Category: Commentary

It has been a tumultuous year. For the UK, the privations forced upon it by the economic and social restrictions necessitated by the pandemic have been exacerbated by the uncertainty caused by the new trading arrangements consequent on the country’s exit from the European Union. While for most countries a post-pandemic return to normal will not see an exact re-establishment of the old order – in many areas, there will have been permanent changes to the old status quo – for the UK, it will be much more of a step into the unknown. Here, it has been impossible to separate the impact of the lockdown from the effects on the economy of Brexit. That our economy had a rougher year  than others in 2020 seems confirmed by the GDP data. But is this because the nature of our economy leaves it more exposed to shocks or because, not far under the surface, Brexit was already having a debilitating impact even before the final withdrawal terms were hammered out? We cannot know.

However, as the chains that have shackled the economy are loosened and removed, we will soon begin to understand the challenges that lie ahead. This will be true for individuals, businesses and government. That some reorganisation and realignment will be required is beyond doubt; the necessary extent will become manifest during the remainder of 2021 and into 2022. In determining what needs to be done, it is important that policy makers do not forget the situation pre-pandemic. It is tempting to think that all we need to do is, as near as we can, get back to where we were, albeit outside the EU’s single market. But must not forget that the decade following the global financial crisis was characterised by a sustained period of sub-normal growth. We still do not fully understand why.

Throughout the period, monetary policy appeared massively expansionary. Quantitative easing was not reversed (and continued in some areas) and interest rates remained exceptionally low. Did substandard economic performance persist despite this continued policy stimulus – a conclusion with implications difficult enough for central banks – or worse, was low growth the consequence of the low-interest rates regimes maintained almost universally in developed economies? The latter is clearly a much greater challenge to established economic wisdom. However, I am firmly of the view that by forcing the risk-free rates of return into negative territory in real terms, central banks created an era of lazy capital. They removed the challenge to companies to grow in order to produce returns sufficiently attractive for investors to take risk. Growth requires investment – currently, however, investors would prefer companies not to invest but to channel cashflow into dividends.

Western economies will not remain permanently moribund. It is ironic that for a while, the recovery from Covid-19 damage will itself provide the challenge that stimulates above-normal investment and growth. In the UK, the bar representing that challenge will be all the higher as companies face up to the new order of the post-Brexit world. What should policy makers be doing to facilitate this process? The important word here is facilitate. Governments and central banks do not themselves produce growth. People and companies do that. But they do it in an environment that either encourages or discourages their activities.

I would like to see government policies that are fully focussed on developing the growth infrastructure of the country; on helping the emergence of a high-valued-added economy. This starts with education, and fashioning a school, college and university system that cultivates in individuals the requisite skills and aspirations. A curriculum has to be developed that is interesting and relevant and that encourages attainment. Too many of our young people emerge from the educational system having already under-achieved and without the skills required to progress in the work place. For so many of our young, the possibility of creating their own business is just too far over the horizon.

Simultaneously, the government must address the business infrastructure. In some respects, this may be as simple as developing the right road, rail and air networks. But it must go so much further; so much deeper. The government can create the environment for centres of excellence to develop. The speed, resilience and security of digital communications must be at the heart of this. Numerous government initiatives aimed at bringing high-speed broadband to 100% of the country have been allowed to fall by the wayside; and there are still many areas where mobile communications are patchy or non-existent (including in some major towns and cities). The UK must be able to encourage new start-ups and attract businesses from abroad with the promise that the communications network will be second to none.

At the core of this must lie a deep understanding of what encourages new business formation – from start to finish and for large, small and micro businesses. This begins in our education system. It is not simply a matter of producing a workforce with the appropriate level of skills; as part of the curriculum, young people should be taught how to setup and run partnerships and small businesses. There should be agencies to help guide people through these processes and to help them source finance (in this context, central banks need to understand that it is most often not the price of money that is important, but the ability to access finance). We need a broad web of economic centres where it is straightforward to develop a site for a new business operation or to find appropriate office space. This requires a planning system that is fit for purpose. And we need a tax system that encourages research and development, investment and entrepreneurial activity. In other words, the government must be focused on lowering the barriers to growth with coherent, joined-up policies that seek first to unlock and then to maximise potential throughout society and throughout the economy. The bottom line is that for the UK to be successful in meeting the challenges ahead (from whatever direction they may come), the government must change attitudes towards wealth creation and then cultivate a broad infrastructure within which this can thrive. The extent to which this is achieved will determine the extent to which the huge national debt currently being accumulated is a long-term burden or a medium-term annoyance.

Over the years, I have written many – possibly too many – articles on the economics of the EU and why, in strict economics terms, I believe that the EU is fundamentally flawed. Thinking about this again, and trying to translate my arguments on the economics of the EU into a more general understanding, I came up with a very simple conclusion. I am sure that many other people have already observed this, but it seems to me it is a point worth making again. The EU works through homogenising processes and interactions within the union.

At one level, this is very obvious and very necessary. For instance, trade and competition are enhanced when there are common standards governing how products are made or structured. We do not want to buy a paint made somewhere else in the EU only to discover that it is full of lead. If the trading standards bodies in different countries can agree, then life is made much easier by homogenising trading standards. You know what you are getting. But when applied more widely, this concept becomes very dangerous.

The EU is not just a trading organisation. To create a more fulsome union of European countries, homogenisation must go much deeper and into all the political, social and economic structures of the area. Furthermore, it is an ongoing process. Once a greater degree of homogeneity has been introduced in one area, then it forces other steps to be taken to secure and embed the change.

The introduction of the common currency was the most dramatic step in this process. It could be seen simply as the last major and fulfilling step in the development of the single market. But as the founding fathers of the EU realised, a common currency was not an end in itself. Rather, it was a step towards a much greater end – it was the means of achieving the ultimate objective.

The reason is simple: for the homogenisation of European currencies to work effectively, there was a requirement for homogenisation in wider monetary policy (this hardly needs stating) but also and more crucially in fiscal policy.

At the headline level, a common currency requires that there is a system for large, frequent and permanent fiscal transfers around the common currency area. These can either be obvious or more oblique – but they have to take place if the common currency is not to be permanently impoverishing to some countries.

Fiscal policy is very different to monetary policy. While there can be some targeting of monetary policy and there are differences in different monetary regimes between countries, it is difficult to use monetary policy to effect redistribution of income and wealth, except on a rather arbitrary and most often unintended basis. Fiscal policy is different. It evolves in a way that is sympathetic to and promotes the political and social objectives of the fiscal area – most obviously, but not always, the nation state.

In my view, homogenising fiscal policy, a process already underway, will become the dominant objective and theme of the European Commission. In this context, it may be considered ironic that Brexit (assuming it happens) will remove a significant impediment to this process – so it ought to be welcomed by the true-believers in the Commission. But that is by-the-by…

As this homogenisation proceeds, it will interfere more and more with national mores. As such, it will threaten what people see to be their national culture and identity. At a time when, in political terms, there seems to be a strong anti-establishment mood and a return to small is best, the EU will be moving not just towards federalisation, but cultural homogenisation and greater central authority.

I doubt that the majorities in the populations of most nation states will find this at all palatable.

The latest release of labour market data for the UK was widely covered in the media, so there is no point in revisiting the headline numbers which looked strong (perhaps, given Brexit uncertainty, surprising strong). The aspect of the labour market that rarely receives much attention is the level of job vacancies.

I think this is a serious lapse on the part of commentators and economists because, all other things being equal, the first way that a business, large or small, can react to a perceived or anticipated change in economic conditions is by adjusting hiring intentions.

Given all the pessimistic comments that have been forthcoming from industrial and employers’ organisations and also from a range of individual companies, one might have expected heightened Brexit concerns to be reflected in a more cautious approach to hiring. However, there has been hardly a flicker. In the three months to February this year there were 854,000 job vacancies (calculated on a survey basis by the Office for National Statistics). While this was slightly down on the previous month, it was still some 39,000 higher than a year earlier and 92,000 higher than in February 2017.

There is an observation I have often made in the past: never mind the driver, watch the wheels. In other words, don’t be mislead by a driver’s comments about which way he is turning or even the way that he seems to be leaning – just watch the direction that the wheels are pointing, because they will tell you the direction of travel.

To be honest, I have been surprised by the continued robust trend in job vacancies; I am surprised that it has not softened appreciably given the fiasco that the politicians are creating around Brexit. But the wheels of industry cannot and should not be ignored, and the direction in which they are pointing remains for the moment very reassuring.

There is no doubt that the emergence over the past 40 years of a very dominant group of supermarkets has changed the face of the high street, and it has not always been for the better. However, there is also no doubt that consumers have seen some enormous gains as a result. The solution for the high street, perhaps, is for empty shops to be converted into homes. But the wider issue is whether the Competition and Markets Authority (CMA) should step in and prevent further consolidation amongst the main retailing groups. This morning the CMA published its provisional findings with regard to the proposed merger between Sainsbury’s and Asda.

According to the BBC, Stuart McIntosh, chair of the CMA’s independent inquiry group, said: “We have provisionally found that, should the two merge, shoppers could face higher prices, reduced quality and choice, and a poorer overall shopping experience across the UK.”

I think this reveals a fundamental misunderstanding of the nature and impact of competition amongst the supermarket groups (and another case of the tyranny of the so-called ‘expert’). Far from being detrimental in terms of product pricing, quality and choice, the consolidation of retail supply has had exactly the opposite effect. The reason can be found in the dynamics of oligopolistic competition (game theory provides many insights in this area). In recent years, competition amongst a small number of very large suppliers has been cut-throat. Margins have been forced down and price reductions have been pushed back down the supply chain, sometimes to the very significant disadvantage of small producers (think of the situation that emerged in the milk supply chain). But in price terms, this has been massively beneficial to consumers.

At the same time, supermarkets have looked for other ways to compete. Quite often this has been on product quality, but it has also become evident in product ranges and retailing styles. In almost all cases, this has benefited consumers – not accidentally, but because that is exactly what the supermarkets are trying to achieve. The supermarkets live or die by their ability to attract shoppers, by presenting a retail offer that suits their circumstances. And if there is a group of consumers that does not seem to be serviced adequately, then it is not long before that retailing gap is filled.

I suspect the mistake the CMA has made is to carry out a largely static analysis, rather than think about the dynamics of the industry, and the ways in which earlier consolidation has had very favourable consequences for consumers – in contrast to many warnings to the contrary while the process was underway.

You only have to consider where you get the best choice, the highest quality and most satisfactory consumer experience for the majority of products that we buy, to realise that oligopolistic competition has been much to the consumer’s benefit. That does not mean there is no room for smaller retailers. There is, but they have to have a very strong niche offering in order to compete, survive and thrive.

Of course, retailing is not the only area in which there has been consolidation over past decades. By and large this has benefited consumers in terms of quality, choice and price. Think of the car industry, for instance, or even, in the service sector, estate agents. Whereas very fragmented industries may seem to offer more choice and a more bespoke service, the reality is that there is often massive inefficiency leading to poor-quality and high-priced goods and services.

Evidently, supermarkets and other suppliers can abuse their market positions – this is happening at the moment in the internet-technology sector. The key is for the CMA and other regulators to ensure that the market place remains fair, transparent and competitive. Most importantly, the authorities have to make sure there is no collusion amongst suppliers. But they do have to understand what constitutes a competitive, vibrant and thriving market place.

Sadly, the CMA in today’s comments seems to have displayed a fundamental lack of understanding with regard to what is (and is not) good for consumers.

For the EU, Brexit represents an existential threat – and that is the real problem.

After a brief respite, we are now back into the daily blizzard of Brexit interviews, rows and disasters. It really does seem to have been a chaotic process. But could it have been any other way? In any negotiating process, it is always evident that, with the benefit of hindsight, one or both of the parties could have played things better. In this particular situation, however, even had Mrs May’s tactics and judgement been better, I doubt that it would have made much difference, and there are a number of reasons why.

In the first place, the extreme nature of the decision taken – to leave the EU – inevitably meant that there were many views between the extremes that have had to be reconciled or accommodated. And that is not just including those who believe that ‘out’ was the right choice. Even amongst the innies, there was a wide variety of views about what our relationship should look like (remember, for instance, the intensity of the debate over whether the UK should participate in the common currency). Because of the fundamental nature of the debate, covering crucial areas such as sovereignty, views tend to be deeply held and compromises are not easily agreed or imposed.

Now add to this one very obvious feature of Brexit, that for most politicians in both the UK and elsewhere in the EU, this will be by far the most momentous event of their political lives, then you have a recipe for an intense if not vitriolic and uncompromising debate. Some people enter politics merely because they feel a call to serve their country and try to bring about positive change. I am doubtful that altruism is the true calling card of most of our modern-day politicians, but perhaps I am being a little ungracious (no change there). But the one thing that unites all politicians is that they are in politics to express their views and to be seen to be doing so. And in my experience, most politicians of whatever colour or shade of colour think they could be doing a better job than the current incumbent of No. 10. Taken together, this means that there is a desperation amongst most politicians in the UK and elsewhere to make their views known and heard as widely and loudly as possible. Is it any surprise, therefore, that the whole Brexit process seems chaotic?

But other elements of Brexit serve to make the situation even worse. It is not just the biggest event that most politicians are likely to be involved in, it is also the biggest and most protracted that the media is likely to have to cover for many a decade. Hence, disaffected politicians can find plenty of places where they can rant and rail about the current state of the negotiations, et cetera. It is also true that no media organisations are truly neutral. Whilst there are some that lobbied hard and long for exiting the EU, there are others who either overtly or covertly are clearly alarmed by the prospect. So, we start the day with BBC’s Today programme giving a daily dose of vitriol and gloom, and from there it simply carries on.

It hardly needs to be said that the media, by its very nature, is a very divisive industry. While this can be justified by the need to hold politicians and others to account, newspapers and broadcasters thrive on extreme views, and in the era of twenty-four-hour news, the pressure to seek out the extremes is even greater. And, of course, there is the new medium of the various, ubiquitous and largely uncontrolled social medias – an area from which emanate the somewhat random and mostly bizarre thoughts of President Trump.

Returning to the political process, it is important to consider the machinations of Brexit in the EU context. There is the very obvious point to make that the EU feels slighted by the UK’s rejection of its grand plan. Furthermore, the last thing that the EU wants is for the UK’s decision to be seen to have been the right one. The prospect of the UK thriving outside the EU could be severely destabilising to the whole EU artifice. This makes for a situation in which EU negotiators think it is in their interests to exploit their size advantage. While the UK always thought it was joining a trade club, this was never the case. The ultimate objective of the EU is to create a federal state. When you read what the founding fathers wrote about the development of the EU, this becomes very clear. Indeed, even the introduction of the euro has to be seen in this context. While it was sold to the peoples of Europe as necessary to make the operation of the single market more effective, in actual fact it was seen by the political theorists as a first real step towards forcing federalisation. While I do not want to go into this too deeply in this essay, suffice it to say that amongst a group of countries as economically and politically diverse as the EU nations, a common currency can only work longer term if those nations federalise. (And yes, the founding fathers did foresee economic and financial crises as a result of the initial introduction of a common currency, but they believed that the resolution of the crises would further the ultimate aim of a federal structure.)

This, in my view, is the reason why the UK took the right decision. I believe very strongly that steps to force federalisation on EU nations could be politically very dangerous with potentially very bad consequences. In fact, one way of interpreting the Brexit vote is to see it as part of the anti-establishment mood that has been growing in the UK and elsewhere. This mood reflects a growing suspicion of established political structures and a rejection of many aspects of big government.

At any time during the life of the EU, there has been one more governmental body than the number of member nations. What we refer to as ‘Brussels’ is an administrative and political structure that is working tirelessly to create its own nation. For those involved in the Brussels machine, Brexit may be threatening to this prospect, but it is also a political event that they judge can be turned around to great advantage and that can be used to increase their authority in the EU at the expense of national governments. And that is not to mention the fact that Brussels administrators and politicians also love the power play and the ability to grandstand.

My personal view is that we should take the deal on offer (as bad as might appear in itself), knowing that Brexit might legally be a moment in time, but that in reality it will take place over many years and will encompass protracted negotiations covering almost every aspect of our lives and then a few dozen more. For all that it might be in individual countries’ interests for the UK to have a ‘good’ exit from the EU, national interests are trumped by longer terms aims and fears.

Undoubtedly, there will be bumps in the road (and some queues), but if the decision to leave the EU is the right one, then moving the focus of the UK to the near-80% of the world economy (a growing percentage, by the way) that is not the EU can only enhance our long-term growth prospects. In the short term, what we must not allow is for a more pragmatic outcome to be stymied by political dogma.

There are some institutions in which the public seems to place extraordinary trust, just because they are institutions (there are some people that seem to have this status as well). In the field of finance, the central banks are just such institutions. It was, of course, a series of catastrophic policy and regulatory errors made by some of the world’s major central banks in the years running up to the financial crisis that were a primary cause of the implosion that is still reverberating around the world economy. Regardless of this, there remains a blind but wholly misplaced faith that most central banks are now getting it right.

So, it is with a necessary degree of scepticism that we should look at the US Federal Reserve’s current policy course and ask whether the financial markets are right to be nervous. Is the continuing process of raising interest rates correct or is the Fed taking an inappropriate and unnecessary risk?

I happen to think that on this occasion, the Fed has got it about right. While it has actually tightened far less quickly that it warned it would, the aim of getting interest rates back to more normal levels has to be economically sensible.

There is a lot of straight-line thinking amongst economists and financial commentators. In relation to monetary policy, this type of thinking dictates that low/lower interest rates always act as a stimulus to nominal growth, and that high or rising interest rates detract from growth. However, whereas this might normally be true, at extreme levels of interest rates, there may be perverse effects.

I think that ultra-low interest rates may actually dampen growth, because they reduce challenge in the system. In real terms (i.e. after adjusting for inflation), risk free rates, measured either by short-term interest rates or by government bond yields, have been near-zero or negative for an extended period. Although this may encourage some entrepreneurial activity by allowing start-up and very small businesses to borrow at better than normal rates, the bigger impact on the economy is to discourage productivity-enhancing investment spending. This is because larger companies can easily beat the returns offered by less risky financial assets through their normal dividend payments and base profits growth, without embarking on risky investment projects. Were interest rates higher, companies would have to work harder to make returns that provided sufficient risk-adjusted rewards to investors. I would also dispute that low interest rates are significantly helpful to smaller companies – the much bigger issue for most is access to credit and investment, not the price thereof.

In effect, abnormally-low interest rates encourage economic laziness.

The Bank of England has fallen into the low-interest trap, and continues blindly and unquestioningly to dig itself deeper. I find it staggering that the Bank’s Monetary Policy Committee has not confronted a very obvious conundrum. Why is it that the economy continues to post such sluggish growth rates despite having been the beneficiary of unprecedented monetary accommodation – made up of massive quantitative easing and exceptionally low interest rates?

In my view, the Bank can reach only one of two conclusions. Either the economy has performed poorly despite the policy course the MPC has followed or because of the course it has followed. Both conclusions are indicative of policy failure, but the latter would also show a hapless inability to understand the growth dynamics of the economy. This, I believe, is the truth of the current situation.

Despite the transparency that surrounds the policy process in the UK, there is no true accountability. If the Bank were held properly to account, and if we were willing to show a lesser degree of blind faith in its capabilities and reverence for its status (the latter seemingly preventing any constructive analysis by or criticism from most City economists and analysts), it might lead to a better quality of economic debate and more inciteful and effective policy decisions.

Unfortunately, the Bank currently has yet another excuse for its long-term policy inadequacies – Brexit.