The Government’s Green Investment Gimmick

Today’s FT has an important story – it looks like the much touted Green Investment Bank is actually going to be a modest Green Investment Fund, or more accurately, a Green Investment Gimmick.

According to the report, the ‘Bank’ will be granted a £1bn budget (with another £1bn coming from asset sales) to distribute. This £2bn of new investment is meant to help plug the green investment gap in the UK. But as the FT notes, the energy sector alone needs green investment of at least £200bn over the next ten years.

A proper Green Investment Bank, one that actually operated as bank, could make a real impact here.

If it were initially capitalised at £5bn it could easily borrow £50bn over the next few years to lend to fund new green investment whilst retaining a very strong balance sheet and being conservatively over-capitalised.

The initial £5bn could come from a variety of sources – new funding from the Bank of England (i.e. a form of QE that directly supports the economy), a one off levy of the banks or indeed from privatisation revenues when Osborne sells off RBS and Lloyds.

£50bn of new investment in the form of loans from a new bank (and new bank which would be able to reinvest the interest earned) would make a meaningful impact on the UK’s green sector. £2bn in a fund is yet another ‘miserable little compromise’.

So, why is the Treasury against a Bank?

Apparently because the money it borrowed would count as public debt and so inflate the debt/GDP ratio.

I find this objection essentially meaningless; it comes from fetishising public liabilities and ignoring assets.

Last week the ONS published new figures on public debt including the liabilities of RBS and Lloyds as publicly owned banks for the first time.

This measure (which got almost no mainstream media coverage) increased the UK public debt by £1.3 trillion pounds. But as this £1.3bn is more than offset by assets of the nationalised banks and as the UK government is not directly responsible for the interest payments arising, this is of academic rather than practical interest.  

The debts of a proper Green Investment Bank would be the same, whilst technically adding to the UK’s public debt, any increase would be offset by assets in the form of interest earning loans and the Treasury would not be responsible for servicing this debt. It’s an accounting exercise rather than a burden.

And all of the above analysis ignores the knock on effects of £50bn of new investment in the UK economy in terms of jobs created, welfare bills reduced and income and corporation taxes paid.

A proper Green Investment Bank, ideally alongside a new State Investment Bank to fund infrastructure, would be an important step both in rebalancing the UK economy and in helping to combat global imbalances. It’s a shame we are being fobbed off with a gimmick.

The Fiscal Arithmetic Looks Bad for Osborne

Hopi has very good post up on what George Osborne will do next. I recommend having a look if you haven’t already.

This post follows from that and is based on a comment I had over there.

As Hopi says:

My suspicion is that George Osborne was always planning to use the Budget to announce his “growth agenda”. If I were in the Treasury, I’d have noted that until Q3 the economic numbers were pretty good, and the PSNB numbers were below projection. I’d figure that growth was likely to continue in Q4 and I could launch my 2011 Budget in March claiming to have fixed the crisis, and that now was the time to put the priority on laying the foundations for a sustainable future economy.

In other words, I’d claim to have fixed the deficit and stabilised the economy, reaped a small reward for that in terms of lower debt and debt repayments and propose to put that extra funding into Business side growth drivers.

This line – ‘I’ve done the hard work now lets talk about a growth’ - seems to fit with what Osborne has expecting. It’s similar to the line he took in a recent FT piece addressed to European Finance Ministers, which now comes across as arrogant and complacent.

The problem is he seems to have overestimated the strength of the recovery.

Hopi is no doubt right that Labour should keep attacking his lack of a growth plan. (As an aside I am rather pleased, 4 months on, with this old post on how Labour should keep the 4 year plan, attack the lack of a Plan B and await economic developments).

But what’s worrying me now is the fiscal arithmetic.

Between April and December 2010 public sector borrowing came in at £118.4bn as against £126.8bn in 09/10.

The June Budget forecast for total borrowing of £149bn in 2010/11 may now well be missed. The horrible December suffered by retailers combined with a generally bad Q4 for the all important service sector suggest to me that January’s corporation tax receipts will be on the light side.

The poor state of the economy at the end of 2010 makes a downgrade to the 2011 and 2012 growth forecasts from the OBR increasingly likely.

A miss (even a small one) in the 2010/11 borrowing forecast would be bad enough for Osborne, but revising down 2011 and 2012 means the OBR will be forced to revise up welfare payments (again) and revise down tax revenues.

How will Osborne react?

After the release of the November public sector borrowing figures (which were awful) I speculated that we might have to start preparing for Emergency Budget II.

With Danny Alexander reaffirming the Coalition’s commitment to cuts in this morning’s FT, and with last week’s declaration that there is no plan B, one has to start to worry about next March’s budget. They’ve lashed themselves to the mast of deficit reduction through spending cuts, and even if it patently fails they’ll find it hard to back down. If the medicine isn’t working they’ll simply double the dose

We only have to look across the Irish Sea to see how this ends.

In December 2009 Irish Finance Minister Brian Lenihan said that Budget 2010 was ‘the last big push’ of this economic crisis, adding that ‘the worst is over’. It didn’t work, the deficit continued to rise as fiscal policy depressed the economy. One year later an even more savage budget followed.

Will next year’s budget be even more savage than the Emergency Budget/CSR? I’m starting to worry that it might be.

In other words, just as Osborne should be announcing a growth plan he may be forced to announce further cuts. We’ll have a better picture once we get the January borrowing figures and our first look at the January economic data, but early indicators (such as consumer confidence) aren’t looking good.

The possibility of further cuts hasn’t really entered the mainstream debate yet, despite Paul Mason flagging this up earlier in the week.

It will not be long before somebody points out that, if the 0.5 contraction is consolidated into the 2011-12 growth projections, then the Budget might have to be more austere than expected.

The March Budget is going to be very interesting – Osborne needs to announce a growth plan, but his tough earlier rhetoric might mean he instead announces yet more austerity.  I suspect we’ll get both – some poorly cobbled together ‘growth plan’, probably made up of a small regional growth fund and some deregulation together with more public sector cuts – probably focussed on welfare.

Banking Reform

The public responses to the Vickers Commission on banking are online and worth a look.

I especially recommend taking a moment to read Sir George Mathewson’s views. This former CEO of RBS, and the man responsible for the takeover of NatWest in 2001, recommends that both RBS and Lloyds should be broken up.

FT Alphaville has some excerpts and suggestions as to where to start reading. (Like them I am most amused by Nigel Lawson’s suggestion that the Commission read a couple of chapters of his memoirs!).

We are seeing a clear divide open up, many outside experts and former bankers are calling for radical reforms – the banks to be broken up, retail and investment banking to be separated, etc. The big banks themselves are digging in and defending their business model.

I would, again, recommend that those interested in this debate that a look at Mark Blyth’s recent piece on how the old model may well be broken and at some of the issues raised in my own recent post on banking.

I suspect the final report from Vickers et al will make for interesting reading. But with Vince Cable emasculated, will George Osborne be prepared to do anything that damages the resale value of our stakes in RBS and Lloyds?

I rather suspect his desire for a pre-election war-chest to fund tax cuts will trump reform.   

PS – For what it’s worth I’d favour some from of separation between retail and investment banking to make protecting deposits more straight forward (and I’d settle for separately capitalised structures within the same group), the remutualisation of Northern Rock (I did a quick post on why this makes sense back in 2009), the break up of the “too big fail to banks”, the introduction of more competition, the establishment of a state investment bank and green investment bank, and a focus on new regional banks.

The Inevitable Costs of the Crisis: Who Pays?

Last night Mervyn King warned that the UK faces the worst decline in living standards since the 1920s.

He stated that: 

unpleasant though it is, the Monetary Policy Committee neither can, nor should try to, prevent the squeeze in living standards, half of which is coming in the form of higher prices and half in earnings rising at a rate lower than normal.

Because: 

one way or another, the squeeze in living standards is the inevitable price to pay for the financial crisis and subsequent rebalancing of the world and UK economies.

The “inevitable price” of the financial crisis, we are told, is falling living standards.

Certainly the financial crisis had extremely high costs – lost output, higher unemployment and hole blown in the Government’s finances. That may be inevitable, but the question of who pays that bill is a political choice.

I’ve argued before that this is the situation Ireland now faces:

I’m sure we’ve all been there – a long and rather good meal with a large group of people, some of them close friends and some of them vague acquaintances. The bill arrives and suddenly people are disputing exactly how much wine they drank, asking who had a starter and who ordered coffee.  

The bill following the financial meltdown is collusal, the political question is – who pays it?

We have Osborne’s and King’s answers: the crisis may have started in the financial sector but the adjustment costs will be met by the general public. And they’ll pay twice, once through the decline in living standards noted above and again in terms of higher taxes and lower quality public services from the Government’s deficit reduction programme.

There is however another answer, one that looks to an increasing wage share of GDP, public investment and growth.

I know which option I prefer.

That GDP number – some quick thoughts

The quickest of quick thoughts.

- The -0.5% number is horrible, even with the snow it suggests a lackluster performance in Q4 with no momentum going into the cuts.

- The full year figure of 1.7% has missed the OBR’s 2010 forecast of 1.8%, made only 8 weeks ago. Suspect 2011 and 2012 will now be revised down.

- Manufacturing is doing well but it only employs 2.5m people, not enough to generate growth and jobs for whole economy.

- Threats to manufacturing next year include the Eurocrisis (biggest export market), higher commodity prices and continued difficulties with financing.

- We’d expect some of the demand lost in Q4 because of bad weather to come through into Q1 2011, but hit to confidence from this bad news plus VAT rise may constrain that.

- This was a surprise but maybe it shouldn’t have been – retail sales in December were awful (worst drop since 1988), unemployment was rising in November and Markitt reckon the service sector (crucial to the UK) was stagnating in December.

- Cutting starting in April strikes me as crazy. The Fiscal Responsibility Act 2009, which set out Darling’s 4 year plan, allowed for the pace of deficit reduction to be slowed if the economy did badly. Strongly suspect Labour in office would be rethinking tough cuts in 2011 at this point.

- We’ll obviously get revisions next month but unlikely to make this number positive 

- Going into 2011 we have rising unemployment, record youth unemployment, high inflation and a contracting economy. This isn’t looking great.

Ed Balls: Excellent News

Back in September I argued for Balls to be made Shadow Chancellor. So, although it is  sad that Johnson has had to step down for personal reasons, I’m delighted by his appointment today.

The Bloomberg Speech last August, one that won high praise from Martin Wolf and Sam Brittan in the pages of the FT, remains the best demolition of the Government’s economic strategy we’ve heard from any politican since the election.

One occasionally wonders how the General Election might have played out a little differently if we’d made such a case rather than arguing over £6bn of in-year “efficiency savings” (which of course turned out to include such efficiencies as scrapping the Future Jobs Fund and Child Trust Fund).

The Bloomberg speech still makes for excellent reading, especially the emphasis on Keynes and the need to question conventional wisdom. But that wouldn’t come as a surpise to those who have read Steve Richards’s “Whatever It Takes“

The youthful Balls had ideas about how to build the stable architechture, and yet like Brown he was also committed to tackling unemployment and poverty. In interviews later Balls described himself openly as a socialist, a rare admission in New Labour circles and not a term used by Brown. Keynes was one of Balls’s heros, long before the economist became more fashionable after the credit crunch in 2008. (pp. 59)

We’ve got a Shadow Chancellor who doesn’t need a primer in economics, things are about to get interesting.

 

Banks: Three Big Questions & Three Places to Start

As we approach bonus season the banking sector and its future is once more moving up the political agenda. We’ve had the usual fight over bonus levels and remuneration and are witnessing a new battle over the level of the banking tax.

New MPs Chuka Umanna and Rachel Reeves have been taking an impressive lead in these skirmishes.

Both are certainly important issues and Labour is on the right side in each case. The government should take a firmer line on bonuses, especially at state owned institutions and the level of Osborne’s proposed bank levy is far too low.  

But with the Banking Commission due to report this year, I think it’s worth taking a step back and asking three bigger issues. 2011 will be a big year for banking policy – possibly a once in a generation chance to get things right and it’s important that Labour goes into that debate with a grasp of the bigger picture and agenda for the kind of change we need. Especially as an emasculated Vince Cable is unlikely to make much progress alone.

I’d pose three major questions to get that debate started.

First, how can we reform the sector to make major crises, like that of 2008, less likely? Remember that it wasn’t a bolt from the blue, but merely the latest in a long series of similar events of increasingly magnitude.      

Second, how can we make sure that banks do what we want them to – namely act as intermediaries channelling savings into productive investment? The declining level of investment in the UK economy is a major economic problem, and the solution lies partly in the banking system.

Finally, how can we rebalance the economy so that tax revenues are not so reliant on the financial and property sectors?

To get readers thinking, I’d suggest reading three articles – all published in the last year and all important contributions to this debate.

First, the LSE’s Future of Finance report, and in particular the work of  the Bank of England’s Andy Haldane. FT Alphaville summarised this as follows:

The period from the early 1970s up until 2007 marked . . . [a] watershed. Financial liberalisation took hold in successive waves. Since then, finance has comfortably outpaced growth in the non-financial economy, by around 1.5 percentage points per year. If anything, this trend accelerated from the early 1980s onwards. Measured real value added of the financial intermediation sector more than trebled between 1980 and 2008, while whole economy output doubled over the same period.

In 2007, financial intermediation accounted for more than 8% of total [gross-value added], compared with 5% in 1970. The gross operating surpluses of financial intermediaries show an even more dramatic trend. Between 1948 and 1978, intermediation accounted on average for around 1.5% of whole economy profits. By 2008, that ratio had risen tenfold to about 15%

…

Banking has undergone, at least arithmetically, a “productivity miracle” over the past few decades . . . Risk illusion, rather than a productivity miracle, appears to have driven high returns to finance. The recent history of banking appears to be as much mirage as miracle.

If the returns of the sector, returns that have been of huge of importance to the British economic model are actually a “mirage”, then this certainly matters.

Next, it’s worth having a look at Mark Blyth’s (a Professor of International Political Economy at Brown, in the US) recent piece from the Huffington Post. In particular his views on the “banking business model”.

Cassidy’s November New Yorker piece asks, “What Good is Wall Street?” If it significantly adds to capital formation, then the argument for compensation orders of magnitude beyond other sectors is somewhat justified. The problem lies in showing this, since doing so rests upon a series of counterfactuals that are hard to prove. For example, the existence of a $400 billion swaps market doesn’t mean that its absence would result in lower GDP growth. It does however mean lots of fees for those who arrange the swaps.

Looking at the link between what banks do and capital formation, Cassidy notes that the part of Morgan Stanley that does link borrowers to savers and raise capital, traditional investment banking, delivered a mere 15 percent of 2009 revenues. For Citibank “about eighty cents of every dollar in revenues came from buying and selling securities, while just 14 cents on every dollar came from raising capital for companies.” As such, the claim that these institutions are doing “God’s work,” AKA capital formation, seems to skate on rather thin ice.

…

First of all, you give up on customers and develop counterparties. That is, you fatten your trading book, and to do that you need lots of different products to trade, hence the growth of complex and opaque securities. Second, you use said securities and the firm’s balance sheet to develop massive amounts of leverage so that even if the margins on each trade are thin, with enough volume you can earn a lot of cash. Finally, you ‘cover’ all this by writing deep out of the money options that give you a near risk free income stream: until it doesn’t.

This is how banks actually make their money, until 2007, when it all went wrong.

This article, which builds upon Haldane’s work, is important in that it sheds light on what banks actually do. We want, and need, banks that help in capital formation (investment), it’s less clear that we need some of these other activities. Adair Turner famously desribed much of banks’ activites as “socially useless”.

Finally a Tyler Cowen article from December on inequality and the financial sector:

Cowen writes that:

For the time being, we need to accept the possibility that the financial sector has learned how to game the American (and UK-based) system of state capitalism. It’s no longer obvious that the system is stable at a macro level, and extreme income inequality at the top has been one result of that imbalance. Income inequality is a symptom, however, rather than a cause of the real problem. The root cause of income inequality, viewed in the most general terms, is extreme human ingenuity, albeit of a perverse kind. That is why it is so hard to control.

(Also summaried here by the Economist)

We need to have a proper debate on financial refrom that moves beyond bonuses and levies, I think these articles are a good place to start.

Nick Clegg’s Unfunded Tax Cut & Complacency

Yesterday Nick Clegg appeared on the Today programme. He repeated the claim that back in May “Britain was the brink of bankruptcy”, a subject I dealt with over at Left Foot Forward.

But perhaps a bigger issue was his claims on income tax – he stated that his policy was to raise the tax free allowance to £10,000. So far the government have only announced a £1,000 increase in the personal allowance.

There are three issues here – first, as Howard Reed and Tim Horton have argued this isn’t the best way to combat poverty or to help the low paid. Most of the money goes to the better off, one reason that Guido refers to the policy as “a middle class tax cut”.

Second, as analysis by the Resolution Foundation (covered by Will over at Left Foot Forward) has demonstrated – what the government gives with one hand, it takes with another – higher VAT more than “compensates” for a higher tax free allowance.

But most significantly, as Faisal Islam yesterday, taking the personal allowance to £10,000 would cost an additional £11.5bn. £11.5bn (the near equivalent of another 2.5% on VAT) that has not been budgeted for.

I imagine we will soon get confirmation that the Deputy Prime Minister “misspoke” and that the £10k personal allowance is an “aspiration” not a “a policy”. I’m sure Mr Clegg would like to go into the next election offering just such a cut in income tax phased in between 2015 and 2020.

This does reveal quite a bit about how the coalition thinks – tough austerity now, then electoral hand outs in 2015.

Responding to bad poll numbers yesterday Tim Montgomerie tried an old trick – “you think an 8% Labour lead is bad, wait till its 20%”. That was  predictable; what’s more interesting is what the post reveals about the Tories’ economic complacency:

The economic cycle is on Cameron’s side. We should be in the upswing phase at the time of the next election. If the economic gods smile kindly on Cameron the UK economy will be ticking along nicely by 2013/14/15 and Osborne, Cameron and Clegg will be able to say they steered the UK economy through difficult times – without any help from Labour. It will be a powerful message. In the meantime there’ll be tough cuts, inflation, higher mortgage rates, internet-powered explosions of protest and, most worryingly, the potential for real €urozone problems. But we will get through it. Hopefully.

Essentially – “don’t worry, we’ll have two awful economic years now, but things will be fine by 2015, I hope” – is this the plan?

The Structural Deficit: Time to Stop Defending It

(A long-ish post that will probably manage to annoy every wing of the party in a different way).

On Friday evening, via the medium of twitter, I got into a fairly long debate with the FT’s Alan Beattie about Labour’s record on the public finances. It started with me making the point that between 1979 and 1997 the Tories ran 2 budget surpluses and 16 deficits – the wider points I was trying to make were firstly that those who live in glass houses shouldn’t be so quick to throw stones and secondly that despite this, the debt/GDP ratio fell – in other words small deficits are fine and it’s growth, not running a surplus, that controls debt.

But the debate quickly turned to the question of Labour running “the largest structural deficit in the industrial world” on the eve of the crisis. Occasional commentator here and blogger Andreas joined the argument defending our record – I feel, in this case, he may have been too quick to leap to Gordon Brown’s defence.

I think I better serve my readers by being honest about Labour’s faults as well as trumpeting its virtues. And I feel the Party would better serve the public, not to mention increase its own credibility, by adopting the same approach.

So let’s be clear then – Labour was wrong to run a structural deficit, of the size and duration it did, from 2003 onwards. What’s more, Labour should be prepared to say this publicly.

Before proceeding there are five important caveats to note. The fact I have to explicitly write these caveats perhaps explains why the leadership finds it so difficult to admit to past mistakes – our political culture isn’t suited to debating complex issues and the news media would no doubt be quick to label any comments on Labour’s past record as a “U-turn” or a “retreat”.

Caveat One – We didn’t “overspend”.

Saying we shouldn’t have run a deficit of the size we did is not accepting that Labour “overspent”. We didn’t – welfare spending (as I’ve noted previously) was not high, the increase in net investment (new schools, hospitals, etc) from a miserly 0.6% of GDP in 1997/98 to 2% in 2007/08 was welcome, the increases in spending on health and education were much needed (respectively from 4.6% and 5% of GDP in 1997/98 to 5.5% and 7.2% in 2007/08).

Labour was not reckless with the public’s money. Total managed public expenditure rose from 38.2% of GDP in 1997/98 to 40.9% in 2007/08.

The problem was the revenue side, not the spending side – in terms of both not taxing enough and being too reliant on what turned out to be bubble-inflated forth rather than sustainable funding.

Caveat Two – Labour/Big Government did not cause the recession/large deficit

Even if Labour had been running a surplus in 2007/08 we’d still have a large deficit now. The global recession did start in the financial sector and it caused a large deficit by depressing tax revenues and causing welfare related spending to increase.

Whilst the existence of a structural deficit did hamper out ability to respond to the recession (it meant for example we had a smaller stimulus than other countries) it did not cause it. Ed Miliband is right here to argue that the Tories are rewriting history.

Caveat Three – The Tories are still wrong

For a start, despite latter shameless opportunism, the Tories supported Labour’s public spending plans until late 2008. I also didn’t hear them arguing for higher taxes to close the deficit.

What’s more, launching a stimulus in 2008 was exactly the right response to a global collapse in demand.

Right now, the pace and size of Tory spending cuts risks being self-defeating and damaging a still fragile economy further.

Caveat Four – The Blairites aren’t right here either

Over the past week various Blairite commentators have been quick to point out that in Blair’s memoirs he claims he argued for a “Fundamental Savings Review” in order to crimp public spending in 2005.

Now, leaving aside that this would be the same memoirs where Blair claims responsibility for Bank of England independence, this isn’t the issue. Lower public spending in 2005-08 (as noted above) wouldn’t mean no large deficit now and it won’t have meant no recession. It simply would have meant less money going into the public services in those three pre-recession years. Had Blair argued for marginally higher taxation in 2005-08 I’d be happy to give him credit. He didn’t.

Caveat Five – Despite what I am saying – the public finances were not a huge mess

Britain was nowhere near the brink of bankruptcy. What’s more, debt as a percentage of GDP was lower in 2007 than in 1997 -although it had been increasing on this measure since 2002/03.

Most importantly, and little remarked on in the political debate, the average maturity of UK government debt was 14 years – the longest in the developed world and providing strong insulation against any crisis in the bond market as debt did not have to be rolled over as quickly.

But, but, but and caveats aside….

Running a structural deficit after a 15 year economic boom is not sound policy making. Nor is assuming that bubble-inflated tax revenues will continue to rise at a rapid pace and nor is proclaiming the end of the boom and bust. That’s simple hubris.

For me, Brown’s major achievement in the field of economic policy making (alongside his role in 2008-2010 which future historians will lavish praise on) was the increase in National Insurance to pay for NHS spending in 2002.

A rise in direct tax to pay for service – done explicitly and a move that proved to be popular.

So I won’t attack the level of public spending in 2007/08, I won’t say it’s simply “another case of Blair right, Brown wrong”, I won’t take let Labour take the blame for the recession and I won’t say “maybe the Tories have a point” but I will say there is a simple principle here – if we want decent public services we have to pay for them.

Running a deficit in the face of a recession is simple economic common sense, running one after the longest boom Britain had ever experienced wasn’t quite so clever.

The thing is – this should be easy for Ed Miliband to say. He began his campaign by noting that Labour seemed to have forgotten its critique of capitalism, and he was right.

The best demonstration of this is the growth in the structural deficit from 2003 onwards – the belief that the market had been entirely tamed, recessions were a thing of the past and that the bonus-relate- income-tax, the banking-related-corporation-tax and the property-related-stamp-duty pouring into the Treasury would never stop.

The markets weren’t tamed, the recession did come and those revenues simply stopped.

Labour are entirely right to lambaste the government for the speed and severity of their cuts and entirely right to defend many of the things achieved between 1997 and 2010. But defending that structural deficit does us no favours.

Some Links

On Friday evening I had quite an interesting debate (via twitter) with the FT’s Alan Beattie (author of this – which is an excellent read and proves very useful if you find yourself in a long chat about Argentinean economic history at a New Year’s Party, I’m aware this may only be something that happens to me).

I promised a blog post – on Labour’s record on the public finances and where we went wrong.  It’s taking longer than I anticipated – but should be up tomorrow (EDIT: :later today).

In the meantime four things worth reading:

Paul Mason’s “interviews” with Karl Marx and Maynard Keynes. Superb writing.

Mark Blyth’s Huffington Post article on the bailouts and banks business models. (And if you haven’t seen it, his video on False Economy about austerity economics).

Chris Dillow on Labour, the deficit and investment.