Stephen Says...

Stephen Says...

This is my blog

sharing occasional thoughts about things that interest me

Corbynomics Nearly Nails It

the state of the countryPosted by Stephen 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 countryPosted by Stephen 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 countryPosted by Stephen 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 countryPosted by Stephen 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 countryPosted by Stephen 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 countryPosted by Stephen 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 countryPosted by Stephen 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 countryPosted by Stephen 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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