the European Court of Justice ruled in the UK’s favour, I noted that any future attempt to “impose limits on non-euro zone trading in the event of Brexit would be much more difficult to refute, as the UK would no longer have such easy access to the ECJ, which could have significant adverse consequences for the UK’s dominant position in the FX market.”
I also pointed out that “intra-EU barriers are likely to be reduced over time as the single market for services continues to develop – something from which the UK will not benefit in the event of Brexit and which will raise potential welfare losses.” It might have seemed a fanciful notion to many people two years ago that the EU economy would ever find its feet again, but the growth differential between the euro zone and UK is projected to narrow considerably over the next couple of years, and in 2018 it is forecast by the EC to grow more rapidly. Given the shot in the arm which French President Macron has given the euro zone, who would bet against it?
It is for this reason that even Chancellor Philip Hammond, who was conspicuous by his absence during the election campaign suggested today that the needs of UK business need to be heard in the Brexit negotiations, arguing that current trading arrangements (i.e. single market and customs union membership) should remain in place until “new long-term arrangements are up and running.” Political commentators see this as an indication of the weakness of Theresa May’s position (and she still has not yet managed to come to an arrangement with the DUP, despite the fact that the new parliamentary term is scheduled to start tomorrow). Her position on Brexit was always out of tune with European political reality and with Michel Barnier reminding the UK that it is they who are leaving the EU and not the other way round, we begin to see the flimsiness of the government’s argument.
To end with, I did come across one article recently which was worth reading, by former head of MI6 John Sawers who, writing in the FT, noted that “Britain on its own will count for little on the world stage.” It is not so much that the argument is new, but Sawers put the decision to leave in the recent historical context which showed how the UK has punched above its weight diplomatically by being part of the EU. Particularly ironic was his comment that “we had two world-class leaders in Margaret Thatcher and Tony Blair, who set us back on the path of growth at home and leadership abroad … While John Major and Gordon Brown were not of the same stature internationally, they played their cards judiciously.” Funnily enough, not a mention of David Cameron or Mrs May, who historians may yet rank highly on the list of worst occupants of 10 Downing Street. And in an echo of the first post I wrote a year ago, Sawers concludes “if we can no longer help shape the world, others will do it for us. And Britain will have to lump the consequences.”
At least Mark Carney’s Mansion House speech this morning contained a thinly veiled jibe at Boris Johnson’s pre-referendum suggestion that his policy on Brexit is similar to his policy on cake (“My policy on cake is pro having it and pro eating it”), with Carney suggesting that “Before long, we will all begin to find out the extent to which Brexit is a gentle stroll along a smooth path to a land of cake and consumption.” Carney and the rest of the economics profession know that there is no cake at the end of this particular road.
He also implied that the idea of putting up trade barriers, which could be the result of failure to reach a Brexit agreement, was a bad idea. In his words, “Bank of England research estimates that up to one half of the post-crisis productivity slowdown could be related to the deceleration in global trade growth.” He argued that a liberalisation of services trade could be very much of benefit to the UK, given its specialisation in this area. In particular, Carney highlighted the importance of financial services: “One million people across this country work in financial services. The industry contributes 7% of output and pays taxes that cover almost two thirds of the cost of the NHS.” He did not need to say explicitly that failure to deliver a deal on financial services was a bad idea – his audience was way ahead of him – and it was a nice touch to link it to the hot topic of NHS funding.
But already there is pushback from continental Europe. London-based banks are being asked by the EU regulator to be more explicit about their plans for dealing with customers in the EU27, and only today ECB executive board member Benoît Cœuré backed the European Commission’s call for a new set of rules to govern euro clearing. Cœuré reiterated the view that the ECB, as the central issuer of euros, should be responsible for the clearing of euro transactions and not central banks outside the region. I warned in 2015 that this was likely to happen in the event of Brexit. Having failed in 2011 to force euro clearing to be conducted on the continent, after (ironically) the European Court of Justice ruled in the UK’s favour, I noted that any future attempt to “impose limits on non-euro zone trading in the event of Brexit would be much more difficult to refute, as the UK would no longer have such easy access to the ECJ, which could have significant adverse consequences for the UK’s dominant position in the FX market.”
I also pointed out that “intra-EU barriers are likely to be reduced over time as the single market for services continues to develop – something from which the UK will not benefit in the event of Brexit and which will raise potential welfare losses.” It might have seemed a fanciful notion to many people two years ago that the EU economy would ever find its feet again, but the growth differential between the euro zone and UK is projected to narrow considerably over the next couple of years, and in 2018 it is forecast by the EC to grow more rapidly. Given the shot in the arm which French President Macron has given the euro zone, who would bet against it?
It is for this reason that even Chancellor Philip Hammond, who was conspicuous by his absence during the election campaign suggested today that the needs of UK business need to be heard in the Brexit negotiations, arguing that current trading arrangements (i.e. single market and customs union membership) should remain in place until “new long-term arrangements are up and running.” Political commentators see this as an indication of the weakness of Theresa May’s position (and she still has not yet managed to come to an arrangement with the DUP, despite the fact that the new parliamentary term is scheduled to start tomorrow). Her position on Brexit was always out of tune with European political reality and with Michel Barnier reminding the UK that it is they who are leaving the EU and not the other way round, we begin to see the flimsiness of the government’s argument.
To end with, I did come across one article recently which was worth reading, by former head of MI6 John Sawers who, writing in the FT, noted that “Britain on its own will count for little on the world stage.” It is not so much that the argument is new, but Sawers put the decision to leave in the recent historical context which showed how the UK has punched above its weight diplomatically by being part of the EU. Particularly ironic was his comment that “we had two world-class leaders in Margaret Thatcher and Tony Blair, who set us back on the path of growth at home and leadership abroad … While John Major and Gordon Brown were not of the same stature internationally, they played their cards judiciously.” Funnily enough, not a mention of David Cameron or Mrs May, who historians may yet rank highly on the list of worst occupants of 10 Downing Street. And in an echo of the first post I wrote a year ago, Sawers concludes “if we can no longer help shape the world, others will do it for us. And Britain will have to lump the consequences.”
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