Monday, 23 January 2012

We're All Economists Now

The British/European/global economic downturn/credit crunch/crisis/recession from 2008, and now making an unwelcome return in 2011/12, seems to have piqued many peoples' interest in all things economic.

You don't need to fully understand what exactly a hedge fund does, or what is meant by derivatives or naked short selling (if only it means what it sounds like it means), or that getting a 'haircut' now has another meaning, to want to know more about the economic reality that exists in the UK at the moment.

And for that, a sound grasp of the basics is more important that being an expert of each and every intricate financial term. But, thank you BBC for this very helpful financial glossary, all the same.
Here is an attempt to makes things a little clearer:
The principal narrative of the coalition ConDem government is that they inherited a huge budget deficit; that is the amount by which government spending in a year exceeds its income, in terms of taxes and receipts.
It is also referred to as Public Sector Net Borrowing (PSNB): the total the government has to borrow each year, resulting in it racking up a deficit, measured as a percentage of GDP.
By GDP, we mean the total economic activity of a country, in terms of all the goods and services it produces. It measures the health of the economy.
The deficit taken on by the coalition was worth £156.1bn, 11.1% of GDP (p.24), which was actually around £11bn lower than the £167bn forecast for the end of the financial year 2009/10, by the then Labour Chancellor, Alistair Darling, in his final budget.
It is important to note that this figure excludes the money spent bailing out UK banks (RBS, Lloyds TSB, HBOS) during the 2008 credit crunch - a total which has fluctuated wildly from a commitment to propping them up to the tune of £1.162 trillion back in 2007, to £612.58bn by March 2010, and then down again to £456.33bn at the end of March 2011.
Then there is the UK's government debt, or its Public Sector Net Debt (PSND), which is the total amount of money the government owes. It is worked out as an aggregate figure, and is the accumulation of all the fiscal deficits, all government borrowing, accrued over previous years, and which is still to be paid off.
Thus, each year's deficit gets added to the existing debt.
The present government inherited debt of £759.5bn or 52.7% of GDP, for the end of the 2009/10 financial year, according to Treasury figures (p.95) released in March's 2011 Budget.
So, who exactly does the government owe this debt to?
Debt can be divided into internal debt, money owed to lenders within the country, borrowed from those in the private sector, such as pension funds, investment trusts, building societies, and external debt, that owed to foreign lenders.
The UK Debt Management Office (DMO) is charged with managing the government's debt through the sale of gilts (risk-free bonds), Treasury bills, and bonds. The latter act as the government's debt security.
The government issues bonds, which are bought up by various bodies in the form of loans (debt investment), which it then has to pay back at a fixed (maturity) date, with interest.
UK government bonds are seen as relatively secure and risk-free investments as buyers know that they will always be repaid.
Pension funds and insurance companies are the biggest owners of government debt, making up almost a third of it.
The biggest increase in debt since 2007 has been caused by the bank bailouts, and the need for quantitative easing (printing money), in order for these financial interventions to have been possible.
And, about a third of debt is external, owed to overseas investors.
In order to make sense of the UK's debt and deficit figures they need to be put into context.
In historical terms, the UK had the largest budget deficit since 1945, and the biggest since the early 1990s. Its current debt stood at the highest levels since the late 1960s. History tells us that the British Empire was in fact built on debt.
However, over the last 100 years, debt levels have been higher before. A lot higher in fact: at 250% of GDP at the end of the 1940s, and over 100% during the 20s and 30s; the result of having to fund two world wars.
And, as one economics commentator points out, the enormous debt built up during the 1940s also coincided with the creation of universal healthcare and the welfare state. Rather than paralyse Britain, this was followed by three decades of strong economic growth.
How does this compare to other countries?
By the end of 2010, the UK had the third highest budget deficit of all the nations in the EU, with only Greece and Ireland worse off.
For the same period, even though the UK had above average levels of debt, it was still less than France and Germany, and came ninth overall within the EU.
It is important to recognise that the EU, and other bodies such as the OECD, an economic think tank of the world's wealthiest states, measure deficit and debt using a different methodology to the government.
For the EU, stats are compiled using methods prescribed by the 1992 "Maastricht Treaty," which advised member states to avoid excessive debt, equivalent to 60% of GDP, or deficit levels exceeding 3% of GDP.
They therefore found UK deficit levels of 11.6% of GDP, and debt worth 71.2% of GDP, for the end of the 2009/10 financial year.
Globally, the Treasury pointed to OECD stats, which in May 2010, estimated that the UK would have the highest deficit of all its members, as well as IMF forecasts predicting that the UK's 2010 borrowing would eclipse all other countries in the G20.
Final figures released by the IMF (p.121) for 2010 found the UK, pipped only by the US, in having the second highest budget deficit of all G7 and G20 nations, with Britain's excess borrowing way above advanced economies and Eurozone averages.
Yet, the IMF also showed that, when it came to government debt, Britain had the lowest levels of all G7 states (p.127), and close to average levels of the countries in the G20.
So, those are all the necessary facts and figures out of the way. Time for the blame game.
This government's main line of attack against Labour is that the latter left the country's finances in a mess.
They have made political capital out of arguing that Labour borrowed and spent too much, and didn't save during the boom years. Now in office, the coalition has committed itself to tackling and then eliminating the deficit as its main priority.
The main charge, that Labour built up an unnecessarily huge deficit, is of course true if you just look at the raw figures but ignore the context.
Labour themselves inherited a small deficit in 1997, and then achieved a budget surplus for the next five years.
But, in November 2002, Gordon Brown, as Chancellor, admitted that Britain would have to borrow to pay for a huge public spending programme, as laid out in the 2000 Spending Review, investing in services that had been chronically underfunded by the Tories, such as the NHS and education.
He was also responding to an economic downturn, caused by world events, such as the global threat from terrorism.
The real spike in the deficit comes in 2008. Borrowing leapt from 2.38% of GDP in 2007/08, to 6.75% in 2008/09, and then peaking at 11.1% in 2009/10 (p.7). Essentially, rising from £33bn to £156bn in the space of just three years.
Whilst the reckless spending charge is easy to level, it deliberately ignores several crucial factors: 2007/08 saw the beginning of a worldwide economic downturn and then recession, the worst since the 1930s, affecting almost all of the world's major economies.
It resulted in the collapse and then enormous bailout of many of the UK's high street banks, crippling the public finances.
The 2009 budget had forecast a growth in revenue. Instead, the government suffered a spectacular loss, with 2009/10 bringing in about £112bn less than they had expected.
The downturn meant higher unemployment, lower tax receipts, and more people in need of state help. A 100,000 increase in unemployment costs the Treasury about £500m, with the reverse happening when the economy is performing strongly.
This therefore required a surge in public borrowing in order to compensate.
Thus, the bulk of the deficit taken on by the coalition came as a result of events beyond Labour's control.
Once in office, the coalition has decided to run roughshod over the economic reality.
For the last 21 months or so they have pursued a series of tough austerity measures: aggressive cuts combined with huge reductions in public spending, believing that this is the only way to eat into the deficit.
This despite the raft of evidence that a weak and fragile economy requires an increase in government spending as the best way to stimulate the economy, especially as, naturally enough, in hard times, people choose to spend less. If nobody's spending, the economy comes to a standstill, or worse.
The last few years has seen a resurgence in support for Keynesian economics: the view, by the English economist, John Maynard Keynes, that fiscal stimulus (more government spending) is essential in a recession. During the Great Depression in the 1930s, he called for governments to invest in infrastructure.
Advocates of this position have consistently warned that cutting the deficit when the economy is weak is dangerously detrimental, and will only serve to harm it further.
As Robert Skidelsky, the acclaimed biographer of Keynes, explained:
"The reason for the slack [in the economy] is that the private sector is not spending enough to employ all those seeking work – whether because investment prospects are too uncertain, or because it is paying off debt. In these circumstances government spending is not at the expense of private spending: it compensates for its absence. If the government were to economise on its own spending at the same time as the private sector was spending less, the result would be a slide into even greater recession. Keynes called this the "paradox of thrift."
Paul Krugman, the celebrated Nobel Prize winning economist, has been cautioning against rapid spending cuts, both in the US and the UK, for years. He has argued that the coalition are ignoring lessons from history with their severe deficit-reduction strategy, and that such a move will fail to stimulate enough real growth:
"Fiscal austerity will depress the economy further...The sensible thing is to devise a plan for putting the nation's fiscal house in order, while waiting until a solid economic recovery is under way before wielding the axe."
"Why is the British government doing this? The real reason has a lot to do with ideology: the Tories are using the deficit as an excuse to downsize the welfare state. But the official rationale is that there is no alternative."
A stagnating US economy with stubbornly high unemployment has led even staunch Republicans to concede that Krugman may actually have a point.
He is also backed by Carmen Reinhart and Ken Rogoff, authors of the universally-praised book, This Time is Different, in which they documented financial crises in over sixty-six countries, over a period spanning 800 years.
Both agree with Krugman that fiscal adjustment is necessary, just not at the moment, or to the extent that it is being implemented.
Rogoff argued that:
"The important thing to do is structural reform. Make us [the US] grow faster. Improve our tax system, build infrastructure, education, view it as a crisis in that way [but]...I certainly don't think slashing the way to go about business."
Instead, 21 months on, whilst sticking steadfastly to Plan A, this is the current economic reality facing Britain:
a stalling economy, unemployment the highest in 17 years, with an average of 23 applicants for each job, record numbers of people 'underemployed,' -those working part-time through lack of choice- the longest ever period of wage stagnation, with analysts warning that the Chancellor's 2011 autumn statement will see, between 2009/10 and 2012/13, real median incomes fall by 7.4%, levels not seen since the mid-1970s.
Noting a lack of any meaningful recovery has led to an increasing number of analysts to publicly question the government's chosen path.
One of Britain's leading economic think tanks told George Osborne to rethink the scale of the cuts, urging something more targeted:
"...fiscal policy is too tight, and a modest loosening would improve prospects for output and employment with little or no negative effect on fiscal credibility."
Another called for spending cuts to be aligned to economic growth, and fiscal consolidation to be less severe in a year where growth is forecast to drop below 1.5%. Cuts should be slowed until the economy was stronger and able to absorb them.
And in recent months, murmurings from various international bodies have got louder, with warnings that austerity drives are in fact harming, rather than healing, sick economies.
This month, the leaders of the IMF, World Bank, and WTO, expressed concern at over-aggressive deficit reduction programmes, and issued a joint plea for governments to:
"...manage fiscal consolidation to promote rather than reduce prospects for growth and employment. It should be applied in a socially responsible manner."
Finally, the public are starting to turn on the government, with a recent poll finding 59% of voters backing a slowdown in spending cuts.
The trouble for Labour is that more people blame them for the state of the economy than the coalition's cuts.
In spite of several months of gloomy economic news, and despite the gathering calls for a Plan B, the government seems more determined than ever to press on, with the downturn used as cover for an irreparable and ideological shrinking of the state.

This article was first published in three parts by Left Futures. Part 1 appeared on Monday 30 January 2012, part 2 on Tuesday 31 January 2012, and part 3 on Wednesday 1 February 2012.
This article was also published in two parts by Left Foot Forward. Part 1 appeared on Saturday 4 February 2012, and part 2 on Sunday 5 February 2012.

Sunday, 15 January 2012

The £32bn Great Train Robbery

The lure of high speed rail travel has proven too much for ministers to resist. Seduced by the chance to finally emulate its European neighbours, Britain will have its very own TGV in the not so near future.
In a 2006 major review of Britain’s transport needs, the former head of British Airways, Sir Rod Eddington, was forthright in this blunt message to politicians:
 “The risk is that transport policy can become the pursuit of icons.”
A message clearly taken to heart by successive governments in pursuit of their high speed fantasy. HS2 will serve as an ostentatious symbol, in an age where ministers seem determined to impose their legacies on future generations, however unnecessary or disruptive they may be.
And, this despite the underwhelming evidence in favour of such a move. Principally, as I intend to demonstrate, the economic case simply doesn’t add up. Supposed regional benefits have been dangerously over-exaggerated, with lessons from Europe ignored.
Decisions have been taken based on shaky assumptions and projections which look no better than overly-optimistic guesswork.
Despite strong support from business groups for HS2, as yet, none of them have offered to commit a single penny to the project. It looks very much like backing from a safe distance, with none of the repercussions if anything goes wrong.
Writing in his column in The Guardian, last week, Simon Jenkins delivered his rebuke in typically cutting fashion:
“…a vast sum of money is going on a single upmarket project whose chief feature is its extravagant glamour. HS2 is gesture spending dressed up as growth. It is Concorde for slow learners.”
When the then Transport Secretary, Philip Hammond, launched the high speed rail (HSR)consultation process back in February last year, he urged Britain not to get “left behind:”
We must invest in Britain’s future. High speed rail offers us a once-in-a-generation opportunity to transform the way we travel in the 21st century and would help us build a modern economy fit for the future.”
Last week, after receiving almost 55,000 submissions to the consultation in the form of letters, emails and petitions, the government gave Britain’s second high speed rail route (HS2) the go-ahead. 
And, in doing so, they have spectacularly failed to take into account the Transport Committee’s published report released in November.
This was the result of the separate High Speed Rail (HSR) inquiry which received more than 200 pieces of written and oral evidence from a wide array of experts.
Certainly not the first time a government has seen fit to ignore the advice of the experts.
Even in giving its approval, the committee’s verdict for HS2 came with many stark warnings:
“HS2 is not commercially viable and it contains huge financial risks: it will require substantial subsidy in both construction and operation, even if all goes to plan. The discounted sum of capital and revenue costs is £44.3bn against projected ticket sales of £27.2bn. If the project proceeds as planned, it will achieve a financial loss of £17.1bn.” (see: Formal Minutes’)
In terms of raw figures, the economic benefits of HS2 had already fallen dramatically just in the space of the appraisal period, March 2010 - February 2011, and before the consultation process had even started.
The benefit to cost ratio (BCR) with wider economic impacts (WEI) for the London-Midlands section had dropped from 2.7 to 2.0. That is £2 of benefit for each £1 invested. The BCR, without any WEI, had plummeted from 2.4 to 1.6.
As the committee commented:
“…[this] demonstrates the sensitivity of the economic case to changes in variables…These revisions were a result of lower GDP forecasts and consequently slower growth in rail demand.” (see: Economic impacts, 60-62)
It is also worth noting that the tidy sum of £750m had been spent on the preparatory work of HS2, ‘without a single space being turned, and before any decision was made to go ahead.’
The most obvious case in favour of HS2 comes, naturally enough, in the form of speed. The proposed new route will cut journey times between London and Birmingham by 35 minutes, taking only 49 minutes; Manchester and Leeds will only be 80 minutes from London; Glasgow and Edinburgh only 3 hours and 30 minutes, quicker by an hour.
However, the time-savings component of HS2, whilst forming a large part of the economic case for, was met with objections from those who argued that this assumes that time spent travelling is necessarily unproductive.
Indeed, of the £44bn of benefits HS2 will supposedly bring, £25bn is reserved for business travellers.
Objectors pointed out that rapid changes in technology, such as facilities for laptops and Wi-Fi aboard some trains, has meant that time spent commuting can often be highly valuable.
Studies carried out in 2004 and 2010 into how rail passengers spent their time, found that those who found their travel time worthwhile had increased by a quarter in six years. The researchers concluded that the “core assumption” that travel time is wasted time was “flawed.”  (see: Economic impacts, 65.)
The most soundbite-friendly contention to come out from HS2’s cheerleaders, had come in the form of the ‘1 million jobs’ claim, something which the ‘yes to HS2’ lobby had seized upon as their clinching argument, especially in such a delicate economic climate.
The Core Cities Group, an organization representing the eight largest cities in England outside of London, had published a study back in July of last year in which they asserted that:
“Investment in a full high-speed rail network and electrification will underpin the creation of 400,000 jobs in Core Cities, and 1 million jobs in total across their wider urban areas” (see page 5).
In fact, the government has only ever spoken of the “creation of thousands of new jobs,” with some 40,000 projected to come from the London-Midlands leg of HS2, and been wary to cite this report. (see: Economic impacts, 46)
As Andrew Gilligan pointed out in last week’s Sunday Telegraph, the Core Cities report does actually admit that there is:
“…relatively little information available that specifically quantifies the economic benefits that can be generated through high speed networks.”
What they were presenting was ‘the upper best case scenario,’ based upon a number of wild assumptions.
Greengauge 21, one of many high speed rail supporters, is far more conservative and estimates that between 25,000 and 42,000 jobs will be created, more in line with the government’s projections.
The leading transport expert, Christian Wolmar, is pretty unambiguous is his dismissal of talk of 1 million new jobs, which he calls ‘outlandish,’ ‘patent nonsense’ and ‘basically a lie.’
A key argument in support of HS2 comes in the form of the supposedly huge nationwide advantages it will bring.
As the Department for Transport commented:
“The increased speed, capacity and connectivity provided by a high speed rail network would reshape our economic geography, regenerate our urban centres and help to bridge the north-south divide that has held us back in the past, allowing Britain to build a modern economy fit for the future.”
Once again, this claim cannot be backed up by the evidence and has been based on many flaky assumptions and unsubstantiated projections.
In evidence given to the Transport Select Committee last year, Professor John Tomaney, director at the Centre for Urban and Regional Development Studies at the University of Newcastle, gave HS2 a far from ringing endorsement:
“…the impacts of high speed rail investments on local and regional development are ambiguous at best and negative at worst.”
He went on to say that far from benefiting more disadvantaged regions, high speed rail has, in many examples across Europe, exacerbated geographical divides, and actually sucked economic activity more towards capital cities at the expense of others:
“…the weight of recent theoretical and empirical academic work emphasises that high speed rail connections between cities or regions with different levels of development may favour already strong regions at the expense of weaker regions.”
Professor Tomaney and other experts have warned that it is in fact London and the South East that stand to gain most.
More than half of the 40,000 jobs mentioned are to be taken up in London, with the government’s own analysis predicting that, overall, seven out of ten jobs created will be in the South East.
Most damningly, HS2 Ltd, the company the government set up to consider the case for high speed rail in the UK, confirmed:
“…that it had not assessed the regional impacts and distributions of benefits or losses associated with HS2.” (see: Economic impacts, 55)
There have also been concerns about ‘winners’ and ‘losers.’ Firstly, from areas which the new line will bypass, such as Stoke and Coventry. Stoke’s two trains an hour to London may be reduced and may well end up being slower as a result of them calling at extra stops.
Coventry, running three trains an hour to London, expects to suffer, as business travellers, making up half of the city’s visitors, go elsewhere.
There is a precedent from France, with towns such as Amiens and Reims losing out economically as a result of not being served by the high speed TGV trains.
The committee heard evidence that augers badly for the economies of Wales and the south-west of England, with the potential loss of up to 60,000 jobs. (see: Economic impacts, 56)
In his analysis of the economic effects of high speed in Europe, Professor Tomaney discovered that it has been capital cities that have gained most.
A 2002 report found that:
“…the main (potential) impact of high speed rail (HSR) is on the location of business services and headquarters suggesting that an increased ability of business service providers and headquarters’ operation to serve remote locations leads to a further concentration of these activities in fewer, larger cities.”
Evidence from France and Spain backs up this assertion. Whilst the French city of Lille has done relatively well out of high speed travel, this has been backed up by sustained local regeneration efforts.
The construction of the Paris-Lyon TGV led to the relocation of headquarters to the capital. The Paris-Rhone-Alpes route led to a 144% increase in flight and train journeys to Paris, with a 54% increase going the other way. Research also reveals that business relocation away from the capital was negligible.
Further evidence showed that in several countries, high speed travel had a knock-on effect on overnight stays by business travellers, dramatically reducing the need for it, and thus affecting regional tourism.
In Spain, the effects of the Madrid to Seville line have benefited the former most, in terms of a greater centralisation of business and population.
 “…the evidence from these countries suggests that HSR is likely to generate or reinforce territorial polarisation.”
In conclusion, there is also a:
“…paucity of evidence to support the contention that high speed rail infrastructure tends to contribute to the rebalancing of regional economies. Additionally, the prediction that HSR will generate growth in peripheral cities is mostly based on assumptions which are difficult to sustain after close scrutiny.” (see: Evidence HSR14, 4.6, 4.13, 4.16 and 4.17)
Away from the questionable regional benefits, it is almost beyond dispute that the wealthiest proportion of the population will be the most direct winners.
“Nearly half (47 per cent) of long distance rail trips are made by people from households in the top quintile by income. HS2 is a railway for the rich, but paid for by everyone.”

All this without even getting to the supposedly environmental advantages, most suspect to say the least, where the transport committee expressed its doubts that HS2 would reduce the demand for domestic air travel, or have any substantial carbon-reduction effects. (see: Environmental impacts)
Personally speaking, I began as an enthusiastic exponent for HS2, having experienced the delights and efficiency of France’s high speed TGV trains. However, the economic case for Britain’s own version just doesn’t add up.
Last week’s green light demonstrates that ministers have opted for a romantic vision over one which is economically viable.
We will be paying for their ‘vanity project’ for decades to come.

This article was published on the "STOP HS2" (the  national campaign group against HS2) website on Friday 20 January 2012

A much edited version of this article was first published by Left Futures on Wednesday 18 January 2012