Faster, higher, costlier

Even as a big fan of athletics I must confess to ambivalence ahead of the Olympic Games, being unsure of the wisdom of them taking place when the vast majority of Japanese did not believe they should go ahead this year. In the event they provided a welcome distraction with a number of great track performances to whet the appetite (world record performances in the men’s and women’s 400m hurdles being particular highlights). Technologically, broadcasters met the challenge of delivering the games superbly. The BBC, for example, which usually sends large teams of reporters out to the host city, managed to cover the games from its studio in Salford (5865 miles or 9466km from Tokyo) and if they had not told us, we may not have been any the wiser.

The Olympic legacy: A big bill

Now that the Games are behind us, many of us will miss waking up to our daily fix of Olympics news. But as the Olympic juggernaut moves on to Paris in three years’ time, spare a thought for the good people of Tokyo who will be left with the costs of dealing with an event which comes with a considerable bill attached. According to Bent Flyvbjerg and his co-authors who have looked at all Olympic Games (winter and summer) since 1960, “at 156 percent in real terms, the Olympics have the highest average cost overrun of any type of mega-project. Moreover, cost overrun is found in all Games, without exception; for no other type of mega-project is this the case” (see chart below). The 1976 Olympics, held in Montreal, resulted in a cost overrun of 720% relative to budget and saddled the city with huge debts for the next 30 years. Not for nothing was the Olympic Stadium nicknamed "the Big Owe".

Tokyo is living down to these expectations. According to Victor Matheson and Andrew Zimbalist, “Tokyo was awarded the hosting rights in 2013 with a bid of $7.3 billion. Yet a government audit has shown the total cost to approach $30 billion.” Even allowing for a $1.3 billion defrayment contribution from the International Olympic Committee (IOC), that is a serious cost overrun. Matheson and Zimbalist reckon that around $3 billion of the cost overrun can be attributed to Covid-related expenditure.

In order to estimate the net financial position we need to take account of revenue where the pandemic has had a significant impact. Not that the host city ever gets a fair slice of any revenue, even in the good times, since the IOC creams off most of the TV revenue and gives only a small proportion back to the host (chart below). Consequently, the host bears most of the financial risk associated with staging the Games whilst the IOC generally gets most of the benefits (the same is true of World Cups, where FIFA takes the largest slice of the revenue). This time around matters were complicated by the enforced absence of spectators which resulted in around $800 million of lost ticket sales whilst it is estimated that Tokyo lost out on $2 billion of associated tourist revenue.

Adding together the Covid-related costs and revenues implies a hit to the bottom line of around $6 billion (almost as much as the event was scheduled to cost when the bid was first submitted in 2013). But even stripping out these special factors, the underlying cost of the Games is almost $23 billion – a 215% increase over the original budget. Incidentally, it is reported that had the Games been cancelled, the IOC would have had to refund $4 billion to its broadcast partners. Unless there are other penalty clauses in the agreement between the organising committee and the IOC, it would have been cheaper for Tokyo to refuse to hold the games than incur the Covid-related hit.

Reform of the process is clearly needed

Questions have been raised over the years as to whether the current model, in which a new host city is chosen every four years, is sustainable. The Tokyo experience has raised these questions to a new level, particularly with regard to the fiscal costs of supporting the economy in the wake of the pandemic, not to mention environmental concerns. This is not to deny that hosting an Olympics is a fun event – the 2012 Games in London will live long in the memory of those who experienced them. But cities are increasingly unwilling to bear the financial costs of acting as host. Boston, Budapest, Hamburg and Rome all withdrew their bids for the 2024 Games, leaving the field clear for Paris, whilst in an unprecedented action the 2028 event was awarded to Los Angeles without even making a call for other bidders.

History records that the LA Games in 1984 were the only one in modern times to make a profit. This was achieved because the organisers were able to leverage off existing infrastructure rather than create all the facilities anew which is where the problems lie. The cost problem is exacerbated by the fact that, to quote Matheson and Zimbalist, “a winning bid not only needs to show how the host will successfully manage the competition … but also how it will generate more amenities, more prestige, and more revenue to the IOC than any other competing bid, leading to an arms race where proposals are increasingly lavish and increasingly expensive.” But despite the claims made by all organising committees that the Olympics will act as a useful economic regeneration exercise, the reality is rather different. As Stephen Billings and Scott Holladay argued in a 2011 paper, “proponents argue that this investment will pay off through increased economic growth, but research confirming these claims is lacking.”

One of the selling points of the 2012 Games in London were the legacy aspects. Whether or not these have been delivered remains a point of contention even to this day. Similarly, investment for the 2016 event in Rio was justified on the basis of its impact on regenerating the local community. This has clearly not been delivered. Organising committees also like to highlight the tourism benefits and here, too, the evidence is mixed. Following the 1992 Olympics, Barcelona did rise from eleventh to the sixth most popular destination in Europe but London in 2012 received fewer tourists than expected as security concerns and expectations of overcrowding dissuaded a lot of potential visitors.

The evidence thus suggests that the direct benefits of hosting the Olympics are dubious at best and possibly non-existent. So why do countries want to put themselves through the ordeal? The one-word answer is simply “prestige.” However, democratic countries facing budgetary constraints may be less willing in future to step up to the plate but those with a less robust democratic tradition may be more willing to do so since fewer questions will be asked about the finances. In recognition of the fact that the field of potential bidders may narrow in future, the IOC has proposed to evaluate bids based on economic and environmental sustainability, which is a good start. Given the difficulties in judging costs and benefits ex ante, a more sensible idea may be for the IOC to choose a permanent site, thus lowering the long-term costs of holding the Games. In the event that this proves too controversial, it may consider a small number of sites based in cities (or regions) which already have a substantial amount of infrastructure in place, opening up the prospect of a rerun of London 2012 or Tokyo 2021 in the not-too-distant future.

As a sports fan who appreciates the significance of the Olympics and its impact in bringing people together, I am much in favour of continuing in the present vein. But they cannot be allowed to continue at any price. At a time when the world is acutely aware of environmental considerations there is a strong case for reining in the costs. It may be too late for the residents of Tokyo, but Parisians take note. It’s your turn next.

Finding a reverse gear

The Bank of England’s Monetary Policy Report is required reading for those interested in UK macro trends and today’s report was no exception. Listening to some of the media commentary ahead of the report’s release, people might have been forgiven for believing that monetary tightening was imminent. In reality, that was never the case although the BoE did provide some guidance on the sequencing as to how the easing of the policy throttle will occur.

The economic outlook supports lifting the foot off the gas

Turning first to the details, the BoE’s macro forecast suggested that UK GDP will grow by 7¼% in 2021 and 6% in 2022, and only slow to trend (1.5%) in 2023. One implication of this is that the level of output will get back to pre-recession levels by end-2021, which is a far sharper rebound than expected a year ago. As a result the output gap is expected to be almost eliminated this year and an excess demand position is anticipated in 2022 (i.e. a positive output gap). With inflation projected to hit 4% in Q4 2021/Q1 2022, questions have been raised as to whether the current exceptionally lax monetary stance is warranted.

One member of the MPC (Michael Saunders) voted to limit gilt purchases to £850bn (it currently stands at £825bn) rather than press on to the currently mandated upper limit of £875bn. Although the idea of calling a halt before reaching the current target is unlikely to make a great difference in the grand scheme of things, it would send a signal of intent that the BoE is prepared to scale back its asset purchases as circumstances dictate. Indeed, when the MPC announced an expansion of the upper limit for gilt purchases to £875bn in November 2020, inflation was expected to peak at 2.1% in late-2021/early-2022 whilst output was not expected to get back to pre-recession levels until early-2022 (i.e. one quarter later than in August).

As the MPC minutes pointed out, the MPC “had policy guidance in place specifying that it did not intend to tighten monetary policy at least until there was clear evidence that significant progress was being made in eliminating spare capacity and achieving the 2% inflation target sustainably.” Although “some members of the Committee judged that … the conditions were not yet met fully”, it is hard to know what more evidence they need to justify scaling back monetary easing with inflation running at twice the target rate and with the output gap set to close. It is important to stress at this point that I agree with those who believe it is perhaps too early to significantly tighten policy. But this is not to say there is a case for easing off the throttle. On the basis that the stock of assets purchased is more important for policy purposes than the flow of purchases, setting a lower limit for gilt purchases implies a very moderate reduction in the degree of planned monetary easing.

Dealing with tightening

The BoE did indicate that when the time for tightening comes, its preference is to use Bank Rate as the instrument of choice and suggested that “some modest tightening of monetary policy over the forecast period is likely to be necessary.” As the Resolution Foundation has pointed out, this has the advantage of being swift to implement and can swiftly be reversed if necessary. But the BoE also indicated that it “intends to begin to reduce the stock of purchased assets, by ceasing to reinvest maturing assets, when Bank Rate has risen to 0.5%.” This could lead to a swifter unwinding of the balance sheet than might be expected and would go a long way towards assuaging the concerns of those who believe the balance sheet is too big.

To illustrate the impact of this, we start by looking at the details of the debt stock currently held by the BoE (here). We can use this information set to determine the precise maturity date of gilts on the balance sheet and my calculations suggest that the median maturity of gilt holdings is just over eight years. Assuming that Bank Rate reaches 0.5% by end-2023 and does not fall back below this level, allowing all maturing debt to roll off will halve the balance sheet in money terms by 2034. Further assuming nominal GDP growth of around 4% per year in the longer term, gilt holdings would decline from around 40% of GDP in 2021 to 12% by 2034. The BoE may, of course, choose to reinvest a certain proportion of maturing debt, rather than letting it all run off, and the resultant stylised scenarios are shown in the chart below. It is notable that even if gilt holdings remained at £875bn over the longer-term, the GDP assumption used here would be sufficient to reduce the balance sheet relative to GDP back towards 2013 levels even in the absence of any direct action.

In addition, the Bank suggested that it would be prepared to consider selling off assets once Bank Rate reaches 1%, thus adopting an even faster rate of balance sheet reduction. In my view, for what it is worth, this may prove unnecessary given the sharp pace of reduction generated by ceasing reinvestment. It may also significantly complicate the government’s efforts to finance the deficit. After all, if the BoE is selling gilts into a market which is saturated by primary issuance, the upshot is likely to be a sharp rise in bond yields.

Whilst there clearly are some risks associated with a policy of running down the balance sheet, the BoE believes that “the impact on monetary conditions of a reduction in the stock of purchased assets, when conducted in a gradual and predictable manner and when markets are functioning normally, is likely to be smaller than that of asset purchases on average over the past.” In other words, running down the balance sheet gradually is likely to have only a modest impact on the economy. However, it is generally accepted that central bank balance sheets will not fall back to pre-2008 levels any time soon. For one thing, there has been an increase in demand for central bank reserves by the banking sector due to changes in regulation and banks’ risk management techniques which has resulted in increased demand for high quality liquid assets. For this reason, it is unlikely that the BoE will follow a policy of full disinvestment over the medium-term.

The likes of the now-departed Andy Haldane expressed concern that the BoE’s balance sheet was too big. Therefore reducing it over the medium-term is likely to diminish the criticism that the BoE is somehow engaged in deficit financing – a point Governor Andrew Bailey was keen to refute during today’s press conference. Nonetheless, balance sheet management is a policy tool which is here to stay. With downward pressure on equilibrium interest rates, as a result of population and productivity trends, the scope for using conventional interest rate policy is diminished and balance sheets will therefore remain a useful addition to the policy armoury. But just as increasing balance sheets proved to be controversial, so the process of running them down will likely prove to be a lot more difficult than currently imagined, as the 2013 US taper tantrum illustrated.

Cummings and goings

In recent months I have tried to steer away from politics and focus on economics. But as a line from the fictionalised memoir The Tattooist of Auschwitz recently reminded me, anyone “who lectures on taxation and interest rates can’t help but get involved in the politics of his country.” So it was that two years after Boris Johnson was elected as leader of the Conservative Party I watched this week’s BBC interview with Dominic Cummings, architect of the Brexit campaign and until December Johnson’s chief of staff, which lifted the lid on life in Downing Street (a short summary for non-UK based viewers can be found here on YouTube). It was many things – compulsive viewing; exculpatory; self-justifying; incoherent and despite Cummings’ denials, clearly motivated by revenge. But most of all it shone a light into the tawdry workings of British politics in recent years and acts as a reminder of how far standards of governance have fallen.

The context of the interview was also interesting. The BBC, and particularly its political editor Laura Kuenssberg, has come in for significant criticism in recent years that it has given the government an easy ride over its many policy failings. In this case Kuenssberg asked some very direct questions, although as many people pointed out, she has not given the same grilling to anyone still in government (though largely because they refuse to submit to such scrutiny). For all that, the interview was highly illuminating and raises questions for anyone with an interest in good governance.

The lies that they told

I will start with Cummings’s observations on Brexit, having pointed out for the last five years that he headed a campaign that wilfully lied to the electorate. He admitted that “on questions such as whether Brexit is a good idea, no-one on earth knows.” This from a man who led a campaign to persuade the electorate that it was! He went further to suggest that “it is perfectly reasonable to suggest that Brexit was a mistake.” As an insight into Cummings’ character, this speaks volumes. His efforts to try and appear thoughtful and rational contradict some of the policies he has long espoused and confirm David Cameron’s judgement that he is a “career psychopath.”

Cummings also denied lying about the costs of membership (the infamous £350 million per week claim), arguing that it was designed to set a trap for his political opponents and dismissed claims that it misled people into voting for Brexit. He further dismissed claims that he used Turkey’s willingness to join the EU to persuade the electorate that the UK was about to be swamped with huge numbers of immigrants. But in the immortal words of Mandy Rice-Davies almost 60 years ago “he would, wouldn’t he.” Cummings did implicitly admit that he did not present the information in its true context (aka he lied) but he justified doing so in order to get people to talk about the issues.

This is both disingenuous and dangerous – dangerous because it has set a precedent for people in public life to make all sort of false claims “in order to generate debate.” But if such lies are not called out, such statements tend to become accepted as truth by those prepared to propagate the falsehoods. Until recently I always thought that George Orwell’s 1984 was a satirical novel warning us of the consequences of totalitarianism (“Ignorance Is Strength”). I now realise that it has become an instruction manual for zealots intent on pursuing their particular interests.

How not to run a government

Given the character of the man, it says a lot about Boris Johnson’s style of leadership that Cummings was appointed the prime minister’s chief of staff. Cummings has little time for Johnson’s ability to lead (although this is undoubtedly coloured by his December sacking) but he clearly thought that Johnson was the only politician capable of “getting Brexit done.” Another insight into Cummings’ character was his response when asked why he took on the role. He told Kuenssberg that he did so only under certain conditions and seemed genuinely baffled when she asked whether he was motivated by any sense of public duty. There was very much a sense that Cummings used the role to pursue his own agenda rather than that of the country. Under the UK’s constitutional arrangements this is highly dangerous. Outside election periods, it is very difficult to call the prime minister to account and they have near-total carte blanche to do whatever they think necessary in order to pursue a particular policy. Giving someone like Cummings the protection of the prime minister’s office is like giving sticks of dynamite and a box of matches to a toddler.

The whole interview exposed the lack of strategy from the current government and the underhand tactics that it used to achieve the one goal that it had – that of getting Brexit done. Outside of this policy, the government seems to be largely rudderless and Cummings gave more insight into its dreadful handling of the pandemic with his central claim being that the prime minister put “his own political interests ahead of people’s lives.” Whilst Cummings' motivation can be called into question, he at least served a purpose by directing the spotlight towards the vacuum at the heart of government.

A deep-seated problem

All this matters because, as I have pointed out numerous times, well-run economies tend to deliver the best outcomes for their citizens. Whilst economics tries to be value neutral, it is hard to accept that the values demonstrated by the British government’s actions in recent years represent a good platform to deliver the best economic outcomes. An excellent post by Professor Geoff Mulgan highlighted that the government is representative of a narrow clique whose interests do not necessarily coincide with those of the wider electorate. Two of his main points bear repeating. The first is that this group does not really understand economics and thus does not grasp the implications of many of their policy slogans. A second point is that this clique “doesn’t really do ideas. It’s much better at commentary and critique than prescription.” 

A second critique was offered by the journalist, broadcaster and clergyman Giles Fraser, who notes that previous Conservative governments were at least guided by some form of moral compass. Even the pro-market Thatcher government, which was widely criticised for its apparent indifference to the social hardship caused by some of its policies, was deeply rooted in a moral view of the world (see, for example, this 1978 article by Margaret Thatcher in the Daily Telegraph). I will come back to the subject of economics and morality another time, but suffice to say a government that continues to make missteps which, (to reuse my all-time favourite political quote from fictional spin doctor Malcolm Tucker) are “the result of a political class, which has given up on morality and simply pursues popularity at all costs”, suggests we are sliding down a very slippery slope.

Last word

Although I do not like a lot of what Cummings stands for, I do understand his position. He sees an ossified political system which is ripe for reform and is prepared to do anything in his power to effect change. But hitching his campaigning zeal to the personal ambition of a Boris Johnson has resulted in a hollowing out of Britain’s political culture. More worrying still is that the vast majority of the electorate do not seem to care. Like him or loathe him, however, I urge people to watch the Cummings interview and make their own minds up as to whether the social, political and economic course upon which Britain is embarking is one that they are comfortable with.