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Stephen Says...

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sharing occasional thoughts about things that interest me

Corbynomics Nearly Nails It

the state of the country Posted on Fri, July 24, 2015 15:44:01

In his crisply presented paper on economic policy (‘The
Economy in 2020’) Jeremy Corbyn comes tantalisingly close to a correct analysis
of the country’s situation and makes some sensible suggestions for addressing
its problems.

He affirms the traditional basis for social democratic government:
using the state as the agent for collective consumption. By doing so he
supports the vision of the electorate as a consumers’ co-operative (the vision originally
established by Beatrice Webb and supported by other foundational Labour figures
like Leonard Woolf). And he confirms an explicit conception of the state as a
subscription society in which it is expected that payments subscribed should
reflect ability to pay.

But he could and should have gone further.

Firstly, he could have pointed out that the UK budget deficit
is not due to the provision of public services as benefits in kind (health and
education): these are paid for by the taxes on people’s spending which they
directly pay themselves out of the money that comes into their households. A
summary analysis of the system as it stands is reported in the tabulation
below.

This analysis considers taxes that households pay directly
when spending their take-home pay (e.g. transactions taxes such as VAT or Stamp
Duty, licences for cars or televisions), compared with the value delivered
through purchases made by the government on their behalf (i.e. as collective
consumption or ‘benefits in kind’ – mainly education and healthcare services).

The figures show that by and large the existing system
operates according to the progressive principle: to each according to their
need, from each according to ability to pay. Those who spend the most
contribute the most. And for the majority of households (the low-money and
middle-income households), the value of collective consumption outweighs the
cost of tax-payments.

Secondly, despite acknowledging that most people pay taxes linked
to their employment through PAYE (so that ‘income tax and national insurance’
are removed before employees see them) Jeremy Corbyn fails to draw the logical
inference that these payments are more truly to be regarded as employment
transaction taxes, paid by employers as incidental to the provision of the
take-home pay required to attract workers. This is unfortunate because if he
did so it would create a more effective platform for the argument which he
rightly makes that such taxes ought to be increased as the most effective
measure to address the persistent UK budget deficit.

As can be seen from figures comparing taxes on employment in
different European countries, UK taxes are lower than their equivalents
elsewhere.

These figures show that the UK’s international competitiveness
would not be damaged by higher UK employment transaction taxes. What’s more, by
representing these charges more accurately as employment transaction taxes, and
doing away from the ridiculous pretence that they are taxes on personal incomes
or individual insurance payments, they would become explicitly the charges for commercial
use of the infrastructure that Jeremy Corbyn rightly wants them to be seen as.
Not only that, it would draw the teeth of arguments about benefit payments as
transfers from virtuous workers to feckless scroungers or from the poor
put-upon working young to expensively pampered pensioners.

Jeremy Corbyn has nearly nailed it: he should take the
further steps that I’ve suggested and hammer home his message about reforming
taxation to tackle the deficit whilst recommitting the Labour party to
collective consumption and social solidarity according to existing progressive
practice.



Double or Quit? Dealing with Greece

the state of the country Posted on Tue, July 07, 2015 12:14:26

It’s frustrating that the Eurozone can’t seem to get their
act together and to use their collective economic strength to deal with the
difficulties currently being faced by quite a small component country of the
zone (i.e. Greece). In order to check out whether my intuitive feelings were
massively wide of the mark I decided to look for myself at the figures that
would illustrate the dimensions of the problem and to consider the potential
for political action to address it.

I think it’s pragmatic to surmise that establishing the euro
as a sovereign currency reflects a nascent common sovereignty for the countries
of the zone in which it operates. On this basis it’s appropriate to consider
the para-statal financial circumstances of the Eurozone as a context for
dealing with ‘the Greek crisis’. The compilation of statistics presented in
Table 1 makes a start.

The figures in the table represent the situation across the
18 countries of the Eurozone in 2014 (Lithuania joined at the start of 2015).
The first thing to notice is the dominant position that devolves upon the four
largest countries: Germany, France, Italy and Spain (the Big4). Together the
Big4 account for over three-quarters of population and GDP as well as state
revenues and government debt across the zone as a whole. And the idea that the
Big4 effectively represent a core or centre-of-gravity for the zone is reflected
by the fact that their aggregate statistics for activity rate (Emp/Pop),
economic significance of the state (GRev/GDP), weight of government debt
(GGD/GRev) and average income (GDP/hd) are all very close to the figures for
the Eurozone as a whole.

The size of the state relative to the economy as a whole
varies quite widely across the Eurozone. Overall within the zone government revenues
equate to 46.7% of the total GDP. But in some countries the share is less than
40% (Ireland, Latvia and Spain are the lowest) whilst in others it is more than
half (Finland, France and Belgium are the highest). Luxemburg, Ireland and Austria have the highest GDP/hd; Latvia,
Slovakia and Estonia have the lowest; the variation is extremely wide. Given
the current focus on Greece, it is interesting to see that the activity rate
(the fraction of the population in employment)
is lowest there (32.2%) whilst the burden of government debt in relation to the
size of government revenue is highest there (406.4%).

Since ‘the Greek crisis’ has
concentrated so heavily on government debt it is worth noting that across the
Eurozone as a whole such debt is equivalent to about double the annual revenue
of the state sector (201.3%). Aggregate statistics for the countries with a state
debt more than 250% of government revenue (Cyprus, Greece, Ireland, Italy,
Portugal and Spain) indicate lower-than-average activity rates and GDP/hd, as
well as a relatively smaller-scale government revenue stream. It’s notable that
2 of the Big4 countries, Italy and Spain, are members of this group.

Turning to an explicit treatment of the Eurozone as a
sovereign area with component country-regions, some proportional figures are
presented in Table 2.

Although all the recent fuss has focused on Greece, it’s a
small part or minor region of the overall Eurozone economy. It is interesting
to observe how closely the various countries’ shares in total Eurozone
government debt mimic their shares in the total population of the zone. Greece,
for example, is 3.3% of the Eurozone population and accounts for 3.4% of total
Eurozone government debt. Germany has 24.4% of the population and 22.4% of the
debt. France has 19.2% of the populace and 21.5% of the debt. Spain has 14% of
the people but only 10.9% of the debt. The countries (regions) whose shares in
the debt are significantly higher than their share in the population are
Ireland, Belgium and Italy. The virtuous, frugal countries (regions), whose
shares in the debt are significantly lower than their share in the population,
are Estonia, Latvia and Slovakia.

Maybe it’s time for the Eurozone to redouble its efforts to
achieve integration and to assume common responsibility for all the government
debt across the countries (regions) of the zone. Because the most heavily
indebted countries (CGIIPS) are dominated by two of the Big4 (Italy and Spain)
it should be possible for these two to broker any such deal, from which the solution
to ‘the Greek crisis’ would emerge as a relatively minor by-product. Doubtless
common fiscal rules and procedures required as part of such a deal would take a
long time to harmonise (with plenty of scope for transfer of good practice
across member states) but since this might effectively amount to much the same
in time-scale terms as debt rescheduling, and since it might much more readily
be presented as (if not actually constituting) progressive development rather
than palliative care, this ought not to detract from the substantial achievement
that such an agreement would create. The opportunity for established
governments in Italy and Spain to demonstrate constructive leadership to their
own electorates at a time when they are under pressure from radical alternative
challengers ought to encourage this sort of initiative. But I’m not holding my
breath.



Greece on the face of it

the state of the country Posted on Mon, June 29, 2015 01:13:23

In the end I just couldn’t help trying to make
some sort of sense of the Greek economic crisis for myself because I have by
now completely lost trust in the reporting of economics by news media. I’ve
used published statistics from the IMF and the OECD, and I’ve adjusted the
presentation and made some supplementary calculations of my own where
necessary. The full tables and commentary are available here. My conclusion based on this analysis is that even though Greece was
relatively poorly placed to weather the economic storm of the great global
financial crisis (2007-2010) it had actually managed not too badly in the
circumstances. In fact it’s been the events of the aftermath (2010-2015) that
have done the damage; and in particular the absolute collapse of wage-payments
(down by 20%) and the explosion of unemployment (the rate has doubled to over
25%). These twin developments, accounting for the 19% decline in Greek GDP, set
Greece apart from other countries at the weaker end of the Eurozone where
unemployment rates and pay have tended simply to stagnate. They do not seem to
justify a punitive refusal to countenance further financial support or debt
rescheduling on the part of multi-national agencies.

Although in the years before the global financial crisis
Greece’s public sector or government debt was, in relation to government
revenue, relatively high, it was not much different from Italy’s. And at the
end of the crisis in 2010 Greece, Italy and Belgium, which had started out with
the highest debt relativities, had controlled their debts better than many other
countries. Then in the aftermath years up to 2015 several other
countries’ debts grew proportionately as much as Greece’s did (and in the case
of Spain by much more). And no other country’s debts approach the scale of
Japan’s!

Regarding the budget deficit, although
Greece was not particularly well positioned prior to the global financial
crisis its 2005 deficit was much the same, relatively speaking, as in Portugal,
the USA and Japan. And at the end of the crisis in 2010 there were several
other countries in much the same situation as Greece, with deficits greater
than 20%. Nor in the aftermath, in 2015, is the Greek budget deficit (7.5% of
government revenue) exceptionally large; France and Ireland (both 7.1%) and
Portugal (6.5%) are not dissimilar; the UK (10.2%), Spain (11.8%), the USA
(11.9%) and Japan (19.7%) are all much worse cases on the face of it.

Although, in the years before the crisis, Greece’s aggregate
expansion (+41% between 2000 and 2005) was not exceptional, Ireland (+57%) and
Spain (+44%) exceeded it, and despite Greece maintaining expansion at the end
of the crisis in 2010 to much the same extent as the other European countries
considered here, in the years of the aftermath Greece has experienced a
collapse in GDP (-19% to 2015) quite unlike any other country. And it is this
special circumstance that justifies giving special attention to Greece’s
situation.

Before the global financial crisis Greece’s unemployment
rate, whilst quite high (10.8% in 2001; 10.0% in 2005) was not exceptional
(Germany had a higher rate, 11.3%, in 2005). And even after the crisis in 2010
Ireland (13.9%) and Spain (19.9%) had higher rates than Greece (12.7%). But in
the years of the aftermath, to 2015, the unemployment rate in Greece grew much
more rapidly than anywhere else, reaching 25.2%. Certainly unemployment rates
did rise in other countries, including other countries identified as
economically weaker members of the Eurozone (in terms of government debts and
deficits), but not so swiftly as in Greece.

In addition, Greece experienced a further exceptional
development: workers’ pay fell continuously across the years of the aftermath;
this caused a cumulative reduction in pay of almost 20% by 2015. In the other
weaker countries of the Eurozone workers’ pay was stagnant but it did not
cumulatively fall. On the face of it,
this continuous fall in workers’ pay is a classic Keynesian unvirtuous spiral
of economic depression: a self-reinforcing reduction in economic activity.

The resolution of ‘the Greek Crisis’ requires the same thing as the rest of Europe needs: an expansion of
demand in the outside world or a co-ordinated programme of public sector
expansion across Europe as a whole. Unfortunately neither of these desirable
events is visibly on the horizon. This is tragic: a condemnation of the western
political process. Singling out Greece for punitive sanctions rather than
co-ordinating a programme of debt rescheduling across Europe (and maybe beyond)
is a failure of imagination against which protests are entirely justifiable.
Greece’s problem is just the most obviously painful instance of a situation
that, in the absence of good fortune in terms of external circumstances
(overseas economic expansion), will blight other weaker economies in their
turn. On the face of it the crisis belongs to Greece. But in reality it’s a
crisis that faces us all. Picking on Greece is a distraction.

The full tables and commentary are available here



Household Economics

the state of the country Posted on Sun, June 21, 2015 18:21:08

I applaud Professor Simon Wren-Lewis for his willingness to
venture out of the ivory tower and to try and engage with the public in a
discussion about economic policy (e.g. in the New Statesman 19-25 June 2015). And I really admire his use of
blog-posts and twitter-tweets to try and bridge between academia and people at
large. But I think he’d be even more successful if he built on the public’s
clear understanding of household economics instead of using ‘household
economics’ as a term of abuse to describe the Chancellor of the Exchequer’s
misguided appraisal of the situation. Anyone who’s got, or has ever had, a
mortgage understands that the big advantage over renting is that you’re living
in the home of your choice, enjoying all the benefits it offers, whilst you’re
paying off the debt the mortgage represents (on the way to ultimate outright
ownership of the property). The national debt represents our collective
mortgage on the infrastructure of the public realm (the institutions and the
public space we live in as we go about our everyday personal, social and
commercial business). We’re paying for it while we’re already using it. And
everybody understands that the size of the mortgage we can afford is linked to
the income we expect to earn. Looked at in this way, in the UK our collective
mortgage (usually called state or public sector debt) is roughly two-and-a-half
times our collective income (the state or public sector revenue-stream mainly
represented by taxation). I doubt if this multiple would faze anyone who’s ever
had, or hopes to get, a mortgage. In France and Germany the state debt is about
twice the state’s annual income (tax revenue); in Spain and Italy it’s about
the same as here; in Greece by contrast it’s over four times, only a bit more
than the USA’s three-and-a-half times and nowhere near Japan’s six-times-plus!
The goal of not having a mortgage makes sense if you’re going to get old and
unable to hold down a job. Luckily the state doesn’t face this prospect;
instead, when it’s paid off its existing mortgage it can take out a new one to
pay for all those developments required to cope with changing collective
household requirements (i.e. the national debt is really a rolling collective
mortgage). I agree with Simon Wren-Lewis that “it is time for Labour to change
the strategy to something completely different – to start telling the truth”. But
I think the party will be more successful if the truth it tells chimes with
everyday household experience: household economics in fact. I suggest that
viewing the national debt as a collective mortgage would be a helpful start.



Anti-austerity Labour could have won

the state of the country Posted on Sun, June 14, 2015 12:01:53

Lord Ashcroft did a very
useful survey on Election Day. Over 12,000 voters were questioned. They were
asked not only about their voting behaviour but also about their attitudes to
economic policy and their personal experience with respect to prevailing
economic conditions. The results are worth reflecting on. (Analysis and tables of results can be accessed here). They illustrate the difficult
political problem that the Labour Party faced with regard to economic policy.
They also prompt some reflections about the wisdom of the party’s policy
choices.

At the time of the election nearly
half of voters questioned (46%) said they would endorse a continuation of
austerity and cuts in government spending for the next five years. Almost a
quarter (24%) chose to adopt a hardline anti-austerity stance, viewing cuts in
government spending as unnecessary and ideologically driven. The remainder
(30%) thought a period of austerity had been necessary but they did not accept
the need for another five years of cuts in government spending. So overall a
majority of voters (54%) was against the continuation of austerity as
government policy.

Only a quarter of voters
(26%) said they were already feeling some of the benefits of an economic
recovery. The rest were evenly divided. There were those who weren’t feeling
the benefits of a recovery but expected to do so at some point (37%). And there
were those who weren’t feeling the benefits but didn’t expect to either (37%).
So a substantial majority of voters hadn’t seen evidence of the much-trumpeted
economic recovery in their own lives.

Those already feeling the
benefit of recovery were overwhelmingly in favour of continued austerity (well
after all it seemed to have worked for them! so why not for everybody else?). Most
of those who expected to benefit from recovery accepted that austerity had been
a necessary precursor, although only about half of them (48%) thought that
there ought to be further cuts in government spending. Most of the support for the
most hardline anti-austerity position was amongst those who didn’t expect to benefit
from recovery anyway.

To summarise: a majority of
voters opposed further austerity and cuts to government spending; and only a
minority had yet felt any benefit of an economic recovery. You might think this
combination of circumstances ought to favour opposition to the existing
government and its economic policy of continuing austerity.

The Conservatives had
established themselves as the party most definitely committed to austerity. Labour
had to choose whether to compete with the Conservatives in pro-austerity
territory or to stand against any further austerity. The problem for Labour was
that a policy incorporating a degree of austerity (which definitely includes
further cuts in government spending) risked writing off the votes of
anti-austerity voters (especially the hardliners who thought it had never been
necessary in the first place). But without accepting austerity as being a
platform for recovery Labour risked writing off the votes of those expecting to
benefit from any recovery (the hopeful or aspirational?), and many of these
people (48%) favoured further cuts in government spending.

In the event, Labour offered an
undefined degree of austerity (definitely including some further cuts in government
spending). But this did not attract substantial support: only about a tenth
(11%) of those who favoured more austerity voted Labour (59% of them voted
Conservative). Perhaps surprisingly Labour held on to half (51%) of the hardline
anti-austerity voters; but significant shares went to the avowedly
anti-austerity Celtic Nationalists (12.3%), the Greens (11.9%) and UKIP (11.4%).
And Labour got a lower share of those expecting to benefit from recovery (31%)
than the Conservatives did (35%). And less than half of those with no hopes of
benefiting from the recovery voted Labour (42%); about a fifth of these
‘no-hopers’ (19%) voted for UKIP, perhaps because UKIP at least promised
‘something different’.

With the wisdom of hindsight
(and Lord Ashcroft’s data) Labour made a fundamental miscalculation by backing
austerity (even though a less austere austerity than the Conservatives:
‘austerity lite’). If Labour had had the courage to define itself as
anti-austerity, and if the party had got the same fraction of the
anti-austerity majority of voters as the Conservatives got of the pro-austerity
minority, then Labour might have won the election.

But, surprisingly perhaps,
this message is not what the Labour leadership contenders seem to have
absorbed. Instead they are mostly arguing that Labour should have been more
convincingly pro-austerity in order to have won.

(Analysis and tables of results can be accessed here)



Before the General Election

the state of the country Posted on Tue, May 05, 2015 15:14:44

Political commentators used to look at living standards,
measured in financial terms, to try and explain the results of elections. This
association of political fortunes with economic circumstances has now become
conventional wisdom. And political parties have reinforced this presumption by
claiming credit for improvements in living standards (if the governing party)
or laying blame for deterioration (if the opposition). Government
responsibility for determination of the country’s economic situation is allowed
to go without saying. And yet, by allowing this, we, the electorate, are
insulting our own intelligence.

Any British government is powerless when it comes to
determination of international market prices for important necessities such as
energy or food. Nor can it affect decisions about interest rates in the
Eurozone or the United States. Or anything to do with China.

This is not to deny that government is a significant
economic actor. Not only is the state responsible for providing the
infrastructure within which both businesses and households carry on their
everyday existence but it also arranges for delivery of health and educational
services as well as disbursing alms to those whose ability to work for a living
is compromised by mental or physical frailty (mainly the elderly). Altogether
government accounts for about 40% of national income.

But for as long as sterling is maintained as a sovereign
currency the context for government economic policy is determined by the
exchange rate. Unfortunately, scandalously even (by defiance of the Nolan
Principles), official economic analysis is developed in denial of this fact.
See here for a summary of this situation.

Presenting the General Election as a choice in terms of
economic policy is fraudulent. As regards economic policy there is nothing to
choose between the main parliamentary political parties: the Government
(Conservatives and Libdems) and the Opposition (Labour) are agreed that the
analysis and judgements offered by the Office for Budget Responsibility should
dictate the scope for public expenditure and taxation. To vote for any of these
parties is to guarantee that the official assessment of the country’s economic
situation goes unchallenged. Since the OBR’s assessments are based on a tragic
misperception of the country’s economic situation it is not possible for a
truly coherent and effective policy to be developed and implemented by any of
these parties (whether alone or in combination). In these circumstances, to
vote for any of these parties is to connive with a public act of collective
self-deception.

Of course it’s possible to believe that economic policy is
unimportant, or that other government policies deserve to be developed along
certain lines rather than certain others, irrespective of the economic context,
and that expressing a preference for one political party over another is
justifiable in these terms. But I expect the economic context will be given priority by the parties. And expecting party place-persons to put citizens’
interests before the interests of their own party places seems to me a misplaced act
of faith.

And in the context of a ‘hung parliament’ it also seems
optimistic to expect that what any Coalition Government actually does will
reflect proposals put to the public in any manifesto. For example: a
Labour-Libdem Coalition Government would be likely to legislate for
constitutional changes introducing state funding of political parties along the
lines previously suggested by the Electoral Commission. Ed Miliband’s only
significant reform of the Labour Party has been to base trade union funding on
members’ decisions to opt in to political funding rather than allowing a system
of default consent to operate: this reform was a pre-requisite specified by the
Electoral Commission, and by adopting it the Labour Party removed the only
major obstacle to the scheme previously officially recommended. Since these
proposals would align state funding with electoral results (votes) all the
minor parties likely to be represented in the House of Commons would assist in
carrying the proposition. Also likely to be smuggled in with this change would
be an introduction of proportional representation (probably in the guise of
House of Lords reform). It is doubtful whether the introduction of these
changes would involve a referendum: more especially so if it’s a
Labour-Conservative Coalition. That’s not to say these are not sensible
reforms, for which a credible case could be made: it’s just an example of the
sort of thing the electorate should get used to being given by government (i.e. no choice), as
coalition is more overtly established as the permanent political context.



BBC Economics and Election Coverage

the state of the country Posted on Tue, May 05, 2015 15:03:04

The BBC Economics Editor (Robert Peston) has stated that:
“the economy is absolutely at the heart of this election campaign”. And several
other BBC Correspondents have made similar observations. But despite these
assertions BBC reporting of the election campaign has failed to challenge the
consensus amongst the main parliamentary parties in relation to economic
policy.

According to this consensus, decisions about the
appropriateness or otherwise of fiscal policy measures should be subject to the
assessment of the country’s economic prospects determined by the Office for
Budget Responsibility.

There are two unsatisfactory aspects to this.

Firstly, the technical analysis upon which the OBR relies
for its assessment is demonstrably flawed. For as long as sterling remains a
sovereign currency the exchange rate will be a significant factor affecting the
country’s economic circumstances. Robert Chote (Chairman of the OBR) states
categorically that:

“The depreciation of sterling
which began in 2007 has led to a change in the relative prices of domestic and
foreign goods which will have had two effects:

(i)
It will
provide a boost (to) export growth as the relative price of exports of UK goods
and services in foreign markets has fallen; and

(ii)
It will
reduce import growth as the relative price of imports to the UK from foreign
markets has increased (often termed import-substitution)”

(source: email from
Robert Chote received 4th April 2012)

But not only are these expectations without justification in
terms of economic theory, they are also directly contradicted by the evidence
provided by the Office for National Statistics.

The ONS figures indicate that the OBR’s expectations are
completely refuted. The devaluation of sterling in the aftermath of the Great
Financial Crisis has raised the prices of goods imported and goods exported
alike: there has been no “change in the
relative prices of domestic and foreign goods”.

And this ought to come as no surprise since you only need
seven types of product to account for more than half of UK exports and you only
need the
same seven
to account for more than half of the UK’s imports as well.
The categories are: Mechanical machinery; Electrical machinery; Cars; Medicinal
& pharmaceutical products; Refined oil; Crude oil; and Other miscellaneous
manufactures. So no wonder prices of imports and exports move together: their
prices come from the same world markets.

In fact, the ONS data is entirely consistent with the proper
economic theory. In this, the crucial price-relativity affected by the exchange
rate is that between tradables and non-tradables. Tradables being those things
that are internationally portable (e.g. motor-vehicles; feed wheat; consultancy
services etc.,). Non-tradables being those things irrevocably confined to our
shores (e.g. residential property; domestic care services; the infrastructure
of the public realm etc.,).

The impact of sterling’s devaluation has been to raise the
sterling prices of tradables across the board (i.e. both the things we buy from
overseas and the things we sell abroad) because their prices are set in
international markets (and not in sterling terms) and apply equally to
‘imports’ and ‘exports’ (translated into sterling terms by the same exchange
rate), so there is no relative price change such as the OBR expects. And
consider the significant difference that this makes: the OBR believes
devaluation is expansionary (increasing domestic output) whilst the correct
theory says it isn’t (rather the opposite, when you take’ income effects’ into
account).

A more detailed consideration of the ONS data confirms that
import and export prices within the same (tradable) product categories
habitually move together (being basically the same international price of
course), showing that the UK is well integrated into global market
determination of producer prices for tradables. The pivotal role of the exchange rate is to alter the balance of
activity in the UK economy between the tradables and the non-tradables sectors
:
this comes about because whilst prices in the latter (non-tradables) are
inherently set in sterling, prices in the former (tradables) are translated
into sterling from abroad by the exchange rate (thus changing when it changes).

The second unsatisfactory aspect of this situation is more
constitutional: the role of elected MPs is to challenge (i.e. hold to account)
the operation of unelected authority; but by agreeing to abide by the pronouncements/judgements/forecasts
of the OBR the political parties are effectively giving immunity from challenge
to the unelected authority represented by the OBR. This is inappropriate. And
since there is no professional body responsible for standards of practice by
economists, the public is excluded from any possibility that errors (such as
that relating to the exchange rate) can be exposed and eliminated.

To summarise then: all the main political parties are
explicitly committed to accepting the authority of the OBR in determining the
official assessment of the country’s economic situation and hence the scope for
adoption of varying fiscal policy measures. This is a clear political
consensus. It is equally clear that the OBR’s assessment is systematically flawed.

The BBC Editorial Guidelines are commendably clear about
what should happen in circumstances such as this: “In such cases…… …our reporting should
resist the temptation to use language and tone which appear to accept consensus
or received wisdom as fact or self-evident. … BBC output should avoid
reinforcing generalisations which lack relevant evidence, especially when
applying them to specific circumstances. …. Care should be taken to
treat areas of apparent consensus with proper rigour.”

Unfortunately, in the case which I have
identified, the BBC has completely failed to live up to these valiant
expressions of intent. By failing to challenge the political consensus about
the operation of economic policy, an issue which the BBC claims “is absolutely
at the heart of this election campaign”, the BBC is betraying its audience, the
general public and the electorate. It’s contributing to electoral fraud.



The Exchange Rate and the OBR

the state of the country Posted on Sat, February 21, 2015 12:04:10

Given that it’s universally accepted political wisdom that sterling should be sustained as an independent sovereign currency, you’d think that the economic significance of the exchange rate would be well understood. But I’ve lost count of
the times it’s been said on the radio and TV News that “devaluation makes our
exports cheaper” (with the implication that this means increased sales abroad,
so contributing to domestic economic expansion with concomitant rises in
employment, earnings and tax-revenues).

And Robert Chote
(Chair of the Office for Budget Responsibility) states categorically that:

“The depreciation of sterling which began in 2007 has led to a change in
the relative prices of domestic and foreign goods which will have had two
effects:

(i)
It will provide a boost (to) export growth as the
relative price of exports of UK goods and services in foreign markets has
fallen; and

(ii)
It will reduce import growth as the relative price of
imports to the UK from foreign markets has increased (often termed
import-substitution)”

(source: email from Robert Chote received 4th April 2012)

But not only are
these expectations without theoretical justification, they are also directly
contradicted by the evidence.

The Monthly Review
of External Trade Statistics November 2012 (published by the Office for
National Statistics on January 15th 2013) reports the prices of UK
Traded Goods as follows:

The ONS figures
indicate that the OBR’s expectations are completely refuted. The devaluation of
sterling in the aftermath of the Great Financial Crisis raised the prices of
goods imported and goods exported alike:
there has been no “change in the relative prices of domestic and foreign
goods”.

In fact, the ONS
data is entirely consistent with the proper economic theory. In this, the
crucial price-relativity affected by the exchange rate is that between
tradables and non-tradables. Tradables being those things that are
internationally portable (e.g. motor-vehicles; feed wheat; consultancy services
etc.,). Non-tradables being those things irrevocably confined to our shores
(e.g. residential care services; domestic property; the infrastructure of the
public realm etc.,).

There is an
important contrast in the way in which prices are determined for non-tradables
and for tradables. For non-tradables, prices are set locally in sterling and so
don’t involve the exchange rate. For tradables, prices are set internationally,
not in sterling (usually in US$), and so require the use of the exchange rate
to express them locally here in sterling. These observations allow us to
appreciate the economic significance for Britain of sterling’s exchange rate.
For when the exchange rate alters so do the prices of all tradables when
expressed in sterling. And this means that prices in the tradables sector of
the British economy have changed, whilst the prices of the non-tradables sector
have not: so the relativity between the two sectors has been changed, creating
pressure for economic readjustment between these two parts of the British
economy (each responsible for roughly half of GDP).

As can be seen from
the ONS figures, the impact of sterling’s devaluation has been to raise the
sterling prices of tradables across the board (i.e. both the tradable things we
buy from overseas and the tradable things we sell abroad) because their prices
are set in international markets (and not in sterling terms) applying equally
to ‘imports’ and ‘exports’ (translated into sterling terms by the same exchange
rate), so there is no relative price change such as the OBR expects between
domestic and foreign goods. A more detailed consideration of the ONS data not
only confirms this but also indicates that import and export prices within the
same (tradable) product categories habitually move together (being basically
the same international price of course), showing that the UK is well integrated
into global market determination of producer prices for tradables.

The language of
‘imports’ and ‘exports’ is beguiling: it obviously holds official thinking
spellbound. However, I’d much rather believe the evidence of the ONS than take
the word of the OBR. And consider the significant difference that this makes:
the OBR believes devaluation is expansionary (increasing domestic output)
whilst the correct theory says it isn’t (rather the opposite, when you take the
depressing ’income effects’ of consumer price increases for tradables into
account).

I protest because
I’m sure this is important. To summarise my argument: it is fundamental to
government economic policy to sustain sterling as a sovereign currency; this
predicates the existence of exchange rates; this further requires that
appraisals of the country’s economic situation ought to be developed using a
proper understanding of the exchange rate’s effects; the OBR demonstrably does not
have this proper understanding; the OBR is immune to criticism (forsworn by MPs
on all sides to protect its “independence”); because decisions about public
expenditure and taxation are dependent on the OBR’s flawed assessment of the
country’s position they can’t command public confidence.

If you’d like to find out more about this topic:

I’ve had a go at making an assessment of the
British situation based on the distinction between tradables and non-tradables
(http://www.stparsons.co.uk/files/britains_economic_situation_2013_final_edit.pdf)

and I’ve described my argument in technical terms using some A-level/undergraduate diagrams (http://www.stparsons.co.uk/files/a_technical_analysis_of_british_macroeconomic_circ.pdf)

and I’ve prepared a
tabulation giving detailed attention to the ONS data (http://www.stparsons.co.uk/files/official_thinking.pdf).



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