In 1979, Gary Numan had hits with two songs which topped the
charts around the world: Are Friends Electric and Cars.
Almost forty years later, societies are asking themselves whether electric cars
are their new friends as policy makers in France and the UK propose a ban on
the sale of petrol and diesel vehicles by 2040 in order to encourage the sale
of electric vehicles.
According to the IEA around 17% of global CO2
emissions derive from road transport – a figure which rises to 19% in non-G20
countries (see p35, here).
It is thus understandable why governments want to take action. But there are
lots of issues which need addressing before we accept that this is a “good”
policy, and I do wonder how much of this policy has been thought through. For
one thing, it will take action by more than just the UK and France to have much
impact on global CO2 emissions. When the US and China follow suit
the policy will have a lot more resonance – or if it were an EU wide
initiative, it would make more sense.
The big issue at the heart of the debate is that electric
cars are simply not as green as many proponents would have us believe. Sure,
they emit less CO2 but the electricity to power them has to be
generated somewhere and if all we do is build more coal-fired power stations it
rather defeats the object. It is unlikely, of course, that the government would
permit a return to coal, so how will we generate the additional power? Let us
start by trying to understand the scale of the problem. The National Grid recently estimated that raising the number of electric vehicles could increase peak UK electricity demand by 8
gigawatts (GW).
That is the equivalent of building three new power stations the size of the
much-disputed Hinkley Point nuclear station. Admittedly, this does represent an
extreme case, with greater use of off-peak charging likely to mitigate the
scale of the problem, but it nonetheless makes the point that putting more
electric cars on the road requires building more generating capacity.
Having determined that the UK will require up to an
additional 8GW of electricity just to keep our cars on the road, how will we
generate it? We could simply build another three Hinkley Point-type nuclear stations, but given all
the concerns regarding their cost – not to mention the perennial problem of how
to get rid of the waste – this would be highly controversial. We could add more
wind turbines but it would mean raising capacity by 50% and we all know how
intermittent wind power can be. Solar is probably a non-starter in the UK. However,
tidal may be an option with a barrage across the River Severn – which has the
second largest tidal range in the word – potentially capable of generating 8GW
at peak flow, which would be operational for 8 hours per day, according to a
1989 study. It would be costly (up to £34bn on one estimate, which is almost
double the cost of one Hinkley Point) but potentially feasible.
So let us assume that we can generate the electricity. What
about the technology – is it good enough to supersede the internal combustion engine?
Only this week, Tesla handed over its
first Model 3 which costs $35,000 and has a range of 220 miles (350 km) – about
one-third what a larger diesel-engine vehicle is capable of delivering. A
longer range version will do 450km on one set of batteries but it costs a
third more and is still more limited than cars can do today. In
order to manage a 900 km journey across Europe, the standard model requires two charges which, given current battery technology, is not going to be
a quick process. Perhaps we could swap over the battery rig, with fully-charged
batteries replacing the old ones. This would mean making a couple of quick
stops whilst the batteries are swapped but it is not dissimilar to the current
process of refilling our cars at a filling station. So far, so possible (at
least not too impossible).
But what happens during the transition process towards our
2040 cut-off point? Relatively few people will want to buy a new petrol or
diesel car after 2030 given the lack of resale value, so we will need to see
significant advances in electronic car technology by then in order to convince
people that the transition will happen. That is just 13 years away. And will
there be a scrapping scheme to help individuals make the switch (that will be costly)?
Will car companies be able to ramp up production to meet likely demand – the
likes of Ford argue that Tesla will struggle to increase production on the scale
required? Indeed it is possible that
until many of these questions are answered, many Brits (and French) will act
like the Cubans by keeping their old cars on the road for longer than they
would otherwise do (assuming that petrol stations are not phased out). And how
will the oil companies respond? How will governments fill the revenue gap left
by the fall in fuel duty which they currently levy on the motorist?
One standard response to these objections is to cast your
mind back to 1994 to a pre-internet age when many of the things we take for granted
today seemed like science fiction. But the difference is that the technology
evolved, and was not imposed upon us. We can still go down to the High Street
rather than rely on Amazon deliveries, but the policy as currently portrayed is
a bit like abolishing the practice of letter writing in favour of email. Clearly,
there are more questions than answers.
Most people are prepared
to do their bit to help save the planet but we need a properly thought out
response to the questions raised. Announcing a plan then saying we will work
out the details as we go along is not a sensible policy strategy. Let us not
forget that in the UK, it was new environment minister Michael Gove who
announced the death knell of vehicles fuelled by carbon. This was the same man who
was fabulously short on detail as to how Brexit would work. There again, he can
always go back to his team of experts to help him out – if he hasn’t had enough
of them.
Sunday, 30 July 2017
Wednesday, 26 July 2017
What does it take?
There are certain central banking events which have gone down in history. Sometimes the event was only momentous in hindsight, as with Ben Bernanke’s 2002 speech setting out the guidelines of what would later become the QE doctrine. Occasionally, as with Alan Greenspan’s “irrational exuberance” comments in December 1996, it was obvious at the time that something truly memorable had just happened. Another such event took place five years ago when on this day in 2012, Mario Draghi made his famous speech in which he promised that “Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough.”
It was! Indeed Draghi deserves a lot of credit for keeping
the show on the road against a backdrop which threatened to become utterly
chaotic. His first act on taking over as ECB President in November 2011 had
been to reverse the ECB’s misguided rate hikes earlier that year. But by summer
2012, the euro zone was experiencing an existential crisis with talk of Grexit
high on the agenda. Draghi’s words helped calm a fragile market, and by subsequently
stepping into the vacuum created by a lack of government clarity, the ECB did
indeed do what was necessary. It pumped huge volumes of liquidity into the
system and apart from a brief wobble in
summer 2015, the euro zone has steadily moved forward. In the sense that Draghi’s
goal was to prevent the euro zone from fragmenting, he very much did what was
required. Indeed, today there is very much a sense of optimism surrounding the
euro zone economy as sentiment continues to rise.
But the ECB still has its foot to the floor, buying huge
quantities of government bonds as part of its QE programme and speculation is
increasingly mounting as to when and how it will begin tapering its purchases.
Meanwhile, the Federal Reserve has been through a tapering process culminating
in a cessation of bond purchases, and has raised interest rates by a total of
100 bps since December 2015. Indeed, the Fed is actively discussing balance
sheet reduction, so monetary policy normalisation is clearly underway in the US.
Despite this, both the MOVE index of US Treasury market option volatility and
the VIX index of equity option volatility have touched all-time lows on data
back to 1988 and 1990, respectively (see chart). It may be summer, and trading
vols have dwindled, but this does raise a question as to whether markets are
too complacent. There again, what do markets have to fear?
Do central banks now need to show that their bite is indeed as bad as their bark? The reason markets are idling along is an indication that they do not fear tighter policy. They should! Central bankers are aware of the dangers of allowing markets to become too complacent because the knee-jerk response in the event of an unanticipated shock will be all the more dramatic. This may explain why various BoE officials have tried to sound hawkish in a bid to jerk the markets into action. Markets may be able to live with the modest degree of tightening we have seen from the Fed so far. So long as interest rates remain low, a dividend discount model in which equity valuations are determined by the discounted value of future revenue streams, will continue to support current levels. But if the Fed starts to run down its balance sheet and put some upward pressure on global bond yields, the equity world may look different.
Unlike in 2012, words no longer appear to be enough. But my sense is that markets ought to take heed of the hints which central bankers are providing. Whatever some investors may think, central banks are not there simply to act as a backstop for market actions. If, or when, the monetary policy cycle finally turns there is a risk that people might get hurt.
Sunday, 23 July 2017
Right on!
A few weeks ago I came across an excellent post on the Flip Chart Fairy Tales blog which
looked at the rise of what the author (known only as “Rick”) called “the
libertarian right” elements within the Conservative Party and how they captured
the economic high ground. Over the past 35 years they have shifted the centre of
political gravity in the UK based on an agenda of “cutting taxes, busting unions and privatising everything down to the
street lights.” So successful were they in their endeavour that they
spawned an imitator in the form of Tony Blair, who introduced a policy based
largely based on low taxes and free markets, thus turning the Labour Party into
something akin to a continental European social democratic party which
consigned the Conservatives to 13 years of political opposition.
Although the political right may have changed the terms of domestic UK politics, they were still not content and devised a call to arms to fend off the creeping influence of the European Commission which, they feared, was about to introduce “socialism by the back door.” Thus was the Brexit war conceived and the terms of engagement defined. But as “Rick” pointed out, “the important thing to understand about right-wing libertarianism is that it is a very eccentric viewpoint. It looks mainstream because it has a number of well-funded think-tanks pushing its agenda and its adherents are over-represented in politics and the media. The public, though, have never swallowed it. Countless think-tank papers, opinion pieces and editorials, telling us that shrinking the state is just common sense and that re-nationalisation is a loony left pipe-dream, have had remarkably little effect.”
We need only look at the way the electorate bought into Labour’s electoral platform this year in a way which confounded nearly all of the pundits. Although the Conservatives’ 2017 election manifesto tried to be less aggressively free market than in the past, there is a sense that many people are beginning to realise that low taxes imply a reduction in the role of the state which they are increasingly uncomfortable with. The 2017 Social Attitudes Survey pointed out that support amongst the UK electorate for higher taxes and more spending is at its highest in a decade. But only this week prime minister Theresa May raised the prospect that failure to deal with the UK’s fiscal deficit could prompt draconian Greek-style fiscal contraction. It was a bad enough argument when used by George Osborne in 2010: Today, it just seems out of touch.
Brexit will be the ultimate test of the right-wing libertarian economic model in the UK. In the event of Brexit, the UK will be forced to stand alone politically and economically in a way which it has not done for many centuries. Indeed, that part of British history which sees Britain as the plucky underdog fighting against the odds is largely a myth. In a fascinating book which challenges the conventional history of World War II, the historian David Edgerton writes “Empire gave Britain manpower. But even the British Empire, vast as it was, was not alone, and did not feel itself to be alone. It was supported economically and politically by much of the rest of the world … The idea of a small island nation, standing ‘alone’, was far from being the central image of Britain it was to become after the war.” Go back to the Crimean War and Britain fought alongside allies such as France. The decisive intervention in the Battle of Waterloo came from the Prussian von Blücher. We don’t need to labour the point here, but if there is a consistent pattern which emerges from Britain’s history, it is less that it fought alone but rather that it picked its allies well.
Obviously Brexit is not a war. But having decided to decouple from its European allies, the UK will face a testing period as it negotiates its way through a very complex geo-political environment. Failure to get this right could sound the death knell for the post-Thatcherite political and economic establishment, particularly since we may be on the verge of a swing in the political pendulum. More than ever in the last 35 years, the UK will have to show that an economic model based on free markets, free trade and low (ish) taxes can deliver the full employment and rising living standards that EU membership has somehow failed to do. Because if it does not, Jeremy Corbyn’s acolytes are waiting in the wings to show us how to do it with a policy straight out of the 1970s. For some reason, neither of these alternatives set my pulse racing.
Although the political right may have changed the terms of domestic UK politics, they were still not content and devised a call to arms to fend off the creeping influence of the European Commission which, they feared, was about to introduce “socialism by the back door.” Thus was the Brexit war conceived and the terms of engagement defined. But as “Rick” pointed out, “the important thing to understand about right-wing libertarianism is that it is a very eccentric viewpoint. It looks mainstream because it has a number of well-funded think-tanks pushing its agenda and its adherents are over-represented in politics and the media. The public, though, have never swallowed it. Countless think-tank papers, opinion pieces and editorials, telling us that shrinking the state is just common sense and that re-nationalisation is a loony left pipe-dream, have had remarkably little effect.”
We need only look at the way the electorate bought into Labour’s electoral platform this year in a way which confounded nearly all of the pundits. Although the Conservatives’ 2017 election manifesto tried to be less aggressively free market than in the past, there is a sense that many people are beginning to realise that low taxes imply a reduction in the role of the state which they are increasingly uncomfortable with. The 2017 Social Attitudes Survey pointed out that support amongst the UK electorate for higher taxes and more spending is at its highest in a decade. But only this week prime minister Theresa May raised the prospect that failure to deal with the UK’s fiscal deficit could prompt draconian Greek-style fiscal contraction. It was a bad enough argument when used by George Osborne in 2010: Today, it just seems out of touch.
Brexit will be the ultimate test of the right-wing libertarian economic model in the UK. In the event of Brexit, the UK will be forced to stand alone politically and economically in a way which it has not done for many centuries. Indeed, that part of British history which sees Britain as the plucky underdog fighting against the odds is largely a myth. In a fascinating book which challenges the conventional history of World War II, the historian David Edgerton writes “Empire gave Britain manpower. But even the British Empire, vast as it was, was not alone, and did not feel itself to be alone. It was supported economically and politically by much of the rest of the world … The idea of a small island nation, standing ‘alone’, was far from being the central image of Britain it was to become after the war.” Go back to the Crimean War and Britain fought alongside allies such as France. The decisive intervention in the Battle of Waterloo came from the Prussian von Blücher. We don’t need to labour the point here, but if there is a consistent pattern which emerges from Britain’s history, it is less that it fought alone but rather that it picked its allies well.
Obviously Brexit is not a war. But having decided to decouple from its European allies, the UK will face a testing period as it negotiates its way through a very complex geo-political environment. Failure to get this right could sound the death knell for the post-Thatcherite political and economic establishment, particularly since we may be on the verge of a swing in the political pendulum. More than ever in the last 35 years, the UK will have to show that an economic model based on free markets, free trade and low (ish) taxes can deliver the full employment and rising living standards that EU membership has somehow failed to do. Because if it does not, Jeremy Corbyn’s acolytes are waiting in the wings to show us how to do it with a policy straight out of the 1970s. For some reason, neither of these alternatives set my pulse racing.
Thursday, 20 July 2017
Location, location, relocation
Remember the EU Financial Transactions Tax (FTT)? Back in
2011, European Commission President Barroso presented a plan to make sure that
financial institutions would “pay their fair share” following the bailouts
which banks received in the wake of the financial crisis. Predictably, it led
to an outcry with a small but vocal minority, led by the UK, intent on blocking
its introduction. Having originally been intended to come into operation in
2014 it has yet to come into law – and probably now never will. Yet as recently
as January, the EU Parliament suggested that a draft text could be ready by
mid-2017. We are still waiting.
The irony is, of course, that many EU countries already had
a form of FTT in place. Even the UK levies stamp duty on equity transactions,
having done so since 1694. But with much of the evidence suggesting it would
have an adverse effect on certain types of business, with derivatives
transactions likely to be the worst hit, the push back was so great that it has
been quietly kicked into the long grass. I have long held the suspicion that
this would be the case, though when I made this point in a panel discussion in
2013, I was told I was wrong. Unfortunately, I will likely be proved right for
the wrong reasons.
It is Brexit that has changed the nature of the debate. On
the assumption that this will mean an end to financial services passporting, it
is going to become a lot harder to conduct international financial services from
London. With Paris and Frankfurt keen to attract business from the City, the
chances of the FTT being introduced have gone below infinitesimally small.
Although both the French and German governments continue to publicly support
the principle of the FTT, it is hard to see either being very supportive at a
time when they are scrabbling for London business. With Frankfurt apparently
ahead in the business relocation race, the German government is unlikely to push
the FTT high up the priority list. And without their support, the FTT is as
good as dead in the water. This, of course, makes life rather more complicated
for Britain, some of whose politicians assumed that the UK could continue to
operate as a low-tax offshore haven.
Abandoning the FTT will certainly make it easier for firms
to relocate to other EU locations. Indeed, some business lines simply might not
have been profitable in the face of its introduction which could have resulted
in them being cut altogether. Now, however, they may be able to continue
operating elsewhere. However, abandoning the FTT alone is not going to be
enough to persuade business to relocate. Given the pick of European cities to
live, many bankers might opt for Paris. After all, it is sufficiently diverse
to match the “charms” of London and is certainly one of Europe’s more beautiful
large cities. But France is perceived as a more difficult place to do business
than the UK and ranks 29th in the World Bank’s Ease of Doing Business index
behind other EU members such as Poland and Portugal.
Anglophone bankers might have a preference for Dublin but
Ireland may be reluctant to host some of the riskier parts of banking activity,
following the problems which it has had to overcome in recent years. The Irish
authorities would welcome asset managers, insurance companies and back office
functions but may be more cautious about taking on big balance sheet risk given
the relatively small size of the economy. It is thus partly due to the lack of
alternatives elsewhere that Frankfurt has emerged as the front runner. Germany’s
Ease of Doing Business ranking (17) is higher than Ireland (18) , although
lower than the UK (7). Frankfurt is also home to the ECB and a well-defined
financial cluster has been established in recent years.
One downside is that
Frankfurt is relatively small compared to Paris and London, and is already operating
at full capacity following the transfer of euro zone banking supervision to the
ECB which has pushed up business and residential property prices. The latter in
particular is not insurmountable. Anyone who travels 20 miles into central
London on a daily basis will find they can do a longer commute rather faster
and more cheaply than they can in south east England. Speaking from my own experience, I can testify that the quality of life is also rather better in the Rhein-Main region. If you like a beer, Germany is a good place to be, though if clubbing is your thing maybe you will find Frankfurt a bit tame.
From an industry perspective, however, the real concern is that
the integrated European financial services sector will begin to fragment. London
will remain the dominant player for some time to come but as business begins to
relocate elsewhere it will be replicated on a smaller scale. It will be very
difficult and highly costly to build the full infrastructure which the modern industry
needs across a number of different European locations. Whilst Frankfurt will
probably gain a lot of London business, my long-standing conviction remains that
the centre of gravity will inexorably shift towards Asia. This trend may have
happened anyway but will certainly be hastened by Brexit. Some politicians
might cheer such an outcome for it will result in the de-risking of European
financial services that the FTT was designed to achieve. But the British
government may come to regret the dismantling of an industry which plays such a
crucial role in the knowledge economy that it claims to support.
Sunday, 16 July 2017
Still talking at cross-purposes
Twelve months ago, in the immediate wake of the EU
referendum, those of us who continued to point out that the UK had made a major
policy mistake were derided as “Remoaners” bent on subverting “the will of the
people” and that we should all pull together to make the best Brexit possible. I
make no apologies for opposing Brexit and disagreeing with its proponents. The
known economic costs are too high relative to the unknown economic benefits (if
any) whilst the UK’s negotiating position is hopelessly naïve. But as I have
pointed out in the past couple of weeks, there are increasing signs that people
are beginning to realise the magnitude of the task involved and the voices
arguing for a change of tactics are getting louder.
One of the more thoughtful interventions was from former PM Tony Blair (here) who went so far as to suggest that “European leaders, certainly from my discussions, are willing to consider changes to accommodate Britain, including around freedom of movement.” Blair also pointed out that because the opposition Labour Party’s position on leaving the single market is similar to that of the government’s, those wishing for a Labour government to change the terms of the Brexit debate may be disappointed. Indeed, he argued that the combination of the economic policy programme advocated by Labour, coupled with the fallout from Brexit, would be a disastrous combination leaving Britain “flat on our back and … out for a long count.” The problem is that whilst Blair is perhaps the most successful UK retail politician of the last two decades, his legacy has been tarnished by his association with the Iraq War to the point that people within his own party no longer listen to him.
Blair is not alone in his position. An op-ed piece in The Times on Friday by Philip Collins pointed out that “we can’t leave Brexit to the Tory wreckers” (here if you can get past the paywall). He makes the point that whilst it is tempting to ask those who got us into this mess to get us out, “they don’t know what they are doing. Their view of the EU is too ideologically narrow.” That latter point hits the nail on the head. It harks back to my point on homophilous sorting, in which like-minded people talk only to each other without hearing the arguments of the other side.
During the course of the referendum campaign, the simple message peddled by the Leavers resonated with an electorate which wanted to believe that leaving the EU was easy. As Tim Harford notes in his latest piece “last year’s Brexit campaign was based on a simple piece of wishful thinking: Boris Johnson’s idea that the UK could have its cake and eat it. How, exactly, was never quite clear, but desirability bias gave a foolish idea more credibility than it deserved. Voters hoped that Mr Johnson was right, and so they began to believe him: it is so much easier to believe what we already wish is true.”
But for all the evident difficulties in negotiating Brexit and the fact that the collapse in sterling is already making people poorer, there is not a lot of evidence to suggest that many people who voted for Brexit are ready to change their view. A radio phone-in discussion (here), in which a journalist skewered all of the arguments put forward by a Leave supporter who refused to change his view in spite of all of the evidence, is a classic example of all that was – and is – wrong with the debate. I must confess that I was not sure whether to laugh or cry having heard it.
More sober proponents of Brexit, such as Daniel Hannan, remain as resolute as ever. The fact that Hannan is one of the more rational proponents of Brexit should be taken with a pinch of salt: He was once described by a cabinet minister as an “arsonist.” In an article published in the Telegraph, Hannan calls Remainers “childish” and argues that “there is no prospect of Article 50 being reversed.” This is where I have difficulties with the likes of Hannan: saying something which is unproven as if it were a fact. Lawyers disagree on whether the government can rescind the Article 50 notice, but I am sure the EU27 would be delighted were it to happen (although it is unlikely). Where Hannan is right is that “staying in the customs union would be the worst of all worlds: it would mean that Brussels continued to dictate our trade policy without our having any input into that policy.” Indeed, I made this point a year ago – but what he fails to point out is that leaving is even more damaging. Hannan further stretches the boundary between fact and fiction by arguing that “the majority of the 48 per cent [of remainers] … now want Brexit to succeed. Publicly undermining our negotiators can have only one effect, namely to encourage Brussels to offer harsher terms.”
One of the real difficulties in the Brexit process is that two sides in the domestic debate cannot agree on how to proceed. We are thus wasting far too much time debating the issue at home when what is required is the presentation of a coherent set of arguments in Brussels. Unfortunately, what we have been presented with over the past year is neither realistic nor sensible, and many people who voted Remain cannot buy into these plans because they represent ideas which are clearly not in the national economic interest. Brexiteers do not seem to understand the damage which a hard Brexit will cause to the UK economy. What is worse, they do not seem to care.
In their book Democracy for Realists, Christopher Achen and Larry Bartels describe a new phenomenon in US politics whereby voters imagine that one party holds a position which fits their view of the world when it clearly does not. This helps explain why those voting for Brexit listen only to the anti-EU part of the Brexit message without hearing the discussion about costs. It may also explain why people voted for Jeremy Corbyn’s Labour Party, as a protest against the hard Brexit Conservatives but without hearing the anti-EU part of Labour's policy. If this hypothesis is true – and I suspect it is – we have moved beyond rational debate and into the world of dog-whistle politics (though I guess that is not really news). However, it does not mean we should stop making a rational case as to why Brexit is an act of economic self-harm. One day, someone might just listen.
One of the more thoughtful interventions was from former PM Tony Blair (here) who went so far as to suggest that “European leaders, certainly from my discussions, are willing to consider changes to accommodate Britain, including around freedom of movement.” Blair also pointed out that because the opposition Labour Party’s position on leaving the single market is similar to that of the government’s, those wishing for a Labour government to change the terms of the Brexit debate may be disappointed. Indeed, he argued that the combination of the economic policy programme advocated by Labour, coupled with the fallout from Brexit, would be a disastrous combination leaving Britain “flat on our back and … out for a long count.” The problem is that whilst Blair is perhaps the most successful UK retail politician of the last two decades, his legacy has been tarnished by his association with the Iraq War to the point that people within his own party no longer listen to him.
Blair is not alone in his position. An op-ed piece in The Times on Friday by Philip Collins pointed out that “we can’t leave Brexit to the Tory wreckers” (here if you can get past the paywall). He makes the point that whilst it is tempting to ask those who got us into this mess to get us out, “they don’t know what they are doing. Their view of the EU is too ideologically narrow.” That latter point hits the nail on the head. It harks back to my point on homophilous sorting, in which like-minded people talk only to each other without hearing the arguments of the other side.
During the course of the referendum campaign, the simple message peddled by the Leavers resonated with an electorate which wanted to believe that leaving the EU was easy. As Tim Harford notes in his latest piece “last year’s Brexit campaign was based on a simple piece of wishful thinking: Boris Johnson’s idea that the UK could have its cake and eat it. How, exactly, was never quite clear, but desirability bias gave a foolish idea more credibility than it deserved. Voters hoped that Mr Johnson was right, and so they began to believe him: it is so much easier to believe what we already wish is true.”
But for all the evident difficulties in negotiating Brexit and the fact that the collapse in sterling is already making people poorer, there is not a lot of evidence to suggest that many people who voted for Brexit are ready to change their view. A radio phone-in discussion (here), in which a journalist skewered all of the arguments put forward by a Leave supporter who refused to change his view in spite of all of the evidence, is a classic example of all that was – and is – wrong with the debate. I must confess that I was not sure whether to laugh or cry having heard it.
More sober proponents of Brexit, such as Daniel Hannan, remain as resolute as ever. The fact that Hannan is one of the more rational proponents of Brexit should be taken with a pinch of salt: He was once described by a cabinet minister as an “arsonist.” In an article published in the Telegraph, Hannan calls Remainers “childish” and argues that “there is no prospect of Article 50 being reversed.” This is where I have difficulties with the likes of Hannan: saying something which is unproven as if it were a fact. Lawyers disagree on whether the government can rescind the Article 50 notice, but I am sure the EU27 would be delighted were it to happen (although it is unlikely). Where Hannan is right is that “staying in the customs union would be the worst of all worlds: it would mean that Brussels continued to dictate our trade policy without our having any input into that policy.” Indeed, I made this point a year ago – but what he fails to point out is that leaving is even more damaging. Hannan further stretches the boundary between fact and fiction by arguing that “the majority of the 48 per cent [of remainers] … now want Brexit to succeed. Publicly undermining our negotiators can have only one effect, namely to encourage Brussels to offer harsher terms.”
One of the real difficulties in the Brexit process is that two sides in the domestic debate cannot agree on how to proceed. We are thus wasting far too much time debating the issue at home when what is required is the presentation of a coherent set of arguments in Brussels. Unfortunately, what we have been presented with over the past year is neither realistic nor sensible, and many people who voted Remain cannot buy into these plans because they represent ideas which are clearly not in the national economic interest. Brexiteers do not seem to understand the damage which a hard Brexit will cause to the UK economy. What is worse, they do not seem to care.
In their book Democracy for Realists, Christopher Achen and Larry Bartels describe a new phenomenon in US politics whereby voters imagine that one party holds a position which fits their view of the world when it clearly does not. This helps explain why those voting for Brexit listen only to the anti-EU part of the Brexit message without hearing the discussion about costs. It may also explain why people voted for Jeremy Corbyn’s Labour Party, as a protest against the hard Brexit Conservatives but without hearing the anti-EU part of Labour's policy. If this hypothesis is true – and I suspect it is – we have moved beyond rational debate and into the world of dog-whistle politics (though I guess that is not really news). However, it does not mean we should stop making a rational case as to why Brexit is an act of economic self-harm. One day, someone might just listen.
Saturday, 15 July 2017
Mr Phillips is resting
Markets are increasingly concerned that central bankers may
be about to take away the punch bowl rather earlier than they had previously
anticipated. The Bank of Canada was the latest central bank to tighten policy,
raising rates by 25 bps this week for the first time since 2010. There is also
increased nervousness regarding the policy intentions of the ECB and BoE. But
whilst there are good reasons for taking away some of the emergency easing put
in place in the wake of the financial crash of 2008-09, it is proving much
harder to justify tightening on the basis of inflation than most had expected.
This is a particular problem for the Fed which has nudged up the funds rate in four steps of 25 bps over the past 18 months, but is reliant on signs of higher inflation to justify ongoing policy normalisation. US core CPI inflation, which was running above the Fed’s 2% target rate last year, slipped back to 1.7% in May and June and is thus at the bottom end of the range in place since 2011. Wage inflation has also picked up, but here too the acceleration has been modest, with hourly earnings running at an annual rate of 2.8% in June which is only 0.5 percentage points higher than the average of the last three years.
For an economy which is running close to what appears to be full employment, this might appear rather surprising. But the headline unemployment rate, currently 4.4%, understates the degree of slack in the US labour market. The so-called U6 rate which adds in “marginally attached” workers – defined as “those who currently are neither working nor looking for work but indicate that they want and are available for a job and have looked for work sometime in the past 12 months” – is still at 8.6%. This is slightly higher than the previous cyclical trough in 2007 when it reached 8.0%, and significantly above the low of 6.8% recorded in October 2000. Arguably, therefore, the jobless rate can still fall a little further before wage and price inflation starts to become more of an issue.
The UK shows a similar – indeed, perhaps more extreme – picture with the unemployment rate in the three months to May at its lowest since 1975 whereas the rate of wage inflation, at 1.8%, is a full percentage point below that recorded last November. As in the US, there is a significant amount of spare capacity in the labour market. Currently, 12% of those working in part-time employment are doing so because they cannot find full-time employment. Whilst this is down from a peak of 18.5% in 2013, it is still higher than the 8-9% range recorded before the recession of 2008-09 and points to a certain degree of involuntary underemployment. This in turn suggests that there have been structural changes in the labour market which have impacted on the traditional relationship between headline unemployment and wage inflation.
For many decades, economists have focused on the negative relationship between wage inflation and unemployment first postulated by Bill Phillips in the 1950s. In its simplest form, this suggests that policymakers face a trade-off between unemployment and inflation. In practice, the relationship holds only in the short-term, if at all. What is notable, however, is that in the UK and US there has been a flattening of the curve in recent years, suggesting that any negative relationship between wages and unemployment is even weaker today than in the past.
This is illustrated for the UK in the chart below, based on an idea presented in Andy Haldane’s recent speech entitled “Work, Wages and Monetary Policy.” The chart shows the trend derived from a linear regression of wage inflation on the unemployment rate over various periods. Two features are evident: Most obviously, the line has moved down reflecting the fact that over time inflation in the UK has fallen. But it is also notable that the slope of the line has become shallower. In other words, UK wage inflation has become less sensitive to changes in the unemployment rate. To illustrate the implications of this, we assess the wage inflation rate consistent with an unemployment rate of 5.5% and how this would change if unemployment fell to 4.5% (current levels).
The results are shown in the table (below). Simply put, an
unemployment rate of 5.5% would be associated with wage inflation of 14% on the
basis of the relationship over the period 1971-1997, falling to 4.1% between 1998-2012
and just 2.1% on the basis of the data for 2013-2016. But what is also
interesting is a one percentage point fall in the jobless rate to 4.5% has a
much smaller impact based on recent years’ data than in the pre-recession
period. For example, this might have been expected to produce a 0.9 percentage
point rise in wage inflation over the 1997-2012 period compared to a 0.5pp rise
based on recent data.
Space considerations preclude a look at the reasons for the
weaker sensitivity of wage inflation to labour market conditions. It may be the
result of factors such as a lower degree of unionisation; the more widespread
use of zero hours contracts and the rise of the gig economy, all of which have
raised the degree of slack which the headline unemployment rate does not
capture. But what the analysis does suggest is that policymakers can afford to
spend less time worrying about the impact of low unemployment on wage
inflation. There may be a case for higher interest rates but it is not to be
found in the labour market.
As a final thought, I am struck by certain parallels with Japan. Following the bursting of the bubble economy, the Japanese authorities failed to spot the structural factors which led the economy to the brink of deflation, notably an ageing demographic profile which prompted a switch towards saving rather than consumption. The one factor we might be missing today is the impact of automation, which threatens a significant substitution of capital for labour and which could put downward pressure on the relative price of labour. I would thus not be in a hurry to raise interest rates to counter a wage inflation threat which has so far failed to materialise.
This is a particular problem for the Fed which has nudged up the funds rate in four steps of 25 bps over the past 18 months, but is reliant on signs of higher inflation to justify ongoing policy normalisation. US core CPI inflation, which was running above the Fed’s 2% target rate last year, slipped back to 1.7% in May and June and is thus at the bottom end of the range in place since 2011. Wage inflation has also picked up, but here too the acceleration has been modest, with hourly earnings running at an annual rate of 2.8% in June which is only 0.5 percentage points higher than the average of the last three years.
For an economy which is running close to what appears to be full employment, this might appear rather surprising. But the headline unemployment rate, currently 4.4%, understates the degree of slack in the US labour market. The so-called U6 rate which adds in “marginally attached” workers – defined as “those who currently are neither working nor looking for work but indicate that they want and are available for a job and have looked for work sometime in the past 12 months” – is still at 8.6%. This is slightly higher than the previous cyclical trough in 2007 when it reached 8.0%, and significantly above the low of 6.8% recorded in October 2000. Arguably, therefore, the jobless rate can still fall a little further before wage and price inflation starts to become more of an issue.
The UK shows a similar – indeed, perhaps more extreme – picture with the unemployment rate in the three months to May at its lowest since 1975 whereas the rate of wage inflation, at 1.8%, is a full percentage point below that recorded last November. As in the US, there is a significant amount of spare capacity in the labour market. Currently, 12% of those working in part-time employment are doing so because they cannot find full-time employment. Whilst this is down from a peak of 18.5% in 2013, it is still higher than the 8-9% range recorded before the recession of 2008-09 and points to a certain degree of involuntary underemployment. This in turn suggests that there have been structural changes in the labour market which have impacted on the traditional relationship between headline unemployment and wage inflation.
For many decades, economists have focused on the negative relationship between wage inflation and unemployment first postulated by Bill Phillips in the 1950s. In its simplest form, this suggests that policymakers face a trade-off between unemployment and inflation. In practice, the relationship holds only in the short-term, if at all. What is notable, however, is that in the UK and US there has been a flattening of the curve in recent years, suggesting that any negative relationship between wages and unemployment is even weaker today than in the past.
This is illustrated for the UK in the chart below, based on an idea presented in Andy Haldane’s recent speech entitled “Work, Wages and Monetary Policy.” The chart shows the trend derived from a linear regression of wage inflation on the unemployment rate over various periods. Two features are evident: Most obviously, the line has moved down reflecting the fact that over time inflation in the UK has fallen. But it is also notable that the slope of the line has become shallower. In other words, UK wage inflation has become less sensitive to changes in the unemployment rate. To illustrate the implications of this, we assess the wage inflation rate consistent with an unemployment rate of 5.5% and how this would change if unemployment fell to 4.5% (current levels).
As a final thought, I am struck by certain parallels with Japan. Following the bursting of the bubble economy, the Japanese authorities failed to spot the structural factors which led the economy to the brink of deflation, notably an ageing demographic profile which prompted a switch towards saving rather than consumption. The one factor we might be missing today is the impact of automation, which threatens a significant substitution of capital for labour and which could put downward pressure on the relative price of labour. I would thus not be in a hurry to raise interest rates to counter a wage inflation threat which has so far failed to materialise.
Sunday, 9 July 2017
Time is running out
I noted three days ago how pro-Brexit campaigners appear to be
distancing themselves from the whole idea. Since then, more evidence has come
to light suggesting that British businesses are not being listened to by
government. This matters. Many people might see businesses as insatiable users
of human resources, chewing people up and spitting them out at a whim. But they
are the providers of jobs and income for the vast majority of us. If businesses
are not going to get a Brexit which works for them, in whose name are we doing
this? A Brexit which does not work for business will not work for the UK
economy.
Only last week, the CBI called for the UK to remain within the single market and customs union until such times as the shape of the final deal was clear. But British government officials torpedoed that option because, according to observers present, Brexit Secretary David Davis fears a political backlash if the UK is seen to be backtracking on its commitment to leave. He is concerned that politicians would be judged harshly if it opts for what can best be described as the Hotel California option – having checked out it, it can never leave. In my view this is to misread the domestic political runes. And it would not be the first time this year that the Conservatives have done so. Indeed, Davis is said to have been instrumental in persuading Theresa May to call the spring election, so I am not sure I would necessarily trust his political judgement. Moreover, surveys suggest that the electorate is not in favour of a hard Brexit. The election was a warning shot across the bows of a party which campaigned on the basis of “no deal is better than a bad deal” and was punished at the ballot box. And if “taking back control” was so important to the electorate, why did UKIP – the party which pushed so hard for it – take such an electoral hammering?
This morning’s story from The Observer warning that the UK cannot expect any help from German business in securing a favourable Brexit deal is further evidence of the delusions under which too many UK politicians are operating. Senior representatives of German industry bodies have repeated what I (and many others) have said all along, namely that the main objective for the EU is to maintain the integrity of the single market. A few months back I had a meeting with a group of senior German politicians, some of whom told me very firmly that Germany would not go out of its way to help the UK if it meant sacrificing relationships with other EU members. I am sure they have said the same things to their British counterparts, but too many British politicians appear to have selective hearing (or should that be understanding) when it comes to Brexit issues.
It is this attitude which brought to mind the Bagehot column in The Economist a couple of weeks ago. The article criticised the government for dealing with the needs of business in an amateur way and highlighted that the only realist is Chancellor Philip Hammond, who “is a grown-up in a political playpen that is stuffed with children. The chief claimant to the throne, Boris Johnson, is the most childish of all. Bumptious and bungling, he wants to grab the shiniest prize for himself for no other reason than that it is shiny. Other claimants also have problems with maturity. David Davis, the Brexit secretary, is a vainglorious contrarian who … habitually underestimates the damage a bad Brexit might cause ... On the other side, Mr Corbyn is an extreme case of arrested development. He is a man-child leading an army of disgruntled youths, a professional protester who has reached his late 60s without ever having to make adult decisions about allocating limited resources, let alone creating them in the first place.”
As it happens, I am pretty sure that the government will be forced to cave in on its Brexit negotiating position. Despite the position espoused by Davis earlier this week, The Observer reports that the government is warming to the idea of a transition deal. Perhaps they are waiting for the EU27 to offer some form of olive branch which will allow them to change course. Perhaps the EU27 is prepared to face down the UK in order for it to change of its own free will. But in an economy where real incomes are falling thanks to the rise in inflation triggered by a fall in the pound, and where consumer sentiment has fallen sharply back to immediate post-referendum lows, I suspect the electorate is in no mood to pay the economic price for the government’s shenanigans. Politicians need to get real – and fast – because in effect they have a year to finalise the arrangements before the EU’s deadline of autumn 2018. The sound you hear is the clock ticking …
Only last week, the CBI called for the UK to remain within the single market and customs union until such times as the shape of the final deal was clear. But British government officials torpedoed that option because, according to observers present, Brexit Secretary David Davis fears a political backlash if the UK is seen to be backtracking on its commitment to leave. He is concerned that politicians would be judged harshly if it opts for what can best be described as the Hotel California option – having checked out it, it can never leave. In my view this is to misread the domestic political runes. And it would not be the first time this year that the Conservatives have done so. Indeed, Davis is said to have been instrumental in persuading Theresa May to call the spring election, so I am not sure I would necessarily trust his political judgement. Moreover, surveys suggest that the electorate is not in favour of a hard Brexit. The election was a warning shot across the bows of a party which campaigned on the basis of “no deal is better than a bad deal” and was punished at the ballot box. And if “taking back control” was so important to the electorate, why did UKIP – the party which pushed so hard for it – take such an electoral hammering?
This morning’s story from The Observer warning that the UK cannot expect any help from German business in securing a favourable Brexit deal is further evidence of the delusions under which too many UK politicians are operating. Senior representatives of German industry bodies have repeated what I (and many others) have said all along, namely that the main objective for the EU is to maintain the integrity of the single market. A few months back I had a meeting with a group of senior German politicians, some of whom told me very firmly that Germany would not go out of its way to help the UK if it meant sacrificing relationships with other EU members. I am sure they have said the same things to their British counterparts, but too many British politicians appear to have selective hearing (or should that be understanding) when it comes to Brexit issues.
It is this attitude which brought to mind the Bagehot column in The Economist a couple of weeks ago. The article criticised the government for dealing with the needs of business in an amateur way and highlighted that the only realist is Chancellor Philip Hammond, who “is a grown-up in a political playpen that is stuffed with children. The chief claimant to the throne, Boris Johnson, is the most childish of all. Bumptious and bungling, he wants to grab the shiniest prize for himself for no other reason than that it is shiny. Other claimants also have problems with maturity. David Davis, the Brexit secretary, is a vainglorious contrarian who … habitually underestimates the damage a bad Brexit might cause ... On the other side, Mr Corbyn is an extreme case of arrested development. He is a man-child leading an army of disgruntled youths, a professional protester who has reached his late 60s without ever having to make adult decisions about allocating limited resources, let alone creating them in the first place.”
As it happens, I am pretty sure that the government will be forced to cave in on its Brexit negotiating position. Despite the position espoused by Davis earlier this week, The Observer reports that the government is warming to the idea of a transition deal. Perhaps they are waiting for the EU27 to offer some form of olive branch which will allow them to change course. Perhaps the EU27 is prepared to face down the UK in order for it to change of its own free will. But in an economy where real incomes are falling thanks to the rise in inflation triggered by a fall in the pound, and where consumer sentiment has fallen sharply back to immediate post-referendum lows, I suspect the electorate is in no mood to pay the economic price for the government’s shenanigans. Politicians need to get real – and fast – because in effect they have a year to finalise the arrangements before the EU’s deadline of autumn 2018. The sound you hear is the clock ticking …
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