Osbornomics For Beginners

The Independent are really good at graphic representations of information. Especially in their latest project, the newspaper they call ‘i’. Well worth a look if you get the chance.

Today, they’ve published this handy graphic to show the rapid and massive changes in Government forecasts for 2011 growth, and lets you draw your own conclusions about George Osborne’s handling of the UK economy. I won’t say any more about it, just have a look and soak it in.

Obama’s Debt Deal – A Limey Perspective

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You may have seen, if you watch the television news, that Barack Obama has been screwed over by the mental ‘tea party’ politicians in the US. This has been over the tax ceiling that the US has, in theory to stop it going into massive debt a la most of Europe.

Something I note from all of what’s gone on is how much the Tory party here in the UK like what they see when they look at the tea party movement. George and co are big fans and I worry that the Tory party will see what they’ve done over there and follow suit.

Another  thought is that this whole thing is perhaps an advert for avoiding the fixed term parliaments in the UK. If such a debt ceiling existed in this country, and the Commons came to an impasse, then Cameron would have ended up going to the country. Under a fixed term, the sitting leader is forced into silly bargaining and trading to get a deal over something relatively simple like increasing the debt ceiling.

And it is a simple piece of legislation. During Reagan’s eight years, he had the debt ceiling raised seventeen times. Of course, he had better numbers in the Senate and house of Representatives. Obama was stuck making deals. If he’d been Prime Minister here instead of US President, you can bet your last penny he’d have held out and called an election.

If you don’t understand just how Obama got screwed by the tea party movement, then the clip below from the office of everyone’s favourite US President, Josiah Bartlet, will explain it in very short order. Enjoy.

Will Inflation Scupper The Forgotten Budget?

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It seemed to have slipped out of the media’s attention, what with all this Libyan stuff, but the Budget is rapidly approaching once again. No doubt the conflict will change the narrative a little but up until a couple of weeks ago, this budget had a lot riding on it. Already, Cameron and his advisers are looking failure in the face and relying on George Osborne and his budget to retrieve what has looked like an increasingly fragile position.

Cameron was busy bigging up the budget, telling anyone who would listen about how ‘pro-growth’ it was going to be. An odd thing to promise when George isn’t planning on offering any significant tax cuts. He will, though, offer plenty of misdirection and sleight-of-hand to distract us from the ‘swingeing’ cuts that are about to come into force next month.

Having shadowed Gordon Brown as chancellor, Osborne learned well how to use one of the rare occasions when the Opposition have no real foreknowledge of the announcements to put the Government in the driving seat. Since new year, Osborne has held back announcements that the various ministries could have made for use on Budget day to do exactly that.

Of course, he has a lot of work to do to put project Cameron back on course. After his initial budget, George was only ever intending to make slight changes to the original deficit-reducing plan. But none of the cabinet seem to have expected what everyone else warned them about all along. Reduced economy, increased inflation, rising oil prices and falling living standards. All of which is viewed through the prism of cuts.

The fact that these things seem to have taken the Government by surprise says an awful lot about David Cameron and his cabinet team. They complain noisily about all the things that stop them, blaming everything but their own policies. They’ve even managed to blame the judiciary and the UK civil service, a sure-fire way of making sure nothing ever happens to your policies as a Government. It’s the civil service who enact all the theories after all.

Inevitably, following this particular insult, the civil service is being a little less helpful than they would normally be. When the Sir Humphreys of the modern world want to follow the rule book to the letter, life can be very difficult for the elected ministers. Those ministers have realised they’re outnumbered and outmanoeuvred by the mandarins of Whitehall, with at least one Secretary of State organising a Freedom of Information request against his own department to get information.

When Team Cameron were in opposition, any problems with the smooth running of Government, were laid firmly at the feet of Gordon Brown and his ministers. Now that they’re in power, Cameron and co have decided that the blame needs to be laid even more firmly at the feet of those famous ‘enemies of enterprise’, the UK civil service.

On top of the economy, there have been unforced errors like the failed evacuations from Libya and the inability to get paperwork processed so that British rescuers could help with the aftermath of the Japanese earthquake.

So the Conservative Government isn’t working very well at all. And the Cameroons are relying on George Osborne to turn it all around. It’s George who runs this government after all. He is the one who makes the day-to-day decisions and very little gets done without his say so. Cameron is little more than a figurehead in this set-up. Chancellor Osborne has even more power than Chancellor Brown did, because PM Cameron is nowhere near as capable as PM Blair ever was.

George has his hands in lots of pies whether it’s the individual Whitehall departments or the organisation of number 10, newly filled with old Osborne staffers and appointees. With all Government policy and practice being run through the Treasury, Osborne’s budget takes on even more importance, and the demands for pro-growth have grown as the Parliament has gone on. Can George save the Cameroon project and enact the reforms (for which read cuts) in Government in time to have any effect? With the time it takes to have an effect, there’s a good chance that policy announced in this budget won’t have much impact before the scheduled date of the next general election leaving the public with nothing but a sense that this Government has failed.

But it could already be too late for the Chancellor. Today, the Retail Price Index figures for February have been released and is now at 5.5%, its highest since 1991. The Consumer Price Index is now also up, sitting at 4.4%. No matter which measure you prefer, inflation is up. This increased inflation will mean the Government will have to borrow more than planned, putting Osborne slightly on the back foot already. The Chancellor will say, and indeed is already saying, there’s less taxes being paid because prices are rising above the rise in earnings. And with benefits index-linked to inflation, the cost of those is increasing faster than planned as well.

That line from the Treasury makes it sound so unexpected as if it was some unforeseen natural disaster. But the truth which Osborne is glossing over is that benefit costs are bound to increase when the Government policy is to cut jobs and make people redundant. Prices are bound to increase faster than earnings when you’re promoting pay freezes across the public sector (and consequently the private sector who have them as customers). Retail purchases will always drop if you deliberately increase the price of all those purchases with a VAT increase right when people need to watch their money closely.

So instead of cutting the deficit, it’s highly likely that the Chancellor will have to increase it and all because of the policies he has enacted since he arrived in power last May. The great hope of the Cameroons that Osborne will turn around a failing Government is beginning to look less and less likely but we’ll find out tomorrow as he rises at the despatch box of the Commons.

Christians Enter The Cuts Arena

This week, Christian charity CARE are to publish a report on the taxation of families in the run-up to the budget. The research in this report shows that the Government’s proposals on child benefit will hurt families in the poorest half of the population.

 

In his keynote address to last autumn’s Conservative Party Conference, George Osborne said

 

“It’s very difficult to justify taxing people on low incomes to pay for the child benefit of those earning so much less than them.”

 

But CARE’s report demonstrates that child benefit is going to be withdrawn from a lot of families in the bottom half of the income distribution whilst a lot of families at the top will continue to receive the benefit. Treasury Estimates show that 1.5 million families in the lower deciles are likely to be affected in this way.

 

The Government needs to urgently rethink these arrangements given the huge disparities and unfairness that will ensue.

For example, a single-income couple with three children currently earning £42,500 (just above the higher rate threshold in 2011-12) is in the fifth decile (i.e. the poorer half of the population) with an income higher than 45% of the population. When child benefit is withdrawn, this family will fall into the fourth decile with income higher than only 38% of the population.

A single-income couple with two children currently earning £42,500 is in the sixth decile (i.e. just in the top-half of the population) with an income which is higher than 53% of the population. When child benefit is withdrawn this family will fall into the fifth decile (i.e. the poorer half of the population) with an income higher than only 48% of the population.

At the same time, a double-income, two child family with a combined income of £57,000 (where neither income reaches the higher tax threshold and thus child benefit is kept) will be in the eighth decile with a higher income than 71% of the population. A double-income, two child family with two £40,000 incomes (and which will consequently again keep its child benefit) will do even better and be the ninth decile with a higher income than 88% of the population!

This disparity is caused by the fact that, when working out how rich or poor a person or family is in relation to the rest of the population, the Treasury measure household rather than individual income. However, as the examples above demonstrate, a number of families in the higher rate band are far from being wealthy while some who do not sit in the higher tax band are amongst the richest households in the population.

 

Leonard Beighton, a former deputy chairman of the board of the Treasury, said,
“Simply looking at pre-tax income does not tells us whether a family is rich, poor or in the middle. The failure to take this into account seems to be leading to poor policy choices and is confusing the debate about fairness and family taxation. Families on £42,375 and above will pay the same tax as a single person without family responsibilities. There is nothing fair about a tax system which takes the same tax from a family of four as it does from a single taxpayer whose income has only to support one person and whips away the only benefit they receive.”
This country’s tax system is rare in Europe and the OECD in basing almost all it’s measures on individual income and results in huge anomalies at a time when every penny counts in family budgets. It’s time to fix this problem.

Plan B? What Plan B?

The Bank of England in Threadneedle Street, Lo...
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The coalition Government has several things to be worried about but one of its major concerns must surely be the chance of a rise in inflation.

In December, the CPI rose from 3.3% to 3.7% with the RPI sitting at 4.8%. Not great if you have a mortgage. Or indeed if you have savings sitting in the bank becoming less and less valuable. The Bank of England, however, are so far maintaining that this rise in inflation is the exception to the rule, and not a sustained trend. They maintain, despite the long duration of this aberration, that if we just stay patient, inflation will come down. All we apparently need to do is keep interest rates as low as we can to keep demand as high as possible.

Mervyn King and friends tell us that the high inflation we are seeing will eventually work it’s way through the economic system if we’re patient enough. They also say that the reason there don’t seem to be any increase in wage demands is that people are happy to accept the current situation and are relieved to be in work and managing to survive despite the loss of value of the money in our pockets and standards of living.

And this is what should make the Government worry. As the purchasing power of our pound falls and our living standards drop, people will begin to lose patience. Which will not be very good for the governing parties when it comes to polls and elections. This is, of course, assuming that the Bank of England are right and this high inflation is a temporary deviation. If they’re wrong, and inflation continues to climb, then interest rate increases will have to be pretty harsh to stem the tide of such inflation. That will hit peoples’ pockets even harder and lead to deeper unpopularity for Cameron, Clegg and Co. 

The Government are going to get caught between the Devil of the Bank of England who have control of interest rates and insist inflation rises are temporary, and mortgage holders who hope interest rates stay low, and the Deep Blue Sea of those with savings who will see the value of their money vanishing before their very eyes.

Given that Gordon Brown ensured the Bank of England had total independence, there’s almost nothing George Osborne or any of the cabinet are able to do. They’re forced to sit there and acknowledge increases in the price of goods and services, while hoping and praying that the Bank is right because there’s no plan to deal with the inevitable problems that arise if they’re wrong.

 

A New Famine

Dear Reader, I feel I owe an apology.

I’m aware that I have written  a lot in recent weeks on the economic situation in the Republic of Ireland.  So if  you’re not all that interested in economics, or Ireland for that matter, then I must say sorry. I realise some of you come here just for my extraordinary wit and others for my amazing insight and still others because you’re looking for an american sports journalist who shares my name. So, sorry if the EU bailout of Ireland isn’t your thing.

However, I’m obviously not sorry enough because this is one more post about it to add to my growing collection. Over the weekend, the EU finance ministers agreed a provisional bailout of the Irish government. Very provisional seeing as there’ll be a new government at some point in the early new year, and that government will be wanting to re-open negotiations over the bailout.

So for a few weeks, Ireland is out of trouble with a bit of breathing space to get back on its feet. Except it won’t get back

The All Might Dollar Will Save Ireland

on it’s feet. Or if it does, it’ll get knocked straight back off them in a month or so. Because this deal does nothing. This deal is a loan to Ireland at 5.6% interest, which Ireland just can’t afford. Such a price means that in 5 years, 20% of all Irish tax revenue will be going towards those interest payments. That’s 1 in every 5 of the rather tarnished Euros that will be collected from an increasingly poor population.

The Euro market had a little bounce back this morning as expected, but that won’t last. In May, the Greek bailout was the end of the Euro crisis. A line in the sand not to be crossed again. Six months down the line and Ireland is reduced to penury and indigence. Portugal won’t get six months.

The endgame for Ireland will come when, after many many months of her people suffering from cuts, rising taxes and huge mortgage debts, Eire will renege on the debts owed to the rest of the EU, including the UK, and then the economic edifice comes crumbling down, leaving the rich nations to refinance the banks and refloat the world’s economy. In the mean time, the Irish people will flee their nation or suffer the consequences of the actions of their banks and government.

The Teetering Eurozone

I wrote yesterday of the impending bailout of Ireland by the EU, and some of the implications. Since inception of the Euro, in 2000, we have had a relatively smooth ride in an economic boom-time. All the member countries have enjoyed the increasing strength of being tied to one monetary standard and all has been well. Unless you lived in the UK and wanted to book a cheap holiday in Ibiza or Crete, in which case you got stung by price increases everywhere.

Ten years later and the boom-time is over. We’re well and truly in the bust part of the cycle which Gordon Brown famously pronounced was no more. And we can now see that, as soon as we hit our first economic problem, the single currency starts to teeter as the smaller members struggle and Germany gets tired of propping up other members. As soon as a crisis occurs, Eurozone member-states return to being individual nation-states out for themselves and their citizens.

Because of this, and because the economic reality is that the member-states were all at different stages of the economic cycle when they joined the Euro and all have different economic theories driving their governments, we shouldn’t be surprised if this is the beginning of the end for the European single currency. It won’t collapse now. The EU will prop it up, but that won’t solve the problems in Ireland, Greece, and Portugal. It will just put them off to a later date. Probably the first quarter of 2011.

I am, broadly speaking, pro-European but it seems to me that this crisis in the Euro is a symptom of the fact that the EU is beginning to look anachronistic in the 21st Century. The European politicians who adamantly insist that the EU can act as one – like some sort of United States of Europe – when in fact it can’t. The differences between the economies of Germany or France and Ireland or Portugal can’t sit within one common economic policy while at the same time maintaining sovereignty over tax rates and adhering to no regulation.

The European Central Bank (based in Frankfurt) is now preparing to bail out Ireland as well as Greece, and will no doubt be closely monitoring Portugal, Spain, and even Italy. It will be thinking the same as me. That to make a single currency work, there must be a single central control of tax and spending. Economically, that makes perfect sense. But politically, German control of the economies of other countries in Europe will not be stood for. That is an unchangeable reality.

Given that reality, it is only a matter of time before the German people and leadership – already voicing concern – decide that money being raised by their economic engine would be better spent in Germany and not in Ireland, Greece, or anywhere else. When that happens, the Euro collapses and so does the UK’s trade with Europe.

Maybe David Cameron should head back to Beijing or Delhi and continue strengthening those Asian trade links.

Will Osborne Look Across The Sea?

There’s big trouble looming over us at the moment. All the hooha about the royal wedding is doing a marvellous job of distracting people from the problem building steam just over the Irish Sea. The economy there in Ireland has reached it’s tipping point now. Despite their protestations that they’re ok and they don’t need a bail out, they’ll be forced by the other Eurozone countries to take said bailout in the next day or so.

 The Irish economic suffering is about to step up a gear because of the path their government chose. And not only the Irish will suffer. Because of the nature of economics  and markets in a shared currency, it becomes more and more likely that the Iberian countries will join Ireland and Greece.

The Celtic Tiger wasn’t able to deal with the amount of capital poured down its throat in recent years. It’s just swelled and swelled until, like the bubble it really was, it burst. What should then have happened is that the Dail Eirann should have taken steps to deflate the bubble, as Gordon Brown and Alistair Darling did in the UK. Unfortunately, they took a different path, and now the other nations of Europe, us included, are going to have to bail them out. And then we’ll very likely have to bail out Portugal and Spain as well. That will be four of the 14 Eurozone countries that willl have had catastrophic economic failures. The economic model on which the Euro is based, the freeflow of capital between nations, has serious problems.

Even after all the failures we’ve seen, there is still a massive lack of real regulation of banks and finance and offshore tax havens. Rather, we see the promotion of market-based economic models being promoted. Especially in the UK where George Osborne said of the Eire economy not so long ago

What has caused this Irish miracle and how can we repeat it?

Up until today, Osborne has been happily and enthusiastically imposing on the UK the exact same economic model which has crushed the Republic of Ireland. And just as it crushed them, it will surely crush us. Osborne needs to realise that he has to regulate the banks, and deal with tax loopholes which bankers sail through at the moment. He needs to do more to stimulate economic growth. He needs to remember that the UK won’t have the European Central Bank to help him if our economy suffers in the same way as Ireland’s. George Osborne needs to do all those things to stave off the crippling combination of inflation, no growth and increasing unemployment.

He needs to do it, but he won’t.

Cuts Day, Part 2 – An economics lesson: what is the deficit and what is debt?

The day has finally arrived. Everyone is now expecting the biggest cuts in spending on public services in decades. The Comprehensive Spending Review (CSR) published today will set out spending plans for the next 4 or 5 years. The Government are telling us these cuts are necessary to reduce the public sector deficit and pay off the debt.

We’ve all heard the coalition ministers blaming using ‘the current economic conditions’ like some sort of catchphrase. And no doubt we’ll hear Labour talking about irresponsible gambles a lot today and in the coming weeks. Osborne et al have been telling us for long enough that the deficit is too large because Labour allowed public spending to balloon out of control.  However, evidence shows that the reason for the increase in deficit is more to do with lower Government revenues after the recession. That recession was brought about by financial markets taking too many risks and bringing on instability, not by Government spending.

What is the deficit and what is debt?

Despite what the Tories would like you to think, all administrations are ‘tax and spend governments’.  Money is raised by the government and then spent on public services. The Deficit is the amount by which income (via taxes) is below expenditure. The total of all the earlier years’ deficits is the Debt.

During recessions, people and organisations spend less, so government income drops, while simultaneously, government spending goes up as benefits claims increase. Therefore, both the deficit and the debt are expected to increase. During a recovery, this reverses. People spend more, and deficits and debts fall again.

Examining public spending over the period of the Labour Government, it’s easy to highlight the effect of the recession on spending.

Total expenditure as a percentage of GDP

  

 We all remember Chancellor Brown’s now famous economic golden rule.

“On average over the economic cycle, the Government will borrow only to invest and not to fund current spending.”

So when times are good, the Government built up a surplus in order to cope with the expected deficit in the cyclical recession. Under Labour, this golden rule was paired with a sustainable investment rule that

“net public debt as a proportion of GDP will be held over the economic cycle at a stable and prudent level.”

That stable and prudent level was most often defined as 40% of GDP.

Brown really believed that by following his fiscal rules, that ‘there would be no return to boom and bust’. As such the practises of the last government were sensible measures. But the crisis of 2008  meant that those rules were abandoned for the remainder of the Labour Government.

There is also a measure of the presumed deficit if the cyclical factors were removed. This is cyclically adjusted public sector net borrowing. As this is a stupidly long name and the acronym would be CAPSNB, economists refer to this as the structural deficit.

George Osborne’s spinners tend to refer to the current structural deficit to prove what bad shape our ‘current economic condition’ is in. The Treasury’s official current estimate has it at 8.7% of GDP.

Structural Deficit as a percentage of GDP

 

This chart makes it very clear that the structural deficit soared right at the point when the recession started. That makes it look like, rather than the structural deficit being a measure of how bad our economy is, is purely cyclical. Following a recession, the level of the deficit will be a larger proportion of  GDP than before that recession. Although the Government are classifying a large proportion of the deficit as structural in order to point the finger at Labour, it is in fact caused by the financial crisis and recession.

Next lesson: Why the deficit is an issue

Cuts Day, part 1

Well, I was going going to write an overview of my thoughts on the Tory strategy of cuts and austerity that they are launching on us all today. Then I read an article by Joseph Stiglitz, Professor of Economics at Columbia University, USA. Quite honestly, I couldn’t hope to come near expressing it any better. So I’m going to do something which I try to avoid and just post the text here in full.

The Keynesian policies in the aftermath of the Lehman brothers bankruptcy were a triumph of economic theory. In Europe, the US and Asia, the stimulus packages worked. Those countries that had the largest (relative to the size of their economy) and best-designed packages did best. China, for instance, maintained growth at a rate in excess of 8%, despite a massive decline in exports. In the US the stimulus was both too small and poorly designed – 40% of it went on household tax cuts, which were known not to provide much bang for the buck – and yet unemployment was reduced from what it otherwise would have been – over 12% – to 10%.

The stimulus was always thought of as a stopgap measure until the private sector could recover. In some countries, such as the US, politics rather than economics drove the size and design, with the result that they were too small and less effective than they might have been. Still, they worked. Now, financial markets – the same shortsighted markets that created the crisis – are focusing on soaring deficits and debts.

We should be clear. Most of the increase is not due to the stimulus but to the downturns and the bank bailouts. Those in the financial market are egging on politicians to ask whether we can afford another stimulus. I argue that Britain, and the world, cannot afford not to have another stimulus. We cannot afford austerity. In a better world, we might rightfully debate the size of the public sector. Even now there should be a debate about how government spends its money. But today cutbacks in spending will weaken Britain, and even worsen its long-term fiscal position relative to well-designed government spending.

There is a shortage of aggregate demand – the demand for goods and services that generates jobs. Cutbacks in government spending will mean lower output and higher unemployment, unless something else fills the gap. Monetary policy won’t. Short-term interest rates can’t go any lower, and quantitative easing is not likely to substantially reduce the long-term interest rates government pays – and is even less likely to lead to substantial increases either in consumption or investment. If only one country does it, it might hope to gain an advantage through the weakening of its currency; but if anything the US is more likely to succeed in weakening its currency against sterling through its aggressive quantitative easing, worsening Britain’s trade position.

Of course if Britain succeeds in getting the world to believe that its economic policies are among the worst – an admittedly fierce contest at the moment – its currency may decline, but this is hardly the road to a recovery. Besides, in the malaise into which the global economy is sinking, the challenge will be to maintain exports; they can’t be relied on as a substitute for domestic demand. The few instances where small countries managed to grow in the face of austerity were those where their trading partners were experiencing a boom.

Lower aggregate demand will mean lower tax revenues. But cutbacks in investments in education, technology and infrastructure will be even more costly in future. For they will spell lower growth – and lower revenues. Indeed, higher unemployment itself, especially if it is persistent, will result in a deterioration of skills, in effect the destruction of human capital, a phenomena which Europe experienced in the eighties and which is called hysteresis. Lower tax revenues now and in the future combined with lower growth imply a higher national debt, and an even higher debt-to-GDP ratio.

Matters may be even worse if consumers and investors realise this. Advocates of austerity believe that mystically, as the deficits come down, confidence in the economy will be restored and investment will boom. For 75 years there has been a contest between this theory and Keynesian theory, which argued that spending more now, especially on public investments (or tax cuts designed to encourage private investment) was more likely to restore growth, even though it increased the deficit.

The two prescriptions could not have been more different. Thanks to the IMF, multiple experiments have been conducted – for instance, in east Asia in 1997-98 and a little later in Argentina – and almost all come to the same conclusion: the Keynesian prescription works. Austerity converts downturns into recessions, recessions into depressions. The confidence fairy that the austerity advocates claim will appear never does, partly perhaps because the downturns mean that the deficit reductions are always smaller than was hoped.

Consumers and investors, knowing this and seeing the deteriorating competitive position, the depreciation of human capital and infrastructure, the country’s worsening balance sheet, increasing social tensions, and recognising the inevitability of future tax increases to make up for losses as the economy stagnates, may even cut back on their consumption and investment, worsening the downward spiral.

No business with a potential for making investments yielding high returns would pass up the opportunity to make these investments if it could get access to capital at very low interest rates. But this is what austerity means for the UK.

Critics say government won’t spend the money well. To be sure, there will be waste – though not on the scale that the private sector in the US and Europe wasted money in the years before 2008. But even if money is not spent perfectly, if experience of the past is a guide to the future, the returns on government investments in education, technology and infrastructure are far higher than the government’s cost of capital. Besides, the choices facing the country are bleak. If the government doesn’t spend this money there will be massive waste of resources as its capital and human resources are under-utilised.

Britain is embarking on a highly risky experiment. More likely than not, it will add one more data point to the well- established result that austerity in the midst of a downturn lowers GDP and increases unemployment, and excessive austerity can have long-lasting effects.

If Britain were wealthier, or if the prospects of success were greater, it might be a risk worth taking. But it is a gamble with almost no potential upside. Austerity is a gamble which Britain can ill afford.

So there it is. A very long quote and not a lot of actual writing from me. Feels like being an actual journalist. No doubt I’ll be writing more over the day. In the mean time, let this sink in. Because Stiglitz has it spot on. Austerity is a risk too far for the UK.