Friday, April 30, 2010

Economics and the Tories

I'm immersed in multiple Facebook debates with friends of mine on the election and how the economy matters in my thoughts about the election.

I wrote the following note today which I'll post here. If it's already obvious, I'm a Christian and so some comments on the note relate to that; but I think these kinds of things should form one's views on other aspects of life such as the economy. Anyway, here goes:

Quite a few people perhaps are interested in my thoughts on the election as an economist. I'm far from the only economist in the world, and my background is as a Labour voter. So hopefully my economist friends will comment on this also and correct me where they think I'm wrong - in case it is (which I hope not) that political matters are clouding the economic judgement.

If you're linked in, I've debated with you on Facebook already so thought you might be interested.

Where to start. Hopefully as I go through these things it'll become clear that my take on how the economy work means naturally I'm more inclined towards Labour than the Tories. More inclined towards Lib Dems too, for that matter.

Deficit. Basic economic theory says that the total demand for goods (stuff produced in the economy and imported) is called Aggregate Demand, and made up of what we as consumers consume (called C), what firms invest in for future production (given the letter I), what the government spends (G), and net exports (NX, so if more people buy our goods abroad than we buy of their goods then this term is positive). So: AD=C+I+G+NX.

Furthermore, money in the economy goes round and round - between firms and workers who consume and so it goes back to firms, who pay workers, and so on...

So: There's something called a multiplier effect. If the government ploughs in some more money (G goes up), then that extra money goes round a few times as firms pay workers who buy stuff in Tescos etc). So that means a £1bn injection of government money will lead to total output (GDP) going up by more than £1bn because we spend it quite a few times between us.

The same has to work in reverse. Pull out money, demand falls, goods aren't sold, the economy has to shrink.

But should we put loads of G in the mixture? No - other economic theory talks about the crowding out effect: Lots of government spending raises interest rates meaning firms invest less and their share of the economy falls. So we can't just go on raising G all the time, that won't lead to strong growth because firms are crowded out of the picture.

So when should G fall? G should fall when its negative impact won't be enough to tip the economy into a recession. Governments should not be compared to households for reasons I may touch on later, but they can be compared to firms in some contexts - one I'm thinking of is this. As a firm, if you borrow to start up, you pay the money back once the firm is profitable - you don't do it immediately because then you'd never get off the ground. So we need to cut later.

And we need to cut: The government's share of the economy can't be the 50% it is now. It is too high. But it's 50% because it owns Northern Rock and most of RBS and Lloyds TSB, and because many jobs have been lost in the private sector in the recession. These are rather special (as in different, peculiar) times.

So as you can see, nothing controversial in there, it's all very basic economics. And it so happens it corresponds to the Labour policy on getting the deficit back under control.

More generally, where do I stand on the economy? Economics teaches that markets are very effective tools for helping the economy function. Via the price mechanism, where the price moves in a market to equate supply and demand, information is immediately conveyed to all people about the state of the market.

But markets are far, far from perfect. Some people in the market are uninformed, and those well informed exploit them. Other times, if left to the market some things (benefits for those unemployed) just would not happen.

So the power of markets needs to be harnessed. That's regulation mostly. Not nationalisation most of the time (tho the army and some thing of course need to remain nationalised). Financial markets are everyone's favourite target, and rightly so.

Perversely, a right-wing view on regulation has held sway since the 1970s (not just under Labour!), and politics has reflected this, and regulation has got lighter. Alan Greenspan in the US (former governer of their central bank) has come under a lot of fire for honestly believing financial markets could regulate themselves. Of course they can't when some people have a lot of knowledge, and others have little, yet a lot of money is going around.

So I'm left of centre on how the economy should be run. But not much left of centre. The benefits system has got to be, as much as possible, not open to abuse (but we live in a fallen, imperfect world, people will always abuse the system). But it's got to be there. As people we just aren't charitable enough.

A tax system should also be progressive. Many right-wing economists (that the Tories love) would say that highly progressive taxes discourage effort - and in the extreme I think this is true. But to use that kind of idea to justify their cuts on inheritance tax just stink and reveal much about their priorities (given their track record).

On purely economic grounds: It's poorer folk that spend a higher proportion of their income, hence if you're aiming tax cuts, you'd aim them at the poorer people not the richer. But of course, I don't form my beliefs on taxation by economics alone, but also as a Christian. A realistic Christian. Of course, it's not nice that the government forces us to pay tax to redistribute income (Toby - you moan about how inequal income is now in the UK - but if the Tories came in nothing they do would reduce inequality!). But left to ourselves, we're sinful and greedy. There's just no way we'd pay enough in charity to ensure abject poverty was avoided. Why did the welfare state come about in the first place?!

Few more election related things. IMF. All parties are as bad as each other at spinning and distorting, but the Tory IMF thing is just wrong on so many levels. Not least this: The IMF was called in in 1976 to bail out the UK. In 1977 there was a hung parliament. Hence the Tories are wrong historically on the link between the two.

Will the UK become like Greece? Dave's linking of our currently deficit to Greece's is almost entirely irrelevant. Bit like saying I'm spending too much today, and so is that guy over there who is about to file for bankruptcy. Our debt is massively smaller than Greece's, and has historically been so. Furthermore, our debt is long-term (10-15 year bonds), Greece's is very short term - hence they keep having to appease creditors that they'll pay eventually. Finally, the UK's debt is given the top rating by credit agencies: Greece's is junk. Maybe the UK will suffer a downgrading (but I doubt it - the last S&P statement basically said there was no risk of this), but the UK has an infinitely better track record than Greece, and hence it's fairly unlikely.

Are business leaders backing the Tories btw? The Tories would like to tell you that, but businesses are after a credible deficit reduction plan, and the IFS has made it clear none of the parties do enough. I'd personally like better, more clearer plans - but I want more clearer plans to reduce the debt once the economy is growing. It simply isn't sensible to cut it and send the economy back into recession.

That's enough for now. Hopefully it's clear why I vote Labour based on my principles formed from being a Christian and an economist.

Incidentally, I just finished chatting with John Fender (on BBC and Sky News in the last day), and despite being a Lib Dem voter, he is most convinced by Labour on the economy.

Monday, April 26, 2010


We've talked at various points about the effect of expectations: On exchange rates, on investment, and hence on national output, GDP.

Today the BBC reports that business leaders fear a hung parliament because of the potential paralysis that it could produce.

This is an expectations effect: If firms are more pessimistic they may invest less, meaning that the economic growth reported in the last two quarters may be unsustainable.

Much political hay will be made of this. The Tories have most to fear about a hung parliament for many reasons: One is that not so long ago they expected to win outright - that looks unlikely now. The second is that a Labour-LibDem pact is much more likely than a LibDem-Tory pact, regardless of the recent pronouncements by the major parties.

If the political maneuvering fascinates you, you should think about taking a microeconomic theory module next year, one that will introduce you to game theory. See you at 9...

Friday, April 23, 2010

Growth at 0.2%

The ONS has announced the UK economy grew by 0.2% in 2010Q1 (first three months of the year).

This is lower than many expected, and of course people are making big game of it. Apparently it's a sign that momentum in the economy is waning according to Ernst and Young. But industrial growth surged 0.7% in the same period, and this is just the first release of GDP. I suspect we'll see the figure revised higher as the ONS counts up more of the economy (this figure is based on just 40% of the numbers).

All Those Lovely Numbers

Today is the big one, but this week has seen a steady release of important numbers relating to the economy.

We've learnt that unemployment finally tipped above 2.5m in 2010Q1, that inflation is up to 3.4% due in part to petrol prices (again due in main part to exchange rate changes and tax), that government borrowing is very large indeed (what didn't we know?).

Today is the big one: GDP growth, from 9:30am.

Also, the debates: Final one on campus next Thursday - get along if you can!

Wednesday, April 21, 2010

If you need another reason not to vote BNP...

...then your economics lectures will have given you some idea about that.

Today the BNP has called for restrictions on imports from China, on the basis that somehow this will protect UK jobs.

What will it actually do? Simply make goods more expensive, making us poorer.

It'll make us reliant on governments to always protect us from those terrible foreigners who have developed better ways to do things. Surely the better thing is to try and compete and develop better ways too instead of protecting?

But, really, it's just too easy to pick holes in BNP attempts at policy...

Monday, April 19, 2010

Big Week!

My apologies for a 10-day delay in new posts - but of course, you were all fervently revising anyway weren't you?

Now you've revised 101b, you have all the key economic concepts under your grasp ahead of a big week for the politicians in the run up to the election on May 6.

After the positive news from the National Institute of Economic and Social Research (very influential think tank) suggesting growth would be 0.4% in the first three months of 2010 (2010Q1), Ernst & Young's Item Club has suggested that growth will be sluggish - under 1% for the whole year. This is likely a different spin on the same news. 0.4% each quarter of 2010 would mean, roughly speaking, growth of around 1% a year (because the 0.4% each quarter is calculated on the previous year so it's hard to calculate exactly based on the quarterly figures).

But this BBC news article reporting the bad news from Ernst and Young points out that most days this week there will be some new economic data released: Thursday is public finances (expect Cameron to harp on again about debt then), and Friday is GDP in 2010Q1. Should be fun...

Friday, April 9, 2010

Petrol Prices at Record Levels: It's the Exchange Rate, Stupid

I'm sure you'll come across many vitriolic outbursts by people this week as petrol prices hit their highest levels ever. That vitriol will be directed at two entities: The government, and the oil companies.

But this FT article gives a good account of why that anger and abuse would be poorly directed.

The exchange rate is causing much of our difficulties. Remember, if the exchange rate depreciates then imports cost more since we need more currency to buy them now. Hence oil costs more, and so petrol costs more.

Added to that, the recession meant people have started driving less (400 miles on average a year, according to the RAC), and so oil companies have had to cut refinery capacity as a result. Hence supply has fallen off too, contributing to the problems.

So it's not all as clear as you might thing, and not all the government's, or BP's, or Shell's fault.

The Exam

I'm getting a lot of emails about the exam, so I'm going to write all that I'm going to reply to any future emails that I get in this post.

The econ101b (i.e. the macro part) exam will follow the same structure as in previous years, so all past papers from the last 5 years will be helpful for you to get some idea of what to expect.

In terms of the economic content of the questions, they are based on what was covered in the lectures. So to prepare best, you must re-cover what was looked at in lectures. This means in the first instance reading back over the lecture slides and notes you made. That's the bare minimum, and I think you'd struggle to get through on just that alone.

You need to consider also reading the textbook chapters corresponding to the lectures (which were clearly advertised). You should read all of the chapters, and not be of the mindset: How little do I need to read. The less you read, the worse you do, the more you read, the better you do. It's a simple production function.

You'll be well advised to take the time in the run up to the exam to do some practice essays and practice exams as part of your revision.

China To Loosen Exchange Rate

We've looked fairly extensively at exchanges rates over econ101b, and considered fixed and floating exchange rates.

China is the most obvious example of a fixed exchange rate system, and that system has long attracted criticism especially from the US because it means Chinese exports remain cheaper as the Chinese economy grows, and imports into China stay expensive. Hence Chinese exporters are helped, while US (and to some extent UK) exporters into China are disadvantaged.

It seems that China will start to allow some marginal changes in its currency - i.e. it will allow more movement. Given the vast amounts of currency coming into China to buy its exports, there is only one direction the currency will go - up!

The linked NY Times article is very nicely written to explain all the various aspects of this possible movement. Well worth a read.

More Good News for the Economy

The National Institute of Economic and Social Research predicts that growth will be 0.4% this quarter (so January-March of this year), the same as it was in the last quarter of 2009.

This is great news if the state of the economy concerns you - regardless of the upcoming election, because of course it'll get a spinning or two in that arena.

You may be of the cynical viewpoint that what does it matter if these GDP figures show growth - what matters is unemployment right? People getting jobs.

GDP is one part of a much bigger picture, but it's important: If the economy is seen to be growing (and 0.4% a quarter is a reasonable rate of growth - not stellar by any means but given the sharp falls in 2008 and 2009 it's growth) then confidence will grow amongst businessmen to invest, creating jobs.

Furthermore, the conditions are good for expansion for many UK firms because of the weak exchange rate: Remember this makes our exports cheaper. Reflecting this, the Grauniad also reports than manufacturing output is up.

It's worth pointing out that in the manufacturing article, the BCC (British Chamber of Commerce, representing UK companies) makes the point that government help will still be needed post election to keep the recovery going.

Now, the Tories propose to cut the deficit drastically post-election if they're in power. They've ring fenced those important things like health and education. So support for businesses has to be one of the areas that would see less funding - and rightly so from a Tory point of view.

Remember: A more right-wing, classical take on economics would say the state should be small, and let business do what it does best without interference from the government. I wonder whether some business leaders will lift their heads above the parapets and voice support for Labour in the coming days?

Finally: The Grauniad. That's what Private Eye calls the Guardian because of the volume of typos in the Guardian. Check out the grammatical error in the manufacturing article (if it hasn't been corrected yet).

Thursday, April 8, 2010

If you're already bored...

...of the election coverage, the Guardian has an amusing take on each day's events. Here's yesterday.

Wednesday, April 7, 2010

The Real World isn't Like Football

Often newspapers and regular folk like you or I will talk about the economic growth of the UK relative to Europe, the US, Asia, etc., as if it's some big World Cup of economic growth - the UK has to do well (make the quarter finals say).

But of course, it doesn't work quite like that. If other economies are not growing, then they will not be buying our goods so much, and so our demand will rise less, and hence our economy will grow less. This is the premise for the rather gloomy article in the Guardian, noting that European growth levels are lower than the UK, and will hold the UK's recovery back.

This is the flip side to the article I referred to earlier from the BBC, reporting that the OECD thinks the UK's growth will be faster than most G7 countries in the latter part of 2010. If others aren't growing, they aren't confident and aren't buying our goods. Much better if they're growing about the same kind of rate that we are. Faster if they like buying our goods!

Plenty to talk about

There's more on the National Insurance hike planned by Labour, and opposed by the Tories. Another 38 or so businessmen have come out supporting the Tories.

There are plenty of reflections possible on this. First, it's an increase in taxation, which is a withdrawal from the circular flow of income. In that respect, it is potentially harmful to the economic recovery since the multiplier will work in reverse. On the other hand, it's hardly a massive increase. Although it appears to go against the general Labour mantra of postpone cutting the deficit, there are plenty of signs now that the economy is picking up - see recent blogs on business confidence.

Businessmen, it seems, are a little put out that Labour have described them as being deceived by the Tories. This is hardly surprising! Luke Johnson has responded by calling the government "economically illiterate", and also remarks in the linked FT article: “I think that’s insulting. Businesses know very well what will encourage them to employ more people.”

Businessmen also know exactly what to say, and what not to say. Of course, NI needn't be a tax on jobs: Firms have the choice of objective. If they are profit maximisers then yes, labour becomes more expensive as an input. Of course, if their objective is to maximise some profit function that includes social welfare as an argument, then the firms may take a hit to profits instead of cutting workers and remain at their previous output levels.

Optimistic of course, but the point is this: Businessmen don't like the NI rise because it will cut their profits, and businessman, as a rule, are greedy. So that's why they are squealing at the moment. And that's what I mean by they know exactly what to say.

Of course, the Tories are promising drastic cuts in government spending if in power. Given the things being protected (education, health), it means that other incentive programs (tax credit, etc) will have to be shelved. I suspect businesses aren't quite thinking through the implications of this.

The fact is, we will all have to feel the effects of the measures to cut the deficit, and there is little reason to protect businessmen at the expense of others, if this is possible...

Good News for Gordon Brown

The OECD thinks the UK will grow faster than all other G7 countries except Canada.

Double Dip Looking Less Likely

From the Guardian, reporting on a survey by the British Chamber of Commerce (which represents UK businesses), it seems that firms are reporting better conditions this year, which suggests that GDP growth in the first three months of this year (the first quarter of 2010, 2010Q1) will not be negative. In other words, the UK will not suffer from a double dip recession.

Negative growth in 2010Q1 would have led to fears of a double dip recession where, having reported positive growth one quarter (2009Q4) hence escaping recession, the economy is immediately plunged back into recession. Remember a recession is two consecutive quarters of negative growth so negative growth in 2010Q1 would have to be followed by negative growth in 2010Q2.

More election economics reading from the FT

I don't really like the FT any more, now that it charges, but here's an interesting article by Philip Stephens on the election:

Tuesday, April 6, 2010

That argument over NI again

Last week, some businessmen wrote a letter supporting the Tories over Labour's planned National Insurance (NI) rise.

Here's an interesting blog article on the whole thing. I don't claim this will be an easy read, this chap is very smart indeed. But it might be quite interesting.

One particular thing is this survey conducted by Natwest. Apparently most of you guys studying for degrees (actually, the study is of teenagers pre-uni I think) think you'll earn £50,000 by your 30s. I hope you do - one surefire way to ensure this is to work hard, and listen to your lecturers!

Skilled or lucky?

Tim Harford is always worth a read. As I've mentioned, he's a journalist also trained as an economist, hence he's able to explain things better that most of us economists. He's recently blogged about whether governments need to be skilled or lucky to get re-elected.

Lucky in that the election is held when the economy is looking good, in the boom part of the cycle, or unlucky in that the election has to happen when the economy is depressed. Clearly, by May 6th we'll know how things are for the UK because we'll know 2010Q1 (that's January-March of this year) GDP growth figures and hence we'll know if the 0.4% growth recorded in 2009 is a sign of things to come or a blip.

But, in reality, how much control does Gordon Brown have over the economy? He isn't in every workplace geeing on the staff to better things (thankfully), and the UK isn't a centrally planned economy (thankfully). But of course, as Gordon Brown has tried to establish that the recession was caused by external shocks (from the US mainly), his opponents have charged that the good times must have been helped by external shocks too, hence not allowing him credit for the unprecedented period of economic growth that came before this recession.

My personal take (and this isn't a Labour voter speaking - you have heard me praise the Thatcher government in lectures for tackling inflation!) is that it is much easier to wreck and economy than to make it work. Sure, Labour and Brown inherited some good work from Major's government, but it would have been very easy to wreck all this rather than to keep it going.

So some credit must be given for the long growth enjoyed in this country before the recession, and while some decisions in the recession were not wise, none were economic no-brainers - you all know by now how difficult it is to exert any influence on the economy because it's such a complicated beast. And it's hard to argue the source of the downturn was adverse economic events elsewhere - even if the fundamentals here in the UK were less solid than we previously thought, contributing to the large downturn here compared to, say, Canada.

Hence this whole thing about luck and skill. Brown's having to call an election in a less rosy economic period, and can we ascertain whether Brown has shown skill over the years, or whether he's been incompetent. Before you rush to judge him as incompetent, use the economics you've learnt this term as you revise...

May 6 it is

Gordon Brown is about to announce May 6th as the date for the election - just four days before the econ101 exam (sorry for the reminder).

Over the next few weeks plenty of bad economics will be banded around, particularly by the Tories and Labour, so watch this space - and if you're revising (as you should be), reading this kind of stuff should be some light relief from the rest of your work. So watch this space as I'll try and dissect it as much as possible.

Take from my ramblings what you like. Alas, the UK political system means that regardless of who you'd like most to be in power in Westminster may not really affect how you vote, since in your particular constituency it may be that it's a safe seat anyway for one party or the other. But it'll still be good to understand what's good and bad economics out there. Good rule of thumb: Vince Cable talks about the most sense on the economy.

Saturday, April 3, 2010

The iPad is Out!

The Wall Street Journal has an interesting article on Apple's latest offering:

Politics and Economics

Having recovered from my equilibrium in front of the United v Chelsea match (delighted with the result in terms of the title race - anyone but Man U please!), here's an article on the Chinese fixed exchange rate.

That is, as mentioned in lectures, China fixes its exchange rate at a particular value against the US dollar, and intervenes on the foreign exchange market (where people offer and and buy the Chinese currency or the US currency). One of the advantages of this is to give certainly to companies that export or import, since prices will stay fixed.

The Chinese may be prepared to loosen it provided that the US agrees with it on sensitive political matters such as Taiwan and Tibet.

On the other hand, the US has a law that permits it to decide certain countries are "currency manipulators", and it is likely that these kinds of movements and indications made by China are attempts to avoid being categorised as a manipulator...

Thursday, April 1, 2010

It's getting tasty

Yesterday 23 businessmen came out in support of the Tories' plans to only raise National Insurance on people earning over £40,000 or so.

The Tories naturally have made a great play of this. Labour plans on increasing National Insurance across the board, one of their more visible measures to show they are starting to get tougher on cutting the deficit.

It's funny though, because this tax increase is quite illogical given Labour's standpoint as not wanting to cut the deficit right away to hamper the recovery. This NI increase comes right at the time the economy is recovering.

On the other hand, the same can be said for the Tories. Their main bag is cutting the deficit yet they are cutting back taxes, one way to cut that deficit. However, of course, the Tories are more about cutting down the size of government and hence cutting spending rather than raising taxes.

So that means "efficiency savings", or "spending cuts" to anybody outside Westminster...