Month: February 2011

 

                 After thirteen years of mistakes and economic disaster, it is refreshing to hear a Minister say “Sorry” when he or she has presided over a mistake. It is also reassuring  that the mistakes have not been on the scale of the Boom/Bust errors of Labour.

                 One apology may be endearing. A couple may be welcome. When  they come thick and fast more people say they would prefer Ministers avoid the mistakes in the first place than parade their apologies on the media.

                So what has gone wrong? Why have Caroline Spelman, Michael Gove, Liam Fox and William Hague all had to say sorry in the last few weeks?

              Each case is different. Caroline Spelman put her name to a set of proposals for the forests which the whole Cabinet approved. She then discovered that the opponents put round a verison of her scheme which was unpopular  before she mobilised support. She apologised for misreading the mood of the electorate, and admitted her own misjudgement. It was clearly a Ministerial mistake which her colleagues failed to see in advance or to help her avoid.

               At the other end of the spectrum, Liam Fox apologised when officials sent emails to fire members of the armed services. I am quite sure Liam himself did not ask for the redundancies to be made like that, and he was clearly very unhappy on learning what had happened. He had to apologise for other peoples’ insensitive errors. If you wish to sustain any criticism of the Minister you have to suggest he should have watched over a level of detail in implementation that no Minister would normally get involved in or have reason to suppose the implementation  would miscarry. You could also query the policy decision to sack soldiers still on active service as a general issue, but that is a different matter.

              We are not yet sure why the Foreign office was slow to get transport into Libya to pick up UK citizens. Was the Minister himself slow to act and decide, or did officials fail to organise transport in a  timely way though this had been requested? Given the sensitivity and the media interest, should the Minister have been more active in following up the policy decision?

            Michael Gove had to apologise for failing to consult enough people when he replaced the Schools for the Future programme with investments in school buildings which he thinks will offer better value to taxpayers. We do not know if he was advised to slow down and consult more widely, or if he was let down by the advice. The Judge did find that he was entitled to make the decision he made, but criticised the process. The case had been brought by some angry Labour authorities who saw scope for challenge.

          Each one was different. The only common current is they each illustrate the need for Ministers to involve themselves in the detail as well as the  main decision. A good decision, like finding a cheaper way of building new schools, can generate  ill will if you do not follow due process, and if you do not get out the message that the aim is not the end of all school building, but more school building for the money.

 

             I was intrigued to see criticism of the BBC for running endless stories of cuts in public spending. However, I also recollect that last summer and autumn I was a very lonely voice pointing out that the government plans to increase current public spending in cash terms every year for five years. The government itself was briefing of big cuts to come, bandying around 20% cuts figures based on a five year real terms assessment of the most squeezed programmes. It is hardly surprising that the BBC picked up all the public sector lobby stories, when the government itself was implying big reductions in many departmental budgets.

            It reveals a common weakness of much media journalism. They do not usually  ask what is the truth, what are the facts? They ask what are the various  important people and groups saying?  These are often very different things, as I know to my cost, trying to stick to the facts and to making realistic forecasts about what might happen next. You get marginalised by the media if you have read the documents and know the truth. You get airtime if you speak for the fashionable consensus, or if you attack the fashionable consensus in a way which they can sensationalise and use against you.

              If the government is now serious about wishing to get across the true position, Ministers need to change their own rhetoric. They need to start by stressing in every interview that they are making more money available for the public sector as a whole. They should say they wish to see this money well spent, and wish to use it to protect all important services which they on behalf of the public value.

                There will be cuts for three main reasons. Firstly, the government has priorities for increased spending. Few will disgaree with the priority for health and schools. The decision to increase spending on the EU and overseas aid is more contentious, so Ministers need to explain why these are the most deserving causes. Priority areas mean less of the increase is left over for other areas.

                 Secondly, inflation is high and could  absorb the cash increases. However, the good news is that if the government sticks to its plans to keep public sector wages down other than for the low paid, and does succeed in buying things more cheaply, inflation need not eat up much of the cash increase. That leaves more scope for better services.

                Thirdly, there are some in public sector management who seem to think it their task to propose damaging and clumsy cuts in the hope that will force the government to find more money. Ministers have to find a way of countering this conduct. They need to show that parts of the public sector can deliver more for less, so there is no need for draconian cuts in valued services. This is the most difficult challenge of all, which has defeated many past Ministers. They have to implement better ways of doing things and then get airtime for them. They need to change public sector management where they can, to promote people who do want to do more for less.

 

                 To judge by the row over Barclays corporation tax payments many people in the Uk think British business gets off lightly. They argue that  if only business was stopped from avoiding tax, the deficit could come down with no painful decisions.

                Many have pointed out that Barclay’s low corporation tax charge for 2010 was the simple product of two  tax rules. The first is, companies do not pay UK  corporation tax on foreign profits earned abroad where those profits are taxed by those overseas  jurisdictions. The second is, if a company lost a lot in a prior period it can offset recent profits against those losses. Remember, the taxman does not give tax back when a company moves into loss. Profits  Tax is a  one way bet for the taxman.

                  A recent piece of work from the University of Calgary, reported by the Cato Institute in the USA, brings us up to date with levels of corporate tax. Chen and Mintz, who did the study, asked how much tax does a company have to pay on new investment in each country. It is the best question to ask when trying to decide who is going to attract most new investment and jobs.  The UK (along with the US) does not come out well from this comparison.

Effective tax rate on new investment:

UK 27.9%

Germany 23.8%

Canada 20.5%

Switzerland   17.6%

New Zealand    17.6%

Netherlands  16.8%

Luxembourg  16.8%

China 16.6%

Ireland  10.9%

Singapore 8.5%

Hong Kong 4.0%

                  These figures are worrying. If the UK wishes to keep all  its successful financial and business services industry, it needs to note that the main competitors for this business, Hong Kong, Singapore and Switzerland, all have much lower rates of tax. If it wishes to keep its successful recruitment of Head quarters operations for multinationals, it should worry that the Netherlands is now much more attractive as well as Switzerland and the Asian centres. If it wishes to grow its manufacturing base in accordance with Uk government policy, the fact that Chinese tax rates are so much lower, and even German rates usefully below should also give pause for thought.

                All those badly informed critics of Barclays need to know that no government, Labour or Coalition , is going to try to tax the overseas profits of UK headquartered businesses. That would be double taxation and lead to an exodus of many companies. Nor is any likely government going to disallow the carry forward of losses to offset tax. This is not unacceptable tax avoidance. It is just one of the norms of international tax regimes. We have to live in the world and make our living in it. Other jurisdictions offer these advantages. They add to them lower rates.

 

              Every year that Labour was in power they announced a clampdown on avoidance and evasion of tax. Every year more complicated provisions were put into Finance Acts to make it more difficult for people to evade tax (illegal), and to make more avoidance schemes (legal) into illegal devices. You might have thought that after 13 years of doing that, the job would be done.

            Apparently not. Now some Labour figures tell us there is £120 billion of evasion and avoidance. All we need to do, is stop all this overnight, and most of the deficit disappears. Meanwhile the Coalition government continues much like Labour before it in this area,with complicated Finance Bills designed to chip away at evasion and avoidance.

            The truth is more complicated. Avoidance is what most people do. It is actively promoted by all governments, as avoidance is another name for tax incentives or preferential treatment  as government seeks to influence our conduct. No government has ever wanted to stop avoidance, because no government has ever wanted to stop influencing how we spend and save our money.

             The main incentives or avoidance methods for individuals  include tax relief on pensions contributions, tax exemption for investments held within a pension plan, CGT relief on your prime residence, tax relief on ISAs, tax exemption on interest earned on certain National Savings accounts, and VAT exemption for purchases of basic items.

             Individuals are often looking at ways of lowering the total amount of tax they pay. Avoidance could include the following legal decisions for example:

1. Using a contractor to do work on your home who is below the VAT registration threshold to avoid VAT charges

2. Entering Central London by car outside the hours of the Congestion Charge

3. Buying a larger home than you need so more of your total  investment is covered by the CGT relief on first homes

4. Investing as much through National Savings and ISAs as you can afford to avoid tax on investments

5. Going by subsidised bus rather than car to avoid fuel duty

6. Buying larger items that attract VAT just before a VAT rise

7. Home brewing to avoid various  liquor duties

8. Playing the lottery instead of betting to avoid gambling taxes

         Some people go further  and break the law to evade tax. They might, for example, pay a tradesman in cash to escape VAT when the local business  is registered to pay VAT. Such cash payments may also contribute to other tax evasion by the tradesman.  They might place money abroad and fail to declare the income to the authorities. They might fail to declare all  their cash earnings if they have any.

         The tax system is now so complicated that  people who do intend to pay all their tax and make honest declarations can make mistakes, as I see from my constituents cases  sometimes. The Revenue would be wise to distinguish between those out to fool the system, and those who fall foul of its complexities. Tomorrow I will look at corporate tax.

 

                  The tragedy of the Eurosceptic movement continues. The enthusiasts for more EU government delight in the  continued divisions.

                  The choice of voting system is important. Eurosceptic Conservatives are sure that keeping first past the post is the best chance of having fair elections which can change governments, and of holding elections which may produce a Eurosceptic majority government.  UKIP are equally sure that we need to introduce AV, presumably as part of their continuing policy of the “need to teach Conservatives a lesson”.

                  Conservatives are not opposing AV because the leadership have insisted we do or because the whips demand it. The party advises voting against AV, but it is a free vote issue over which campaign you back and vote for. Most Conservatives oppose AV because we think it undesirable that elections are settled by the second preference votes of those who vote for minor or  unpopular parties. We also see that the federalist Lib Dems  believe this new system of voting will help them greatly. The arithmetic of past elections shows that if  the AV system had  been in place it  would haven increased the pro EU majority in the Commons. Why should the candidate who comes second or third on the normal measure get the job?

                  So why do UKIP think otherwise?  UKIP presumably hope that AV would encourage more Conservative voters to vote UKIP first choice , with the back up that they could continue  voting Conservative second choice. UKIP say they would be able to argue that a UKIP vote was not then a vote for Labour or the Lib Dems. Instead removing a vote for the only Euosceptic party that could beat Labour and Lib Dems, the Conservatives, they hold out the hope that all would be fine on second preferences.

                      This argument is a difficult one for UKIP to sustain, as they have to imply that even with AV they would continue to poll well short of a winning margin and would expect their voters’ second preference to come into play. The fact that they would be unlikely to win under an AV system is realistic. They have never won a European election under a party based PR system, and did not win in Buckingham in 2010 when there was no Labour, Conservative and Lib Dem opponent. The danger of course is that the UKIP and Conservative first choice  votes would be so split that it would make it easier for the pro EU opponents to get past the Conservative total and the magic 50% in marginal seats.

                             Let us suppose that in a marginal the Conservatives last won with 37% of the vote. Labour had 31%, Lib Dems 22%, UKIP 3%, others 7%. If the UKIP theory is right and numerous Conservatives switch to UKIP on first preference, the  AV first round result might be  Conservatives  27% (10% switch to UKIP), Labour 39%,(they are currently well up on their 2010 result) Lib Dems 12% (as they are well down in the polls currently), UKIP 13%, others 9%. Second preferences would easily give this seat to Labour, with the UKIP voters’ second preferences not coming into play.

                            This is why many Conservatives  who are good Eurosceptics do not agree with UKIP that AV would give us a majority Eurosceptic Parliament. The Eurosceptic movement continues to split itself  in a way which undermines its influence.

      I am grateful to contributors for some thoughtful comments on the boom and bust question.

      There is general agreement that the ERM period and the era of combining an ‘independent’ central bank with big rises in spending and borrowing did not work. I have been asked to explain  how the Uk could follow an honest money policy.

         The answer is as we did in the two better periods of low inflationary growth, and as Germany did for  much of the post war period in the last century.  The authorities set a target for money growth and adjust interest rates and banking regulations accordingly. They seek that Goldilocks approach, neither too tight nor too lax. Print too little and you have a credit crunch and deflation. Print too much and you have an inflation. Allow banks to expand too much relative to their capital and you inflationary overstretch. Stop banks lending enough and require too much capital and you have recession.

         Some say you can never trust politicians, or for that matter their appointed independent authorities, to run a fiat currency in a non inflationary way.  Yet history shows that some countries can succeed with low inflationary growth and sensible money policies for quite long periods. Any individual country can be blown off course by external events and by political decisions to tolerate a bit more inflation, but there should always be people at such times exposing what the authorities are up to and trying to use the pressure of public opinion and elections to get things back on course.

            Some say we should return to the gold standard. If paper money had to be backed by gold the authorities would be prevented from debasing money. Past experience of the gold standard shows that politicians may well conclude if it gets too tough to stay virtuous that they will abandon it, so gold provides no final solution to inflationary preferences.It also brings other hazards. As advocates accept, if the supply of gold does not keep pace with growth in the world economy it is deflationary. Such a policy endows those states that mine gold, and states that happen to have kept or acquired substantial reserves in gold as opposed to bonds and foreign currencies. The Gold standard in the UK is associated with a particularly unsuccessful policy period bring on recession and susbtantial job losses.

             It is true that both money targets and gold raise the issue of the velocity of circulation. If velocity changes then the  quantity theory is affected. If for some reason velocity increases, then you clearly need less money to sustain a given level of wealth and trade. Most economists conclude, however, that it is possible to set sensible money targets to influence both the price level and the output level. They need to look out for any important changes of velocity as they do so. None of it is a precise science. It requires judgement, and corrections if things start to go awry.

 

                 There have been two bad periods of boom and bust in the UK in the last thirty years. The first was the 1986-92 boom-bust cycle. The second was the  bigger boom-bust of  2005-10.

                 They have several things in common. Both owed much to the influence of European policy on our economy. The first was wholly created by shadowing the DM at a time when the pound wanted to go up. This caused the authorities to print too much money, allow too much credit, and keep rates too low, in a desperate attempt to keep the pound down. Entering the Exchange Rate Mechanism sealed our fate. Soon the pound wanted to go down as there was too much inflation in the system.  Then the government had to keep rates too high, destroy money and credit, and bring about a collapse.

                    The second was influenced by the idea of the independent Central Bank, again influenced by the German example. Perhaps the government  believed that giving charge of rates and inflation to the Bank gave them a licence to borrow large sums  to sustain rapidly rising public spending. They certainly did not follow the German example of prudence over public borrowing. Their banking regulation and other  policies put us through an even more violent banking cycle. First there was a massive build up of credit and debts. Then there was a sharp contraction in money and credit, which undermined some of  the banks.

                The good news is that the UK has also enjoyed two periods within the last 30 years when it has followed  a sensible economic policy. It shows it can be done. On both occasions it avoided magic boxes, European currency systems and independent Banks. Between 1981 and 1986 the UK economy recovered well from the 1970s boom-bust cycles. It entered a period of decent growth, low inflation and rising tax revenues. Public spending  went up every year, but fell as a proportion of National Output. Public borrowing was brought under good control.

                Between 1992 and 2000 the Uk enjoyed an even longer period of decent growth, low inflation, and public spending  rising whilst coming down as a proportion of the economy. Public borrowing was brought under control, and in the final Labour years some debt was actually repaid.

               So what can we learn from this? It is better to do what Germany did – control public spending  and borrowing and pursue an honest money policy with targets for money growth – than to try to hitch a ride by following the DM or joining the Euro. When we followed a prudent path right for the UK it worked. When we sought independent or magic box solutions we suffered from violent cycles.

 

                  On Thursday I gave a lecture to a Cambridge University audience on the conduct of public policy. I chose to speak about UK economic policy over the last thirty years. Today I will share the summary of what I said about independence in Central banks, and tomorrow my conclusions on what has been good and bad in UK economic policy since 1981.

                 I do not see how you can have a truly independent Central Bank in a democracy. The elected officials and Parliament have the last say. They are accountable for the economic results, and they will override the Bank  when they think it is necssary or when the public complains about the Bank’s conduct.

                The UK is said to have an independent Central Bank following the Brown reforms of 1997. It is strange this piece of spin has stuck, given how far from reality it is. Mr Brown took away the power of the Bank to raise the government’s money, putting that task into the Treasury under Ministerial control through the Office of Budget Management. He stripped the Bank of its powers to regulate the commercial banks, giving those to the FSA. He said he strengthened the Bank’s independence over monetary policy.

                       However, he subsequently altered the aims of the Bank when he switched the requirement from keeping the RPI to 2.5% a year increases, to asking for 2% increases in the CPI. This represented a loosening of monetary policy, inviting the Bank to keep rates lower for longer at a crucial time in the build up of the credit boom. CPI usually goes up    by 1% less than RPI.

                       At the peak of  the Credit collapse Finance Ministers including the UK Chancellor met and agreed concerted interest rate reductions. They were right to do so. The Bank quickly convened a special unscheduled meeting and cut rates by the agreed amount. It is difficult to say this was anything other than political leadership on rates. When it came to decisions to increase bond buying and money printing all agreed that the senior elected official, the Chancellor had to authorise it. Some independence!

                                Some commentators say the German Central Bank is truly independent. It is the case that for many years  after 1945 the Bank was allowed to supervise rates and money policy  without material interference from politicians. This was because there was a political consensus about what the Bank was doing,and it was relatively successful.

                             When the politicians wished to amalgamate the DM with the Ostmark in East Germany, the Bank advised delay. They were overriden. The Bank advised a lower rate for the Ostmark. The politicians insisted on one DM to one Ostmark and forced it through. The Bank gave good economic advice. The politicans required they act on a political imperative.

                             Finally, the politicians decided to abolish the DM altogether. As the whole point of the Central Bank was to defend the external and internal value of the DM, who can say it was independent when it had its currency taken away from it?

                            There is no such thing as an independent Central Bank in a democracy. The elected polticians can always change its remit, its personnel, or even the currency it manages.

 

                 The scenes from Libya and Bahrain tell us that the successes of protest movements in Tunisia and Egypt are spreading. People are losing their fear of repressive regimes. The more that police forces and troops fire bullets and tear gas into crowds, the bigger the anger grows and determination sets in. It looks as if it is no longer possible for some of these regimes to control the crowds using the very considerable forces they have at their disposal.

                  The fast changing situation makes western governments look flat footed. For many years western governments have flattered and humoured dictators for fear of worse. Sometimes they have allied with them for good reasons, because they have offered peace in the Middle East. Sometimes they have linked with them to fight other forces in the Middle East they dislike even more.  The west has wanted to trade with these countries, both to buy their oil and to sell them a wide array of western goods. Western countries have been prepared to sell defence equipment as part of the package.

                Western governments can argue that it is not their job to seek to topple governments of the world, however unpleasant they may seem. Or they might argue they should only seek to topple the worst, and then to do so in as orderly a fashion as possible without preferably resorting to force. Western governments should believe in democratic systems and more freedom, but also have to accept that it is beyond them to impose democracy from outside on many countries where the government does not want it.

                 The challenge for Obama and for European governments is to decide at what point they should drop their support for dictators under pressure from their citizens. At what point can the West decide that a dictator no longer can govern his country? Or should western governments, seeing the growing instability, seek to add to it by offering early moral  support to protest movements? Are all challengers to these regimes equally worthy of support? Does support mean ending supplies to the dictators, or does it imply also offering more practical help to the protesters? When should aid and certain types of  trade be cut off, if at all?

                    If you licence weapons sales to governments, you have to allow for the fact that they might decide to use them. You can hardly make it a condition of sale that they do not use them. There will now be regrets about some of the supplies allowed to some  of  these regimes. Soon there will be new agonies. Should new regimes that emerge warrant our support and should they in turn be allowed supplies of military and police equipement?

                 Yesterday in Oxford I gave the Oxonian lecture about the future of the Euro. I have attached the slides I presented here: The Future of the Euro.

                 Every currency needs a sovereign to love it and control it. The Euro has been an orphan currency for a decade, seeking government parents to look after it. Benign neglect by the member states has meant :

1. Some member states have borrowed far too much in the common currency, breaking the rules of the Stability and Growth Pact.

2. The transfer payments between the richer and poorer regions have remained  well below the common levels in single currency areas like the dollar and sterling (1% of GDP versus 5% of GDP)

3. Some member states have experienced relatively rapid inflation, making them far less competitive against the German core of the Euro area.

4. There has been no successful common banking regulation. The banking systems of several Eurozone members are stretched, leading to state guarantees and recapitalisations the countries can ill afford.

5. The European Central Bank has been reluctant to reduce the gaps between the borrowing rates of the different Euro zone members by buying bonds. The ECB helped bring on the Irish crisis by refusing to carry on funding Irish banks.

          The Euro zone does need an economic sovereign or government to make the following decisions:

1. How much can member states borrow in the common currency?

2. How much of the common currency should be printed?

3. To what extent can the ECB intervene in bond markets to keep borrowing rates  closer together?

4. What would be a realistic level of transfer payments around the Union?

5. Can the Union develop a more jobs friendly pro enterprise set of policies to give countries more hope of growing out of trouble?

                      The UK should encourage the emergence of proper Euro institutions to regulate their banks,create a stable bond market and provide budgetary discipline. It should also make clear that none of that should apply to the UK, and should make its consent to the greater integration required dependent on the UK stepping outside that and getting powers back from the EU.