Author: johnredwood

                 The Office of Budget responsibility and the Bank of England have been famous for getting their forecasts of growth and inflation wrong in recent years. They do so for a common reason.

                They both believe that the UK has a trend rate of growth similar to that before the 2007-8 financial crisis, of more than 2% per annum. They therefore believe that the current level of  output is well below what it should be – there are “missing years” since the crisis hit. As a result they conclude that the economy can be given extra demand through borrowing and printing money  without causing inflationary pressure. The OBR has also believed that there would be a “normal” cyclical recovery from the large downturn, to get the economy back to its “trend”.

              So far none of this has come true. Inflation has been obstinately high in the UK, hitting more than 5.2% on one occasion at a time when the Bank said it should be much closer to the 2% target owing to large unused capacity.  Growth is now forecast by the OBR to be only half the level this Parliament of its 2010 forecast, and that is still optimstic by the standards of  other forecasters.

             Two of the main points I argued in the Conservative Economic Policy Review published shortly before the crash were that the Uk reached an unsustainable level of activity based on excess borrowing in 2007, and that its future trend growth rate would be around 1% lower than the post war average. The big figure for future  trend growth would be 1, not 2.  I hope I was not too optimistic.

            The trend rate of growth is lower and is likely to remain lower for two important reasons. The first is demand and output was buoyed  up by a massive extension of credit in both the private and public sectors prior to 2008. The Central  Bank induced crunch makes sustaining the levels of private sector credit impossible, leading to a deflation in the private sector. Few want to return to the excesses of private sector lending and borrowing prior to 2008, though it would be good if a new generation could have access to mortgages and business finance on a sensible scale.

         All political parties agree there is a limit on how much extra debt the public sector should take on.  The outgoing government pledged to halve the deficit between 2010 and 2015. The incoming government first pledged to eliminate the structural deficit over this time period. Both have had to suggest delaying adjustment, but neither say the public sector can or should go on adding to its borrowing at recent rates.

         The second is government raised the proportion of the economy represented by public sector activity to a peak of 50%. The public sector in the UK has a very poor productivity record, so a larger public sector holds back growth which rests on productivity advances. In large parts of the public sector there was no productivity growth in the first decade of this century, whereas manufacturing as a sector has sustained a lively rate of productivity growth. When manufacturing only represents 10% of the economy this has limited impact on our general living standards.

          In subsequent posts I will examine what if anything can be done to raise demand in the economy. I will also look at the productivity issue. We can only get richer on average by working smarter and adopting productivity raising technology. How is it going to be done?

Instead of being a critic of the Prime Minister, Dr Budd should tell us why the OBR forecast faster and rising growth from 2010 onwards in each of its forecasts. Why did they have to constantly scale them back? They knew the plans for spending and taxing and did not think they got in the way of good growth. Tomorrow on www.johnredwood.com I will  be offering one of the main reasons the OBR has been so off target. It’s nothing to do with deficit reduction. The OBR in Mr Chote’s letter accept that they took into account Labour’s tax rises and capital project cuts, and the further measures the Coalition took in June 2010, and still came up with forecasts of rapid growth for most of the Parliament. They have subsequently revised these down for reasons unconnected  with the policy.

    Mr Floru sent me a copy of his book for review. His study of  the USA, UK, Chile, Hong Kong, Germany, New Zealand and Singapore demonstrates how free enterprise policies generate more wealth and prosperity for all.

      He favours reducing the proportion of the state in the whole as the economy grows. He believes in slimming oversized states by prrivatisation and deregulation. He feels the private sector needs to be given enough freedom and space to grow, innovate, create jobs.

        His case studies over time and ranging widely geographically show  how a dynamic free enterprise sector to an economy can transform living standards and lifestyles for the better. He agrees that we should always take care of the poor, and make sure competition and  the rule of law allows the wealth and income  to spread widely for the benefit of all.

        Lower tax rates, stable and democratic government, and a climate which favours risk taking and peaceful commerce are important elements for success. So too are free trade and the need to stand up to vested interests. Whilst China has done well growing from great poverty through state sponsored capitalism, Mr Floru thinks they will need to pursue liberty more extensively to catch US living standards sometime.

        It is an interesting book with some good case studies. I wonder if the Chancellor will  pick up any good points from the success of other countries willing to unleash free enterprise to generate prosperity? The USSR, Cuba and other communist states illustrated just how bad state planning proved for both living standards and individual liberty. The great experiment between 1945 and 1990 in Europe showed the planned system in the East was far worse than the mixed system in the West. The Asuian success stories show the power of free enterprise to lift people out of poverty.

      In the last 24 hours the Governor of the Bank of England has declared that the government does need to do more to fix and sell the assets of RBS – reinforcing a view expressed here ever since the crisis first hit.

        Dr Cable has wrritten a long and thoughtful article in the New Statesman. I agree with much of it. He too accepts that the commercial banking  system is not operating in the way we need. He also accepts that his approach of developing state banks cannot do nearly enough quickly enough. There is no substitute for fixing RBS, and that should entail a transfer of  as many of  its risks as possible to the private sector.

   The press have lasered in on Dr Cable’s  question whether   the UK state should borrow more long term to finance infrastructure. I agree we need more infrastructure investment, starting with energy, broadband and roads. However, I think given the state’s balance sheet it is vital this should be wholly or largely fiannced by the private sector. Fix the banks, and use the markets. At current interest rates it could be made to work. Offering longer term infrastructure bonds to private investors could also help them, by delivering a reasonable quality covenant with a higher income than is currently available on government or high grade corporate b onds.

        Indeed, I would save the money being spent on the state banks which will remain too tiny to have much impact, fix RBS, selling as much as possible to the private sector, and let the government  lead a move to launch substantial bond  issues for infrastructure to private sector buyers.  That way we cut public spending a little, cut public sector liabilities massively, and have more capital spending.

      Recently the government has responded to its consultation on “Renewable heat incentive: providing certainty, improving performance”

      Let me give you a flavour of the prose:

“DECC intends to introduce a degression based approach similar to the regime adopted for the Feed-In tariffs scheme. This will involve tariffs available to new applicants being gradually reduced if uptake of the technologies supported under the RHI is greater than forecast. This will be done by monitoring uptake on a quarterly basis against a series of triggers”

In more normal language, the subsidised prices offered for alternative energy will be cut as the popularity of the chosen technology rises.

They are also  allow biomass energy to qualify for subsidy:

“In order to be eligible for the RHI, biomass installations will be required to demonstrate, either through reporting or sourcing from an approved supplier, that their biomass meets a greenhouse gas lifecycle emissions limit target and (from no later than April 2015) land criteria.”

The complexity and cost of all this means the UK ends up with energy which is too dear. It also means we run the danger of not having enough energy available for future needs. Much of this is driven by EU regulations and directives.

I have posted my contribution to the debate on the new Renewable regulations yesterday in a Commons Committee, now available under Debates on this site.

Sometimes a picture replaces a thousand words. This German 2 million mark stamp  from 1923 in Germany reminds us that even in an advanced western country less than a hundred years ago people lived through a dreadful hyperinflation.  By the peak of the price rises in November 1923 the authorities decided to remove 12 zeros from their currency, creating a new or Rentenmark.  In August 1924 the new Reichsmark replaced 1 trillion of the old marks.

                  The fear of inflation has haunted Germany ever since. It lies behind German current reluctance to print too many Euros to deal with the probpems of state and bank debts in parts of the Eurozone.  Germany knows from bitter experience that if you print too many to get round the problem of managing your debts and deficit you can trigger a collapse of confidence in your currency, a rapid move in to goods, and eventually a hyperinflation.

               Creating a new currency that might be more stable and which people trust is the easy bit of recovering from such a situation. The hard bit is the deep recession or deflation that can follow the bursting of the bubble and the creation of the new stronger currency.

              The Euro area does not today stand on the edge of too rapid an inflation – far from it. The main safeguard against printing too many  Euros  to try to stave off the day when state and bank debts have to be paid is the attitude of Germany herself. That image of the overprinted postage stamp is a timely reminder to Germany and the architects of the Euro that there is no easy way out of excessive state and bank debts or large deficits. If you try too hard to inflate your way out of your debts, you can end up with a worse crisis.

The Uk is a generous country. The government remains wedded to its pledge to spend 0.7% of our GNI on aid. Recently Mr Cameron has suggested that more of our aid spending should be used to stabilise countries in strife and assist law enforcement in troubled countries, so that more UK armed forces spending can count as overseas aid spending.

There are international rules on what does and does not count as aid spending. You can spend on teaching peacekeepers or police and that counts as aid, but spending directly on peacekeeping or policing yourself once invited to do so by the host country may not count as aid. Where our forces are helping a civilian population by assisting medically, or in other ways that usually qualifies for aid, it would make sense for that to be included in the totals.

More importantly, the government should look at the large transfers and payments made from this country to developing countries. Surely much of that money flowing to developing countries is doing exactly what aid budgets are doing – boosting incomes, offering financial assistance, providing cash for investment. Whilst UK charitable donations do not count as aid for these purposes, the tax relief granted to charities sending donations can count towards the total as this is state aid. Where the UK pays state benefits to people who then remit some of this money to families in developing countries, this is not counted as aid though it looks very like it.

France and Germany have typically included more of the loans advanced from their countries to developing countries as part of their totals of recognised aid. We need to recognise more of what we are already doing, at a time when public budgets are too stretched. To qualify as aid the state needs to be involved and there has to be a concessionary element to the loan.

Meanwhile the government is right to cut back overseas aid out of taxpayers pockets by removing aid to countries like China and India, as they are now doing. They are right to cut the budget back from the original plans owing to the lack of growth in the economy. It needs less spending to hit the 0.7% target if growth is reduced. How much aid would you spend?