Rock, paper, scissors

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The Chancellor and Prime Minister seem to be increasingly fond of telling us that nothing will stand in the way of their ambition for growth. According to Reeves, “Growth trumps other things”, including the commitment to a net-zero economy. Leaving aside any questions about whether a commitment to net zero actually hinders growth in any event (there are reasonable arguments to be made that it can change the nature of economic growth rather than inhibit it, but that’s a subject for another time), the government’s own actions make it clear that there are some things which growth does not trump. The most obvious example concerns the UK’s relationship with the EU. One of the easiest things that a UK keen on economic growth could do would be to re-enter the customs union and single market. It's something which could be done without ‘betraying’ Brexit, given that prominent Brexiteers argued at the time that Brexit didn’t mean that we had to leave them in the first place. However, growth might trump net zero, but Brexit trumps growth. If only net zero could trump Brexit, we could play a sort of rock, paper, scissors game. A neat closed circle into which Starmer and Reeves could quietly disappear. But Starmer's much-vaunted 'reset' of relationships with the EU appears to be little more than a Labour version of cakeism, under which the EU gives the UK a better deal without the UK conceding anything.

It is being widely reported that Reeves will announce tomorrow that, in pursuit of that magical growth, the government will give the go-ahead to building a third runway at Heathrow. Or rather, they will give the go-ahead to starting a process which means that the third runway might be in place in about 10 years from now, assuming that the project goes rather more smoothly than any large UK infrastructure project in recent decades. In terms of her self-imposed and arbitrary fiscal rules, the operational ‘benefits’ from Heathrow expansion will start to flow only a decade hence, well outside the 5 year timescale of those rules, and only after at least two general elections have taken place. Since the planning phase is going to take a minimum of 2-3 years, there’s unlikely to be any sort of boost to the economy, even in terms of the relatively short-term construction phase, until after the current government has faced the electorate.

The argument for expansion is usually presented in terms of showing that the UK is open for business. It conjures up images of businessmen jetting off to far-flung places to sell their wares to grateful foreigners, or of rich foreigners jetting in to invest their fortunes in UK businesses (preferably without anyone enquiring too deeply about the source of those fortunes), and encourages us to believe that, if only there were an extra runway, more of both of those things would happen. It isn’t quite the reality though. Estimates of the proportion of business traffic passing through Heathrow vary. This one suggests it’s around a third of all passengers; other estimates put the figure as low as a fifth. Despite its carefully cultivated image, Heathrow is, first and foremost, an airport used for leisure travel. And many of the travellers come from elsewhere in the UK, not exclusively from the London area, even if that’s where the majority come from. There’s another aspect to that last part as well. Whilst it’s obviously true that an airport contributes to GDP in a variety of ways, including shops and restaurants as well as the jobs involved in processing passengers and planes, an airport which sucks in passengers from further afield than the local catchment area also concentrates GDP geographically around itself.

Like so much else of what the current government is doing, a decision to expand Heathrow looks largely performative. Taking – or, rather, being seen to take – tough decisions (a phrase which seems to be a euphemism for decisions which will upset as many potential Labour supporters as possible) has become an end in itself. The belief that doing so will somehow magically lead rich foreigners to pour their zillions into the UK is more an act of blind faith than anything else. But it’s not the sort of faith likely to survive contact with economic reality.

Chickens, eggs, and confused Chancellors

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There is a report today that the Chancellor is pressurizing the Office of Budget Responsibility to use planned but not yet implemented planning reforms to change its estimate of the rate of UK growth. If they agree, then she will be able to spend more money without breaking her own arbitrary fiscal rules. It doesn’t mean that there will actually be any more money, of course; merely a forecast of extra government revenue at some future date. If they agree to roll over and do as she asks, she will then spend that extra non-existent money on investment in the UK economy. Planning and implementing the spending will, as it always does, precede the actual receipt of the money (always assuming that it is eventually received), and in the short term, that spend will be presented in the accounts as though the money has been ‘borrowed’, even if it’s actually simply been created out of thin air by the Bank of England.

There’s nothing new or unusual about that as a process, it’s what always happens, no matter how much the politicians attempt to deny it. Government spending always precedes government revenue. But here’s the twist: spending the extra money will expand the economy (i.e. create economic growth), thereby validating, to a greater or lesser extent, the original assumption about higher growth. The cause of that growth may not be the one stated when it was first built into the assumptions. But in terms of the outcome, that’s unimportant. Government spending creates economic growth, which eventually leads to increased government revenue.

She could, of course, achieve the same thing by simply adjusting the arbitrary fiscal rules to which she is working. She is, however, too confused about the order of chickens and eggs, and too deeply imbued with Treasury and Bank of England orthodoxy. Maybe it doesn’t matter too much (unless the OBR refuse to play ball), because as long as she abandons her obsession with insisting that the income must precede the expenditure, she does actually stand a chance of achieving the magical growth on which everything, apparently, depends. Whether it’s the right type of growth, in the right places, is a question for another day…

Magical economic growth

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One of the many areas of agreement between Labour and the Tories when it comes to economics is their unshakeable belief in the Great God Growth as the solution to all economic problems, to say nothing of other problems such as health and education. There is, it seems, no need to consider further taxing, or redistributing, accumulated wealth or disproportionately high income because the Great God will magically make the cake bigger, and a bigger cake goes further. To the extent that there is a difference between the parties, it relates only to the question of which particular rites and ceremonies need to be performed by the devotees of the Great God before (s)he performs his or her magic. The problem with this whole belief system is that it depends on some unstated and very dubious assumptions.

The first of those is that the government itself has no direct role in making growth happen. Government’s job is simply about providing a bit of infrastructure and slackening a few rules, and suddenly growth will just happen. It’s an approach which, incidentally, treats government expenditure as though it is a drag on the economy and therefore to be avoided rather than something which can itself directly stimulate growth, and undermines its own aims in the process.

The second is that a bigger cake means that everyone benefits. But without any consideration or control of the way in which the extra cake is shared out, what stops those who already have the biggest slices from simply grabbing all the extra cake for themselves? After all, recent history of growing disparity suggests that that is the most likely outcome.

And the third is that, as the cake grows, the government’s tax income grows in proportion. It’s a belief which rather overlooks the fact that those taking the biggest slices of the cake are also those who are best at avoiding paying tax, and most likely to be able to conduct their financial affairs in such a way as to take their income in the form of (lower-taxed) capital growth rather than taxable income, and/or shift their wealth and income into off-shore havens.

Perhaps the biggest assumption of all is that growth is, in and of itself, always a ‘good thing’. It is at best arguable and at worst a potentially disastrous approach to the utilisation of the Earth’s resources.

Maybe they believe that their Great God will add a magic ingredient to the cake mix which ensures that baking a bigger cake doesn’t need any extra resources; maybe the same ingredient turns greedy hoarders of wealth into altruists keen to share the cake more evenly. Maybe the moon really is made of green cheese, and revolves around a flat disc called Planet Earth. Or maybe, in the real world, we actually need government to take deliberate action to ensure greater fairness in the allocation and use of resources. That’s an option which currently looks unlikely to be on any ballot papers come the election. Seen solely in terms of the choice of a future UK government the question is very much simpler: which colour disillusion do we prefer?

Four negative numbers can become one positive number - with enough faith

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The UK Government continue to insist that they have a ‘plan for growth’. They do not: they have a plan for tax cuts, half a plan for spending cuts, and a half-baked plan for deregulation, the sense of which the head chef, Jake, is having difficulty convincing even his fellow cultists about. Their ‘plan’ for growth consists of little more than an unshakeable faith that growth will inevitably follow the implementation of those three ‘plans’ despite a complete lack of corroborating evidence.

Leaving aside the question of whether growth is always desirable or even attainable anyway (infinite growth in the context of a finite quantity of resources, for instance, is at the very least questionable), and assuming that what the PM means (although she hasn’t actually spelled it out in so many words) is an increase in overall GDP, how likely is it that growth will actually happen? There are a number of different ways of calculating GDP (all of which should ultimately produce the same answer, although the presence of estimated numbers in all of them means that there can be some variation). One of the most common is the simple equation:

GDP = C + G + I + (X-M)

By the same token, any increase in GDP can be measured by the increase in the total of the four factors, which are: C = consumption, G = government spending, I = investment, and (X-M) = the difference between exports and imports. (Prof Richard Murphy has more here). For GDP to increase, simple arithmetic tells us that at least one of those four terms must increase. The problem is that the increasing gap between prices and income will reduce C, the government is due to reveal on 23 November (assuming that the markets and restive backbencher allow it to wait that long) by how much it will reduce G, I is outside the control of the government to a large extent, but investment in new plant, equipment etc looks like a risky assumption in a time of economic uncertainty, and we know that (X-M) is impacted directly by Brexit. A government which was serious about growth would want to ensure that household consumption could at least remain static rather than fall, it would ensure that government spending – particularly on infrastructure – rose, it would do its best to create the sort of stability which reduces the risk to businesses of making large investments, and it would seek a closer trading arrangement with the UK’s closest and biggest markets. In reality, a government which claims to be committed to growth is actively taking decisions in relation to all four of those factors which will either suppress growth or, even worse, ensure a recession. No amount of blind faith can make four negative numbers add up to a single positive one.

There is, though, another possibility, and that is that the PM is not referring to growth in GDP at all. She wouldn’t be the first to confuse ‘making people wealthier’ with ‘economic growth’, and leaping from there to an assumption that an increase in the concentration of wealth amounts to economic growth. It would make rather more sense of her statements, to the extent that making sense of them is a realistic possibility. If the wealthiest in society have more money in the bank, the inescapable corollary is that they will be wealthier as a result, and if all the people with whom you mix are in that ‘wealthiest’ category, it can be easy enough to believe that ‘people in general’ are getting wealthier. The salary of a back-bench MP puts MPs in the 95^th percentile of employed people in the UK, and many of those with whom they socialise (and from whom they seek donations) will be in an even higher percentile. The numbers, to say nothing of the everyday experiences of the rest of the population, might tell a different story; but who needs numbers when you have faith? That would be almost like asking an expert.

The wrong type of growth

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Yesterday, the government floated the idea that the EU-imposed cap on bankers’ bonuses might be lifted. It was well-timed; with most of the Labour Party observing an entirely unnecessary self-imposed ordinance not to indulge in politics, and most of the media dedicated to broadcasting live images, almost 24/7, of a crowd which is barely moving filing past a coffin which is not moving at all, it’s a good time for the government to carry on as normal, just with less criticism. They haven’t managed to avoid the criticism altogether, but they’ve had a lot less than the proposal deserves.

Much of the criticism which has been voiced has concentrated on the apparent injustice of allowing huge increases in the remuneration of bankers whilst everyone else’s pay is held down because of fears of inflation. It’s fair criticism, and it’s true that allowing the fattest cats to get fatter will look like appalling politics to many. It misses the point, though. There are two far bigger concerns than how much bankers get paid.

The first of those is about what they do to earn those bonuses. The reason for imposing the cap in the first place was because large bonuses were incentivising reckless and short term patterns of behaviour, which ultimately caused a major meltdown of the banking sector. I see no indications from a government that also wants to reduce regulatory control over banks that the implicit dangers of that have been understood. Hatred of EU rules and a desire to steal business and jobs which might otherwise be located in the EU seem to have trumped caution.

But the even bigger problem is the notion that they’ve got into their heads that this is somehow going to address the problem of the UK’s low economic growth. There’s no doubt that, as a result of the way GDP is calculated, an increase in banking activity in the City of London will lead to an increase in GDP, and the statistics will mechanistically report that as economic growth. The problem with headline figures for growth is that the detail is ignored; but in this case, that detail matters. Only a tiny minority in a very small corner of the UK will benefit from any growth which follows from uncapped bankers’ bonuses, and it won’t feel much like economic growth in the left-behind areas, such as Wales. What the UK needs is the sort of economic growth which spreads prosperity rather than concentrating it – we could give it a fancy name, such as, I don’t know, how about something like “levelling up”?

The ideology driving the current government claims that higher wages and lower taxes for the already well-off benefit the entire populace rather than only those whose pockets are directly filled. There is, however, absolutely no empirical evidence to justify such an assertion; such studies as have been performed all tell us that the result of putting more money in the hands of those who already have most simply leads to the rich getting richer and inequality increasing. It turns out that simple common sense predicts the outcome of giving more money to the richest better than any ideologically-driven economic theory. Who’d have thought it?

Sharing the eggs between the baskets

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Last week, the leader of Cardiff Council told us that the City of Cardiff is ‘Wales's best economic asset’.  As is ever the case, such terms need more precise definition before being accepted uncritically, but in the sense that Cardiff and the area around it is the wealthiest part of Wales and contributes most to GVA, then I agree with the statement.  That isn’t the same as agreeing with the conclusion, however, which seems to be that Cardiff should therefore receive a disproportionate share of future investment to make it even more successful and wealthy.  There are two main reasons for rejecting that conclusion.

The first is that it ignores, or overlooks, the question of how that situation has come about in the first place.  There is nothing inherently special about Cardiff which means that it has become wealthy while the rest of Wales has not (in the same way as there is nothing inherent in being Welsh which dooms us to being one of the poorest parts of the UK).  One of the reasons for Cardiff’s greater success has precisely been that it has already received a disproportionate share of past investment.  Imagine for a moment replacing Cardiff with London, and saying ‘As the result of previous wealth concentration, London is the UK’s best economic asset, therefore future investment should be concentrated there’.  As a statement of current UK government policy, it looks pretty accurate, but most of us in Wales would reject that as a basis for determining future investment strategy.  Why would we want to simply replicate that in Wales?

The second is that, ultimately, such an approach amounts to seeing the future economic growth of Wales in ‘average’ terms.  That is to say that Wales, as a whole, looks better off if the average GVA per head increases, and the easiest way of achieving that might well be to put the investment into those areas where GVA growth is potentially the fastest.  But improving the ‘average’ GVA per head isn’t the same as making everyone in Wales better off.  Indeed, it is perfectly possible in mathematical terms to increase the average whilst decreasing the actuals across most of the country.  And sometimes it even looks as though government policy is to attempt to prove that mathematical theorem in practice.

That isn’t to say that Cardiff shouldn’t receive a ‘fair’ proportion of future investment (although defining ‘fair’ is a major topic in itself, far more complex than mere headcounts).  But any Welsh government which was serious about sharing prosperity would be looking to a strategy which improves life for all the people in Wales.  And that can’t be measured simply in averages.

All models are wrong - and some aren't even useful

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On Monday, the Tory group leader in the Assembly demanded that the First Minister dissociate himself from Corbyn’s policies, claiming that they would result in around £4,000 of extra debt for each person in Wales, and that the UK would end up paying around £5.8 billion a year in additional interest payments if Labour’s plans were implemented.  It’s the stuff of good political knock-about, but without a lot more information on how they’ve done their sums (and the Tories don’t exactly have a brilliant record when it comes to financial arithmetic), it’s difficult to know what, if any, relationship exists between his figures and ‘truth’, in the mathematical sense of the word.

But, for the sake of argument, let’s suppose his figures are accurate ones.  Is it really the economic disaster as which he paints it?  Of course, £5.8 billion sounds like a very large sum of money to be paying in extra interest every year, but that’s in absolute terms.  And it makes a number of unstated but implicit assumptions.

The first comparison that has to be made is not, as the Tories effectively claimed, with the status quo, but with what the outcome would be over the same period with a Tory Government.  The implicit assumption in what Davies said is that Tory spending plans would not lead to a similar outcome, but given the way in which out-turn has varied from predictions over the last few years, and the way in which much of the (uncosted) Tory manifesto has been ditched, that looks to me like an invalid assumption.  If there is a gap between the likely outcome under a Corbyn government and the likely outcome under a Tory government (and even that is a significant ‘if’) then it is probable that the gap would be much smaller than Davies is suggesting.  All the signs are that the Tories will also increase borrowing to pay for their programme; the honest question is not how much Labour would need to borrow, but what is the difference in borrowing levels between the two.

The second question is about what proportion of GDP the debt would represent, and what proportion of expenditure any extra interest payments would represent.  Both of those are dependent on a range of assumptions and guesses about the likely level of inflation, economic growth, and interest rates.  Given the propensity of all involved to get such estimates wrong, it would be a very brave person who would claim to know the correct value of any of those variables over a five-year parliament.  But in principle, simple mathematics shows that a debt which increases in absolute value by a smaller percentage than the rate of economic growth will end up reducing the ratio of debt to GDP, which is why the absolute value being used by Davies is irrelevant.  The same mathematics also demonstrates that when interest rates are lower than the rate of inflation, paying more interest in absolute terms can still result in a reduction in the percentage of government income committed to paying interest.

What we do know is that, as things stand today (and I accept that’s a very important caveat), the UK Government is effectively borrowing money interest-free.  It’s costing us, in real terms, absolutely nothing, and given the demand from people who want to lend money to the government, there is no immediate problem in borrowing more.  Indeed, some would even argue that increasing government spending actually generates more tax income than the amount spent: the calculation all depends on the value assigned to the infamous ‘multiplier’.

Now of course it is true that different economists will give different answers to questions such as these, but that merely serves to underline that economists base their predictions on models rather than on absolute truths, and there are a number of different models available.  As the famous statistician, George Box, said, “All models are wrong, but some are useful”.  It’s a point worth bearing in mind that when politicians state categorically what the outcome of a particular policy will be for the economy they are depending on a model of some sort, whether they admit it - or even realise it - or not.

As I said at the beginning, this sort of guff from Davies is all good knock-about politics, but it’s really froth; he has no more clue than do I about the accuracy of what he says.  The real question is why one particular model – the idea that the government is like a giant household, which is used by the Tories when they come out with this stuff – is taken as gospel truth by a media which regularly demands that politicians from other parties explain themselves in the terms mandated by that model.  It would be more useful to political debate – let alone to economic policy – if the idea which underlies much of what they say was challenged more forensically rather than being simply accepted.  And it’s a shame that more opposition politicians don’t appear to have the understanding or the confidence to do that.

Borrowing and investment

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That there must be limits to economic growth is self-evident, but pinning down precisely where and when those limits will be reached is considerably harder.  Whilst pretending that we can carry on and simply ignore the issue is foolish complacency, there is a danger that those of us who take an alternative view can sometimes sound a bit like American fundamentalists looking for evidence of the End Times.

To listen to Vince Cable, one would think that economic recovery depends largely on a willingness by the banks to lend more money to businesses for investment.  I’m not so sure; and not solely because it sounds like a return to the excessive lending which was part of the reason for the crash in the first place.

Dylan Jones Evans pointed out about two weeks ago that “it is estimated that large companies in the UK are currently sitting on around £65 billion of cash within their balance sheets”.  As far as big businesses are concerned, at least, it isn’t simply a matter of lack of access to capital.

Dylan puts the lack of investment down to this stuff called ‘confidence’ – or rather, the lack of.  I’m not so sure, although I suppose it depends on confidence in what.  But I wonder whether there isn’t also a serious lack of investment opportunity at present.

My doubts were heightened by the reported comments of another well-known Welsh-based economist, Patrick Minford (coincidentally in the same edition of the Western Mail), in which he suggested that we could be in for a long period of readjustment, and that the global economy simply cannot expand any more at present.

It certainly seems likely that we will be facing a world in which countries such as China and India use a growing proportion of available resources, and probably without a significant increase in the total availability.  It’s also likely that they will be meeting higher levels of domestic demand as well. 

Price rises for many commodities and raw materials would be an inevitable consequence of the former, and for finished goods of the latter.  It’s hard to see where demand is going to come from in our own economy if we have both rising prices and falling real wages.

Faced with a possibly lengthy period of stagnation, Plan B needs to be about more than a difference in the speed and size of public sector cuts.

Consultants and Fishermen

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Reading this report in yesterday’s Western Mail brought to mind the old story of the consultant and the fisherman.  It’s true, of course, that many Welsh SMEs are not engaged with the export market – but is it really a problem?

The underlying assumptions behind the criticism of companies which are not exporting are that all businesses must want to expand, expansion means always looking for new opportunities, and looking for new opportunities means exporting.  And it isn’t just the newspaper report which is built on those unstated assumptions – the economic development policies pursued by successive governments of all parties at all levels appear to be based on the same assumptions.

I tend to be with the fisherman on this, however; not all businesses want or need to grow, but that doesn’t mean that they’re not useful, or should be considered as failures in any way.  There are limits to economic growth, and economic policy needs to start recognising that fact, not simply continuing as though it were not so.

Neither is exporting necessarily a good thing either.  Indeed, in a world where energy for transportation is going to become increasingly expensive, having more localised businesses is generally likely to be a ‘greener’ approach.

There is a mismatch between the needs at a macro level and the needs at a micro level.  At a macro level, governments are – quite rightly – concerned with ensuring that there are well-paid jobs available for all, and that the country’s total imports and exports are kept in balance.  That is generally translated into economic policy as meaning that all businesses need to be helped to grow and export – but there have been a few points lost in the translation.

A sustainable economic strategy means deliberately encouraging more localised businesses and distributing production rather than merely distributing product.  Meeting more of our own needs locally is just as effective a way of contributing to a reduction in the balance of payments deficit as producing more than we can sell and sending it abroad, whilst importing the same goods and services from elsewhere.  It requires a major shift of thinking to achieve it though.

Good GDP, Bad GDP

Tweet It is clear that the underlying problem affecting Wales' potential viability is the under-performance of the Welsh economy, and that to address that, we need to improve the level of GDP per head. But not all GDP is 'good' GDP; there are good ways and bad ways of increasing Wales' GDP, and chasing growth per se will not necessarily provide a sustainable long term economy for our country.

As an example, I'm sure that the oil spill in the Gulf of Mexico has led to an increase in GDP in some areas, as people have been employed in clean-up operations, in extra drilling operations to set up a relief well, and in manufacturing a 'cap' for the well head. Similarly, a major nuclear accident would boost GDP in managing the clean-up after the event. But I don't think anyone would seriously suggest that an oil spill or a nuclear accident would be good things for Wales.

It's even more subtle than that. When people think of creating wealth, they often think in terms of boosting manufacturing industry, and indeed, the front page of today's Western Mail draws attention to the slump in manufacturing in Wales. There's a problem with manufacturing though – making stuff almost invariably requires raw materials, as well as using environmental resources, and in the developed world, we are already using more than our share of both of those.

That doesn't mean that we don't need manufacturing, or that we should simply depend on other people doing the manufacturing, of course. The raw material cost and the environmental cost is still down to the ultimate consumer rather than the manufacturer; we don't escape those costs by simply 'exporting' manufacturing to India or China.

But we cannot continue to seek economic growth based primarily on an unfair share of the usage of finite resources, and there is no evidence to suggest that increasing efficiencies in the use of resources will square that circle.

'Good' GDP is GDP which requires no extra use of raw materials or environmental resources, or which involves investment in restoring the earth's environmental systems. It's likely to be more service based, more labour intensive and less profitable in the traditional sense.

Are we ready to embrace that sort of future, and accept that it means building a different type of economy?