Letting the Government Off the Hook

With so much attention focused on the consequences of leaving the EU, I have begun to fear that the Tories will be able to blame every failure on the referendum. I shared this thought in an article published by  Left Foot Forward on 27 November 2016.

Brexit cannot become an all-purpose alibi for Tory incompetence

Remember the Marmite crisis? A few weeks ago leaving the EU had led to Britain’s favourite (or least favourite) spread being lost to consumers. So keen were we for evidence of the negative impact of EU exit that this squabble between a monopoly supplier and a monopoly buyer became a story about the EU.

The prime minister’s hard tone on leaving the EU caused the pound to fall causing import prices to rise and promising soaring inflation. Marmite was off the virtual shelves.

Now we have the Office of Budget Responsibility forecast on inflation.

They predict that inflation will soar to a peak of 2.6 per cent next year. In other words, CPI will go from one percentage point below the government’s target to 0.6 of a percentage point above before falling back to the target. That is not the bad news we were expecting.

The OBR does not dispute that the pound has fallen. A trade weighted index has sterling down almost 30 per cent compared with 2007, but actually only a little lower than the period 2009-2013.

 Sterling effective exchange rate assumption

The lesson we should draw from this is that commentators are so focussed on the aftermath of the vote that every piece of economic news is fitted into a post referendum narrative. Psychologists call it confirmation bias. Commentators see what they expect to see and what they expect to see is an economic impact from EU exit.

EU exit is distorting our understanding of developments in the economy. One issue with this distortion is that we lose focus on the questions that matter. Leaving the EU will slow the economy, but that is not the whole story.

Another problem is that it lets the government off the hook for its failures. Leaving the EU could become the all-purpose alibi for Tory incompetence.

Labour front benchers like Clive Lewis and Rebecca Long Bailey, did a good job challenging this narrative following the Autumn Statement. They pointed out that EU exit accounts for only half the increase in government borrowing. The other half represents government’s own failings.

Sources of changes to public sector net borrowing since March

This last chart is copied from the OBR presentation on their report. It illustrates the changes made to their GDP forecasts in November compared to the pre-referendum forecast in March. It shows a clear slowdown in the rate of growth in 2017 and 2018 compared with their earlier expectations.

Annual real GDP growth

The most striking fact is not the temporary slowdown in growth but the low level of expected growth overall. Before the financial crisis growth averaged over 2.5 per cent. Even before the impact of leaving the EU was taken into account the OBR foresaw slow growth continuing up to 2020.

There is another story being told in the OBR figures. It is one of inadequate investment and a stagnating economy. Minor changes in government policies announced yesterday do nothing to improve the country’s prospects.

There is a story about the impact of leaving the EU but the narrative which emphasises the effects of EU exit risks masking other fundamental problems.

The tale of productivity, living standards, investment and inequality still needs to be told.

Jos Gallacher represents Labour International on the National Policy Forum of the Labour Party

NPF Returns to Life

In November I attended the first meeting of the NPF since I became a member. I've written about the meeting for Labour International.

     

Lessons of Landsbanki

Below is an extract from the submission I made to the National Policy Forum in October concerning the issue of "passporting" financial services. The story of Landsbanki explains why the Financial Services Authority concluded that,

 “Existing single market rules can create unacceptable risks to depositors or to taxpayers”.

Lessons of Landsbanki

In his memoir former Chancellor, Alistair Darling describes Landsbanki in 2008 as “a disaster waiting to happen. ...all the action was in London but the regulation and detailed supervision of what was going on was supposed to be carried out over a thousand miles away in Iceland.”[1] The FSA had alerted the Chancellor of their concerns about Landsbanki and Haupthing, another Icelandic bank operating in London. At their prompting he held meetings with an Icelandic government delegation and later spoke directly to the country’s Prime Minister. The passporting arrangement meant that the UK authorities could do little more than put pressure on Iceland over Landsbanki. [2]

Landsbanki failed in October 2008 by which time its online Icesave accounts held £4.6 billion in UK deposits from 230,000 British customers.

In theory Icesave customers were protected by a deposit guarantee scheme. Iceland guaranteed only the first €21,000 (about £17,000) of each depositor’s funds and Landsbanki had voluntarily joined the UK’s deposit insurance scheme which topped this sum up to £50,000.Unfortunately the government of Iceland was unable to honour this guarantee.

The UK government intervened. Firstly the bank’s UK assets were seized using powers originally intended to deal with money laundering by terrorist organisations. To avoid further loss of confidence in the banking system the Chancellor of the Exchequer insisted that depositors should be repaid in full.

The funds paid in compensation to Icesave customers by the British government were treated as a loan which Iceland needed to repay. The UK launched prolonged legal and diplomatic challenges to recover the money. The final instalment was eventually handed over in January 2016.[3]

Iceland had a population of 318,500 in 2009 and GDP of €2.2 billion[4] yet Iceland’s taxpayers were expected to pay compensation to UK savers amounting to £4.6 billion. To make matters worse the Krona was steeply devalued by Iceland’s crisis.

The full text of my submission is available here.

---

[1] Alistair Darling, Back from the Brink: 1000 days at number 11, Atlantic Books, 2011. p147

[2] See also The Turner Review: A regulatory response to the global banking crisis, FSA, 2009.p38

[3] Financial Times, 15 January, 2016. https://www.ft.com/content/3ec13e4c-bbaa-11e5-b151-8e15c9a029fb

[4] Eurostat

Labour Party Conference 2016

I attended this year's conference held in Liverpool as a delegate for Labour International.

Here is the report back I prepared for the CLP.

Perspective on the Economy after EU Exit

EU exit will be bad for the economy robbing us of some future prosperity. It does not mean the economy is about to melt down. We need to get the bad news into perspective.

With that in mind I wrote this piece which first appeared on Left foot Forward on 26 October 2016.

The economy is stalling – but to fix it we need to look beyond Brexit

What is today’s most pressing economic issue?

The average reader of newspapers and the blogs would probably think that it is Britain’s decision to leave the EU. News reports continue to cite predictions of dire economic consequences from implementing the referendum decision.

Despite what you might have heard, Britain outside the EU is likely to be a far wealthier country in 2030 than it is today. How much more wealthy depends a little on the nature of the trading relationship with Europe but it depends a lot on the issues that concerned us before June – low productivity, low investment, low wages, low inflation, low returns on savings, the current account and the imbalances between regions and sectors.

That this idea seems surprising is partly because too many of us are still fighting the referendum. We remainers see every piece of bad economic news as vindication of our position. The other side at least get to cheer when the news is good.

The exaggerations of the campaign still colour our understanding.

Take for example the Treasury study whose central prediction was that Britain’s GDP would be 6.2 per cent lower outside the EU in the long term. That’s the figure Mr Osborne turned into an unbelievable £4,300 loss for every household. (I doubt Mr Osborne ever met a statistic he couldn’t torture into saying what he wanted it to say.)

The figure came from a serious study so let’s take it seriously: after 15 years Britain’s GDP would be 6.2 per cent smaller. The question is smaller than what? The claim is that, ceteris paribus, Britain out of the EU would be poorer than Britain in the EU, not poorer than Britain today.

	In the EU	Out of the EU
Good policies	44.8%	38.6%
Bad policies	25.0%	18.8%

If GDP grew at its historical trend rate of 2.5 per cent per annum then after 15 years Britain would be 44.8 per cent richer than today. If leaving the EU cost 6.2 per cent then Britain outside the EU would be 38.6 per cent richer.

That might be too optimistic. Growth as high as 2.5 per cent has been rare in recent years when austerity has held back the economy. Suppose that due to poor policy choices GDP growth averages only 1.5 per cent per annum. After 15 years GDP would be 25 per cent higher than today in the EU and 18.8 per cent outside.

Increase in GDP with good or bad policies, in or out of the EU



These figures should not be treated as a forecast or a projection. They are merely an illustration of the scale of the impact of leaving the EU setting it in perspective with other developments in the economy.

What can we conclude? Firstly, it would be better to stay in the EU, which follows from accepting the Treasury analysis. Secondly we see that other economic policy choices can have a bigger impact on our future wellbeing than the decisions on Britain’s future trading relationship with the EU.

The conservative leavers have their idea of those other policy choices. They favour further deregulation and cut to corporate taxes to lower business costs. However this approach leads to a low wage low productivity environment where insufficient demand and deflation risks locking the country into a low growth trajectory.

The alternative lies in a virtuous cycle of investment, rising productivity and rising wages. Higher wages provides an incentive to productivity enhancing investment which in turn funds the rise in workers income.

An active industrial policy accompanied by public investment is needed to drive this process. Leaving the EU could start a rebalancing away from the financial sector but active policies will be needed to support an expanding manufacturing sector in its place. Industrial policy needs to promote manufacturing exports to take advantage of the fall in sterling. A low pound is necessary to address the current account deficit, but without active measures the opportunity may be missed

Cross border supply chains will face new frictions and industrial policy should aim to help firms to create shorter supply chains without compromising quality.

With inflation is still one below the government’s target, rising wages could help steer away from the danger area of deflation. Only when inflation is significantly above target will it be safe to raise interest rates which will have the benefit of increasing returns to savings.

Despite the media focus on the economic impact of leaving the EU, that is not the main determinant of future prosperity. The disruption of leaving will weigh on the economy for some time and the loss of efficiency will have permanent effects. Nevertheless there remain many important policy choices which will have greater influence on future economic outcomes.

We need to get back to the policy debates we were having before June.

Jos Gallacher represents Labour International on the National Policy Forum of the Labour

Pass the Port

If we were to remain in the EU then financial services passports would be an issue in financial sector reform of interest to people who worry about the next crash. EU exit has pushed the subject up the agenda; mostly in the form of the City demanding that passporting is preserved.

Here are a couple of articles explaining why we should think again.

Passporting peril: How can the UK make banking safer post-Brexit?

Brexit: Is the financial services passport actually worth fighting for?

My First Reaction to the Referendum Result

No-one knows anything. On the morning of Friday 24 June we entered a new world where we no longer knew the rules. Over that weekend I met with friends to share the shock and begin to think about what it all means.

Those discussions led to an article first published in Left Foot Forward on 20 July 2016.

We’re still grieving for Europe – big decisions should be avoided

It is not surprising that everyone I know voted Remain.

I’m a Scot living in Brussels. In my circle, the grieving over the loss of Britain’s European future has barely begun. All of our politics have been thrown into chaos.

The assumptions we stood on have been whipped away. New issues and unexpected questions occupy us. Everything has changed and no-one knows anything.

A good piece of advice is: do not make any decisions too soon after a loss. Yet we expect politicians to have answers to quell the uncertainty we feel in this post-referendum period. I urge caution. The solutions which seem most attractive now may not in reality be the best for Britain in the long run.

The first stage of grieving, they say, is denial. We hope to awaken from this nightmare and find that Britain’s position in the EU is restored. Parliament will act. Leavers will have buyers’ remorse. There will be a new referendum or a general election.

Sadly, denying reality does not change it.

Denial gives way to anger, the second stage of grieving. There are many targets at whom to direct anger: the leavers’ lies, the poor campaign, media moguls and unscrupulous politicians. To appease the anger party leaders must be sacrificed. Those who made the mess should be given the job of cleaning it up, whether or not they are the most capable of performing the task. Anger, however, is a poor guide to action.

The next stage is bargaining. Maybe if we do this then the fates will be kind to us. We can delay Article 50 and hope that something turns up. We could realign political movements to create a pro EU party or a pro EU alliance. We could let the reality of an economic shock shift opinion against leaving.

The last stage before acceptance is sometimes described as confusion.

In this stage there is a realisation that something fundamental has changed but all the complexities of the change are difficult to grasp. What does Britain outside the EU mean for policy on agriculture, science, competition, innovation, urban regeneration and regional development, tax rules and employment rights?

Given the complexity, the interactions and spillovers between these areas, being confused is perfectly rational. Recognising how little we know is the beginning of wisdom.

Hence my argument that we should not rush into decision. If EU membership is the best option then it is tempting to think that the closest to membership is the best alternative. We might assume that the Norway model is better than the Swiss model which is better than a trade deal or no deal. It would be rash to reach that conclusion without much more thought and analysis.

Membership of the EEA, for example, would mean accepting many EU policies with no say in policy-making. Even the most ardent Remainer agrees that many EU policies need major reform.

There are many issues to consider before deciding how Britain should position itself in Europe. I offer three out of many examples. They concern competition policy, public procurement and the free movement of capital.

The EU has a successful approach to competition policy which is capable of challenging anti-competitive behaviour by even the largest corporations. However, EU state aid rules can be an obstacle to providing support to major employers in difficulty or to using subsidies to promote industrial development. Would we want to continue to operate with these rules when we have no influence in shaping them?

Equally the EU approach to public procurement is based on sound principles of transparency and objectivity. We could agree that reciprocal access to each other’s public contracts is in Britain’s interest. Alternatively we could conclude that public purchasing power could support a more active industrial policy.

My last example concerns the financial services ‘passport’. This allows banks and other financial firms regulated in one member state to operate in any other without further regulatory scrutiny.

While this seemed like a good idea in the 1980s, since the crisis of 2007-2008 we understand better then need for stronger oversight of banks. Lobbyists for the financial sector claim that passporting is essential for the City. Should we believe them? These are the same lobbyists who oppose every attempt to make banking safer through more active regulation and requirements to hold bigger capital buffers.

Without passporting banks would face more regulatory scrutiny and would need to hold more capital. At present passporting allows undercapitalised Italian banks to offer their services in Britain without oversight by the Bank of England. We need to ask if there are risks to passporting we would be better off without.

If Britain had voted remain then each of these issues, and many others, would form part of a reform agenda. They would be technical issues of interest to policy specialists who take an interest in financial regulation, competition policy or industrial strategy.

In the changed circumstances of the leave vote they become important aspects of the most pressing issue of the next four years, namely how do we want to relate to the EU in future.

While still reeling from the shock of an unwelcome plebiscite we must begin to assess carefully many questions across many policy areas and to analyse the trade-offs between them. These are not decisions to rush.

Jos Gallacher represents Labour International on the National Policy Forum of the Labour Party.

Jobs and Growth

Beware of promises that a policy will be good for "jobs'n'growth", especially trade policies.

I explained why in this article on Left Foot Forward on 27 January 2016.

Here’s why TTIP won’t create jobs

The current buzzword in policy discussion seems to be ‘jobs’n’growth’. Any policy which has an economic impact is being sold as good for jobs’n’growth.

When so many products are marketed with the same unique selling point, how are voters to know which policies really will remove stubborn unemployment and bring the sparkle back to the economy?

The concatenation of jobs and growth is in part due to a lazy assumption that anything which increases growth creates jobs. In part it is a result of ambiguity in what we mean by growth.

TTIP, the transatlantic trade and investment partnership, a trade deal currently in negotiation between the EU and the US, os a good example of policy makers and economists saying different things.

According to a House of Lords report, ‘both the European Commission and the UK government have identified ‘jobs and growth’ as the overriding purpose of concluding a TTIP agreement’.

But economists know that trade deals do not increase employment – nor do they raise the rate of growth.

For example, Paul Krugman, whose Nobel prize was for work on trade economics, made the point many years ago.

“Most US businesspeople believe that trade agreements … are good largely because they mean more jobs around the world,” he wrote in the Harvard Business Review.

“However, economists in general do not believe that free trade creates more jobs worldwide or that countries which are highly successful exporters will have lower unemployment than those which run trade deficits.”

To support its policy the European Commission has produced an impact assessment. This report makes no claim that TTIP would increase the number of jobs. That should not be surprising, since the document draws on research by the Centre for Economic Policy Research (CEPS), a think tank staffed by economists who know better.

Nor does the impact assessment claim an increase in the growth rate but only a small increase in GDP in the longer run. CEPS economists estimated that a very ambitious version of TTIP could add a half of one percent of GDP after ten years.

This is a slightly higher estimate than similar studies have produced, and it assumes an agreement which goes beyond current aspirations; but a half of one percent is small enough.

Can a small bump to GDP count as growth? Dani Rodrik, a well-known development economist, argues that ‘the standard gains-from-trade argument is one about levels, not growth rates’.

The difference between a half percent increase in the level of GDP and a half percent increase in growth is huge.

Suppose EU GDP was to grow at 2 per cent a year for the next 10 years. At the end of that period GDP would be 22 per cent higher without TTIP and 22.5 per cent higher with TTIP.

On the other hand, if growth increased by 0.5 per cent to 2.5 per cent then GDP would be 28 per cent higher after 10 years.

Frequently, policy-makers’ claims for growth exploit an ambiguity in the term. It can mean growth in actual GDP, which is the total of all goods and services produced in a year. This is the GDP which Eurostat and the Office of National Statistics measure.

There is also potential GDP which is the output that would be possible if all capital and labour are fully employed. In the absence of full-employment, actual GDP will be below potential GDP.

Potential GDP normally grows steadily over time due to the accumulation of capital, increase in the workforce and improvements in productivity, for example due to better technology.

Growth in actual GDP depends also on the level of effective demand in the economy and fluctuates as demand rises and falls over the economic cycle.

The link between jobs and growth is strongest when we talk about demand. In a recession falling demand reduces both growth and jobs, while during the recovery rising demand is a prerequisite for job growth.

The economic theories of the benefit-of-trade relate to potential GDP. Trade deals can increase the level of potential GDP but higher potential GDP does not guarantee that actual GDP rises.

There would also need to be sufficient demand. The obvious conclusion is that TTIP cannot be a solution to recession or depression. Any politician who promotes TTIP as a way out of the current depression is seriously misguided.

This also explains why the impact assessment makes no claims about increasing jobs. The approach economists take to identifying the effect of such a policy is to compare the economy at full-employment before and after.

TTIP is just one example of policy-makers making spurious promises about jobs and growth. The explanation on TTIP might help to spot other false promises attached to other policies.

Firstly any claim that a policy for trade, ‘competitiveness’ or exports will create jobs is normally wrong. As with TTIP there may be new jobs in some sectors but overall the level of employment will not be affected.

Secondly, supply-side policies, those usually labelled as reform, are aimed at improving potential GDP. Claims that they will help tackle unemployment or offer a solution to recession are equally unlikely.

By contrast, if the economy is below full-employment then policies which stimulate demand are the only ones which will increase employment and bring the growth rate back to its trend.

Increasing public and private investment works; tax-cuts are less effective but easier to implement; and raising wages works when inflation is low.

If the economy is at full employment then increasing the number of jobs means increasing the size of the pool of labour, for example schemes to bring back people who have dropped out of the labour market, schemes for childcare to enable parents to seek work and immigration all support job growth.

The next time someone uses the jobs’n’growth slogan to sell you a policy, ask yourself: is this about demand or is it false advertising?

Trident Renewal

The replacement of the submarines that carry Britain's Trident missiles is a controversial issue. In an article published on Left Foot Forward I argued that the options available are limited by the history of Britain's nuclear deterrent. A path was set in the early 60s which determines today's choices.

The government’s nuclear weapons policy is still dictated by a decision made in 1962