Charles Dickens Revisited – A sad Christmas story for the Brexit Era.

The Chancellor of the Exchequer, George Philip Scrooge, or GP to his friends, distantly related to Ebenezer Scrooge, was at home in No 11 Downing Street, on Christmas Eve, 2019, writing a paper for the Prime Minister on what to do about the British economy, following the departure from the EU earlier in the year. Deep down he admitted to himself that the only reason he was doing this on Christmas Eve was because he was lonely. All his parliamentary friends (not that he had many of them these days) had left Westminster to go home to their families and even his neighbour, the Prime Minister, had gone to Washington to spend time with her friend Donald and his Russian acquaintances. GP also knew that he was very unlikely to get a visit from Santa this year. Not only were most presents held up at Calais because of the delays caused by border controls, Santa was having difficulty getting permission to bring his reindeer into the country because of new regulations affecting animals entering the UK and, if that wasn’t enough, his friends and relatives blamed him for the higher prices caused by import tariffs imposed on goods from the EU.

Gradually, despite his interest in the Treasury’s latest macroeconomic forecasts and the excitement of looking at all the negative numbers they contained, he started to feel sleepy, very sleepy. The next thing he knew, the room was full of people all keen to talk to him. The first, who looked well over 100 yet was wearing a very trendy hoody with a large letter K on the front,  started to talk to him about the need to raise aggregate demand, by cutting taxes and raising government spending in order to offset the fall in consumption and investment which had occurred early in 2019 as the UK economy crashed out of the EU after Parliament failed to ratify Teresa May’s plan and the subsequent “People’s Vote” resulted in an almost dead heat when 50.5% of the voters opted for a No Deal departure from the EU. One of K’s friends, a Canadian called MC, asked what he should be doing about interest rates since he had people telling him to cut them to boost the economy while others, due to go off skiing in the New Year, told him to increase them to boost the value of sterling, which had slumped after the decision to leave and was now at parity with the dollar. K was not too bothered about interest rates – he kept going on about being caught in something painful called the liquidity trap.

As soon as K and MC stopped talking, a new American voice piped up, with the letter L on his back, suggesting that what was really important was not to listen to K and his friends but to focus on the supply side of the economy and, in particular, on increasing incentives to work and raising productivity in the economy. L was illustrating his ideas on a napkin, suggesting that taxes should be cut, therefore encouraging people back into work and explaining that this would be self-financing, since government spending on benefits would fall and revenue would increase as the newly-employed paid taxes and spent more, increasing VAT and corporation tax receipts.

Suddenly GP awoke from his nightmare and his unwanted guests disappeared.  “I need a holiday” he thought said to himself and grabbed his laptop to start searching for a short break. He gave up on Europe pretty quickly because of the permit he would have to buy to go to the EU. Although it was only 7 euros, these days, following the fall in the value of sterling, 7 euros was a lot of money. He started to look at breaks in the UK. Driving was out because of the rising cost of fuel after recent oil price rises and the fall in the pound so it had to be a train journey, until he remembered that Crossrail had not been finished, HS2 had been scrapped because of rising cost estimates and the rest of the network were not running between Christmas and the New Year.  Back to the Treasury forecasts and looking forward to Xmas Day with the Queen’s Speech, while eating a Gregg’s turkey sandwich for lunch.

Advertisements

The UK’s current problems

Attention in the UK is focused heavily on Brexit and what might or might not happen in the next few months – will Mrs May’s deal get through Parliament? If not, will there be a new deal negotiated or will we leave with no deal? Will there be a second referendum or even a general election or both or neither? However it is worth looking beyond the short term and  considering the problems we face, many of which might have influenced the Brexit vote.

On a global scale, there is talk that another recession might be approaching (although to be fair, there is often talk of another recession approaching!) A possible cause is the rise in interest rates which have already happened in the USA and the UK and is likely to happen in the Eurozone during next year. The US rise has already started to cause problems for some emerging economies because money which moved into their economies as interest rates fell and QE reduced bond yields in developed countries, has moved into dollars to buy US government bonds or to be placed in interest-bearing accounts. In addition, the strength of the dollar has caused some emerging economies further problems since many of their loans and interest payments are denominated in US dollars. A further potential cause of a world slowdown is the decline in China’s growth rate. A growth rate in China of 6% adds the equivalent of Russia’s entire GDP to Chinese GDP each year so even a small slowdown has an impact on the world economy. There is a fear that, as China grows, the opportunities for continued, fast growth diminish so it becomes more difficult for them to rapidly expand. Nearer home, there is also concern about Italy’s high level of public borrowing and the possible implications of this for the euro.

In the UK, there has been much discussion about possible economic factors which influenced the vote in 2016.  One issue was the regional imbalance between London and the South East compared to the North of England, with the latter feeling that they were ignored by governments which focused their activities on the South. Infrastructure is poor in the North with lower transport per head than in the South, incomes are higher in the South with average London incomes being 2 ½ times those in the North East and, since 2010, London incomes have grown 20% while those in the North East have only risen 6%. Many Northern companies have moved their headquarters down to London and there has also been a move in skilled labour in the same direction.

Another issue was the falling real incomes which many workers have experienced since the financial crisis. Following the recession in 2008, average wages fell almost consistently in real terms until mid-2014. Although there has been some recovery, there are still major problems with poverty in the UK. The Joseph Rowntree Foundation reported this month that almost 4 million working adults were below the poverty line because their wages were so low, about half a million more than five years ago. This was based on the idea of poverty being people or families receiving less than 60% of the median income by household type (e.g. married with two children), adjusted for the cost of housing. The implication of their report was that, although unemployment has fallen significantly in the UK, many of the new jobs are low paid ones. (It is worth noting that these figures are not accepted by the government since they focus on relative poverty and uses a definition of poverty now updated).

A further issue has been the effects of a decade of austerity on voters. Not only is there increasing concern over the quality of public services (think train delays and NHS waiting times) but a recent report from the OECD points out that the % of GDP taken by taxation has risen to 33.3%, a 49 year high, and above countries like France (46.2%), Italy (42.4%) and Germany (37.5%), but below Japan (30.6%) and the USA (27.1%). The prediction for this year is that the tax burden will rise further and if correct, since 2009 the share of GDP taken by tax will have risen by 2.2% while the share taken by government spending will have fallen by 5%, hence people feeling that they are paying more but receiving less from the government. There has also been a perception that EU migration has imposed further strains on the economy – using the NHS, filling up schools, taking scarce housing, claiming Job Seeking Allowance and other benefits and taking jobs from UK workers (although these last two are contradictory!). The positive benefits of migration in terms of providing skilled labour and contributing tax revenue have not received the same attention.

While there is very little, if anything, which the UK can do to prevent the global problems mentioned above, it can take steps to tackle the issues specific to the UK. Solving these will place the UK economy in a much stronger position to withstand global shocks and to make the best of whatever Brexit outcome occurs and will be the focus of the next post.

Trade Wars

In an attempt to escape from the latest Brexit news, this week’s blog examines the trade war between the USA and China. Until recently, economics textbooks glossed over tariffs, quotas and protectionism; they were mentioned as possible approaches to improving a country’s balance of payments but it was accepted that although there were customs unions in existence, such as the EU, with a common external tariff (i.e. all products entering the union paid the same tariff, irrespective of where the goods entered the customs union, tariffs were not changed frequently as an economic weapon. This was because the accepted view among economists and (most) politicians was that world free trade was beneficial, allowing goods and services to be made  in the countries most suited to their production (lowest opportunity cost in economic terms) and then traded for products made overseas, thereby allowing consumers to benefit from lower prices and an increased standard of living.

However all of that has changed with the imposition of tariffs by the USA on Chinese goods and retaliation by China, followed by retaliation for the retaliation by the USA! The crisis began in July, after months of negotiations, when the USA imposed 25% tariffs on an initial $34 billion of Chinese goods, including machinery, electronics, cars and computer components such as hard drives.  China then retaliated and the following month the USA placed 25% tariffs on a further $16bn of Chinese goods which were matched by reciprocal Chinese tariffs on American goods such as cars. Then in September, President Trump imposed further 10% tariffs on $200 billion of Chinese goods and has threatened to increase this to 25% next year. China has retaliated with tariffs on $60 billion of US goods. The rationale for the American tariffs was two-fold – firstly that, according to President Trump, China had an “unfair” trade surplus in goods of $376 billion with the USA, thereby hitting American jobs, and secondly that China engaged in unfair trading practices, frequently involving foreign firms being forced to share their technology with Chinese ones.

The effects of the tariffs will depend on many factors. It is possible that businesses might find a way round the tariffs. For example, US soya producers have complained about the tariffs on their products but there is already evidence that they have been able to increase their exports to Brazil and Brazilian firms have exported to China. However many US businesses have expressed concern over the rise in costs of components imported from China and the effect they will have on consumer prices in the US. On the other hand, President Trump has argued that the tariffs will persuade US firms to produce more in the US to avoid the tariffs but others suggest that US firms will still produce overseas, where manufacturing costs are cheaper, but in countries other than China. A key factor will be the price elasticity of demand for the goods affected. This will determine whether producers can pass on the tariff,  whether they will have to absorb some or all of it and whether they will need to cut output with subsequent effects on output and employment.

The Population Crisis

According to popular legend, the science of economics was christened “the dismal science” by Thomas Carlyle following the publication by Thomas Malthus in 1798 of “An Essay on the Principle of Population”. In this he suggested that poverty and hunger would be a country’s natural state since increases in population would tend to outstrip increases in food supply. Fortunately he was proved wrong as birth rates fell and new techniques increased the supply of food and the science of economics moved on.

We are currently focused on short-term issues such as Brexit but it is worth taking a longer perspective following the publication of a report in ‘The Lancet’ which has highlighted falling fertility rates across the world between 1950 and 2017. The reasons behind the fall include better education and employment prospects for women, improved access to contraception, better maternal education for mothers and prospective mothers and improvements in infant mortality. As a result, 91 out of 195 countries have been identified as having a fertility rate below 2.05 – the minimum necessary for stable population growth. For example, in Britain over the period, the fertility rate fell from 2.2 to 1.7.

The implications of falling fertility rates in richer countries, partially masked by inward immigration, focus on the conflict between increased life expectancy, creating an increased number of elderly pensioners receiving benefits and increasingly needing expensive medical care, and a falling supply of workers who are paying taxes to support the elderly. These workers will therefore face a greater burden in terms of the taxes they will need to pay to support the elderly.

This is already significant in Japan where 28% of the population are over 65, the highest proportion in the world, compared with 18% in the UK and 22% in Germany. One offsetting feature in Japan is that people often work on beyond their retirement age – 3% of their labour force is over 80! Although it is not suggested that working until 80 becomes the norm, the retirement age in many countries is being increased as a result of increased life expectancy and, in the UK, it will reach 66 by October 2020 and 67 by 2028 for both men and women. This will reduce pension payments and increase tax revenue but, alone, is unlikely to be enough to prevent developed countries facing increasing budget deficits to finance care and benefits for the elderly.

As this crisis unfolds, the people who will suffer most are not the elderly but younger generations who will not only be working longer and paying higher taxes but will face student debt and higher house prices than experienced by their grandparents

UK Inflation

UK inflation, as measured by the CPI, fell in September to 2.4%. Not only was this below last month’s rate of 2.7%, it was also 0.2% below the expected rate of 2.6%. (Note we are talking of a fall in inflation, not a fall in prices).  Currency dealers believe that the effect of this was to make a further rise in interest unlikely and therefore there was a fall in demand for sterling, leading to a small fall in the value of sterling on the foreign exchange market.

However, it is not clear whether their reaction was correct. The day before these figures were issued, figures for average earnings in the three months to August were published by the Office for National Statistics, which showed that wages are rising at 3.1%, up from 2.9%, their highest rate since the financial crisis.  The rise in earnings is not surprising since it has been predicted ever since unemployment started to fall towards the current, record low level of 4% or 1.36 million.

The idea that inflation and unemployment are inversely related was expressed by Phillips using what became known as the “Phillips Curve”. Recently, economists have doubted it since unemployment has fallen without the previously-expected rise in earnings which would, in turn, feed through to prices via increased demand and higher costs for firms.

If the increase in real incomes continues, it is possible that higher spending and higher wage costs for businesses might increase inflation which, although falling, is still above the 2% target. It is also worth noting, firstly that uncertainty created by lack of progress in the Brexit talks might limit increases in consumption, secondly, that the increase in earnings is not likely to be shared by workers across the country and thirdly, unless the UK is able to increase its productivity, which is still low compared to our competitors, significant increases in earnings are likely to be limited.

Brexit – considering some of the issues.

UK politics is in a state of turmoil. There are Tory MPs making public pronouncements about possible budget measures the Chancellor might include in his budget, the DUP are threatening to vote against the budget – something which commentators say might bring about the end of Theresa May’s premiership – and at the moment, less than six months before we leave the EU,  it is extremely difficult to predict whether a Brexit deal will be agreed between the UK and the EU, then ratified by Parliament and whether there might be a second referendum or even another election. Significant elements of our post-Brexit existence – namely the Northern Ireland border issue, the nature of any agreement with the EU on trade in goods and services and the movement of labour between the UK and the EU are yet to be agreed.

The possibility of a “No Deal” Brexit is still with us. This would mean that goods and services exported from the UK to the EU would have the same tariffs as those coming in to the EU from any country with which the EU does not have a trade deal  under what are referred to as “WTO (World Trade Organisation) rules”. It is also not clear whether we would be able to persuade countries which currently have trade deals with the EU to create identical deals for us once we leave. Although EU tariffs average 4%, our food exports to the EU would face a 15% tariff and our car exports (70% of our car exports go to the EU) would face a 10% tariff. Equally worrying to many producers are the non-tariff barriers such as customs checks which they would face. At present, because we are in the Single Market which gives free movement of goods, services, labour and capital, goods produced in the UK can be sold in the EU without needing to meet any additional safety checks or face customs delays at the border. UK financial service companies can offer their services across the EU and they would lose their ability to do this from London, hence a number are setting up offices in the EU. Many manufacturers now operate “just-in-time” methods of production where components and raw materials are delivered very shortly before they are needed, therefore avoiding the necessity of having money tied up in holding stocks and having to build large warehouses. There has been talk of how, with a hard Brexit, (i.e. no free trade agreement) small delays at customs posts could cause havoc for manufacturers. The head of Jaguar Land Rover talked of how they produce 3,000 cars using 25 million parts a day and how even a small delay would cause havoc and BMW has announced that, in the event of no deal, it will move production of the Mini and new electric Mini to the Netherlands

The Northern Ireland issue is tricky because of the way it goes beyond economics and into the religious and political history of the island. Without some sort of border between the EU and the UK, it would be possible for goods to flow into Northern Ireland and then cross into Eire without paying tariffs. Therefore, unless we have a free trade agreement with the EU, there must be a customs border between ourselves and the EU. For England, Scotland and Wales, this will be a sea border and existing customs facilities at ports and airports will deal (possibly with difficulty) with incoming and outgoing trade as they do at present for trade with non-EU countries. However Northern Ireland and Eire would either require a land border or an agreement which essentially keeps Northern Ireland in the EU for the purposes of trade and creates an imaginary border between Northern Ireland and the mainland – i.e.  separating Northern Ireland from the mainland, something the Government has pledged not to do. Because of the troubled history of Northern Ireland, a hard border (with customs posts, customs officers and possibly police) is not likely to be politically acceptable. It is also difficult in practice because there are many small roads between the two countries which would be impossible to police. Some politicians have suggested that technology might be able to solve the problem, somehow tracking the goods between Eire and the UK and ensuring that the correct duty is levied and paid to the EU. However, the UK’s record on introducing complex IT systems is not good and it is unclear whether this would be ready by the end of the transitional period before we totally leave the EU.

On the positive side, it is possible that, before you read this,  a deal might have been agreed but …………

How are we doing?

Those of you who are Manchester United fans will have been pleased by their comeback against Newcastle over the weekend. However, in the excitement, you might have missed the news that former United star, David Beckham, and his wife Victoria have sold their Beverley Hills house (or mansion) which has six bedrooms and nine bathrooms, for $33million. They bought it eleven years ago for $22milion. At the other end of the scale, you might also have missed the report from the Social Metrics Commission, (SMC) putting forward a new measure of poverty for the UK.

Measuring the number of people in poverty is difficult. Some countries, such as the USA, focus on absolute poverty where an income is identified as the minimum needed to meet a family’s basic needs and those below it are deemed to be in poverty. A variant of this approach involves estimating a minimum standard above which people should live. An alternative, which has become the benchmark for the UK, is to focus on relative poverty (i.e. compared to other people) and consider those in poverty as living in households with incomes below 60% of the median.  However this is not straight-forward since there are two different ways of considering income (before and after housing costs are deducted) and the measure excludes assets people possess.

The SMC focusses strictly on measuring poverty, which, for them, is not having the resources available to meet current needs to be able to “engage adequately in a life regarded as the “norm” in society.”

To assess the number in poverty they consider the resources available to households, namely net income (net earnings from employment and self-employment, benefits and unearned net income (e.g. from rent or interest). They also include assets, such as savings which can be easily accessed and subtract any costs that the family must pay. These costs include debt repayment, housing costs (rent or mortgage payments), service charges in flats, building insurance, council tax, water rates, the community charge, childcare costs and additional costs faced by the disabled. Subtracting these costs gives an estimate of the resources available to a household. The next stage was to estimate the required level of resources needed to meet their benchmark and then set a poverty line at a threshold of 55% of the three-year median resources available measure.

Using this approach, their key findings, using 2016/17 data, were that:

  • 22% of the population (14.2 million) is living in a family considered to be in poverty. However 52% of people in lone-parent families (2.6 million) are in poverty.
  • Of those in poverty, 8.4 million are working-age adults; 4.5 million are children and 1.4 million are pension age adults.
  • The poverty rate for working-age adults is 21.6%; for children it is 32.6%; and for pension-age adults it is 11.4%. For pensioners, the rate has fallen from 20.8% in 2001 to 11.4% in 2017.
  • The majority (68.0%) of people living in workless families are in poverty, compared to 9.0% for people living in families where all adults work full time.
  • Those in poverty are not equally distributed across the country. Poverty rates in Scotland are lower and Welsh poverty rates are higher than in other UK countries. England has the highest child poverty rate and the overall poverty rate in London is more than 10% higher than in some other English regions.
  • The report also found that the number of people (2.5 million) above the threshold by 10% or less is almost identical to the number of people (2.7 million) below the threshold by 10% or less, suggesting that small changes in circumstances can either take people out of or put them into poverty. However 2/3 of those in poverty (12% of the total population) have been in persistent poverty, (being in poverty for two out of the last three years), suggesting that although they might be close to the benchmark, it is not easy to escape from poverty.

The SMC findings raise questions about the benefit system and how we deal with poverty.

Are we happy that over half of single parent families are in poverty?

Are we happy that 2/3 of those in families where no one is working are in poverty?

Are we happy that twice as many working age adults and three times as many children are classed as living in poverty compared to the percentage of pensioners in poverty?