Duncan’s Economic Blog

How did the economy do in July? Early signs aren’t good

Posted in Uncategorized by duncanseconomicblog on July 28, 2011

Today and yesterday we got our first look at how the economy might have performed in July and whilst it is too early to draw conclusions, the news isn’t good.

Today’s CBI distributive trades survey saw the headline number fall to -5% from -2% in June.

The CBI Distributive Trades Survey was conducted between 28 June and 19 July. It revealed that 33% of retailers saw sales volumes rise on a year ago, while 38% reported a fall. The resulting balance of -5% was the weakest since June 2010 (a balance of -5%) and disappointed retailers’ expectations. It continued the weakness seen in the June survey (-2%).

Yesterday’s industrial trends survey made from grim reading, as the CBI’s chief economist noted:

this slowdown is expected to persist into the third quarter. Consequently, manufacturers are now reappraising their business plans, with firms expecting to lower recruitment in the coming quarter and invest less in the year ahead. How far the slowdown will be borne out is yet unclear, but the combination of political and economic uncertainty is sapping confidence.

The economy doesn’t, on this limited evidence, seem to be bouncing back from sluggish growth in the second quarter.


Bouncing along the bottom of the ‘L’

Posted in Uncategorized by duncanseconomicblog on July 27, 2011

The economy is stuck -we’ve had nine months of near stagnation and the prospects for the next two years look grim.

In many ways we now seem to be bouncing along on at the bottom of the ‘L’.

Even excluding ‘temporary factors’ (warm weather, cold weather, tsunamis and royal nuptials) the economy only managed 0.7% growth in the past nine months – a pathetic recovery. As the NIESR have noted this is an historically weak recovery – the only real precedent being the 1930s.

The causes are varied – an over indebted consumer sector who are experiencing falling real wages, falling disposable income and lack confidence. Companies which are cash rich but reluctant to invest, banks which simply aren’t lending to productive businesses, weak export prospects with our major trading partners dealing with their own crisis.

The real austerity hasn’t yet been felt economically – sure the VAT rise has sucked some demand out of the economy and contributed to falling real wages and Osborne’s doom and gloom talk has depressed confidence, but the real impact in terms of public spending cuts is just being.

The regional picture looks even worse with what little growth there is concentrated inLondon and the South East.

So far the government has managed to stop the recovery dead in its tracks but made little impact on the deficit.

‘Expansionary fiscal contraction’ seems to be more contractionary than expansionary.

We can argue about the multipliers of government spending and how effective a second stimulus might or might not be, but what seems clear to me is that cuts in government spending will subtract from growth. Policy makers may or may not be able to spend their way out of recession – but they certainly can’t cut their way out of one.

The right has come out with its preferred growth agenda – dismissed in detail by the TUC’s Nicola Smith here – and it contains few surprises. Attacks on the minimum wage, the welfare system and calls for cuts in red tape and corporation tax – this isn’t their growth agenda, this is simply a repetition of their own long standing prejudices.

The core issues are how we get the corporate surplus down, the banks lending (to the right sort of business), investment increased and demand restored. Get this right and the deficit will start to come down.

Ed Balls proposals for a temporary VAT cut and small investment led stimulus funded by a bonus tax has much merit but isn’t enough to deal with the serious issues we face. I’m less convinced by Cable’s calls for more QE (without radical reform) and don’t see the logic at all of Osborne’s reported desire to cut the 50p rate.

As I’ve argued before, what we need now is a ruthless focus on wages, employment and investment.

GDP growth & the missed OBR forecasts

Posted in Uncategorized by duncanseconomicblog on July 26, 2011

The chart below shows the OBR forecasts for the last four quarters of growth as they were in June last year before Osborne’s emergency budget, in June last year post that budget, in November last year and (the most up to date) forecasts from March. It also shows the actual outturn.

As can be seen the economy is 1.3% smaller today than the OBR thought it would be before Osborne’s first budget and 1% smaller than it thought afterwards.

It’s 0.4% smaller than the OBR estimated it would as recently as March.

The OBR forecast for the year of 1.7% now looks to be about as accurate as its previous estimates.

(More from me on Labourlist)

Vince Cable: Both right and wrong

Posted in Uncategorized by duncanseconomicblog on July 25, 2011

In less than 24 hours we’ll know what the first estimate of GDP growth in the second quarter of 2011 is.

It looks set to be a poor number – showing either very weak growth or even an outright contraction.

To judge from the government’s reaction – they are worried. Whilst Osborne is once again talking of tax cuts – this time the 50p rate, Vince Cable has broken cover and plainly stated that demand is weak and that:

Clearly we haven’t got a strong recovery – that’s abundantly clear.

This has been ‘abundantly’ clear for some time.

But perhaps more worrying than Cable’s admission is the fact he doesn’t seem to grasp how Osborne’s fiscal targets work. Later in his FT interview :

he stresses the “flexibility” of the fiscal plan, which targets the underlying structural deficit. This means the chancellor does not have to cut even deeper – or raise taxes – if economic growth is more sluggish than expected and the deficit is falling less quickly than planned, he says.

Well – yes and no. Yes Osborne does target the structural deficit so in the event of a new downturn the automatic stabilisers (of more welfare spending and less tax revenues) could operate. But Osborne set himself a dual mandate.

As well as the target of eliminating the structural deficit by the end of the Parliament he is also targeting that debt should be falling (as a percentage of GDP) by 2015-16. As he reaffirmed in the Budget statement in March:

Our fiscal mandate is to achieve a cyclically-adjusted current balance by the end of the rolling five year forecast period – which is currently 2015-16.

We have supplemented that with a fixed target for debt: so that debt should be falling as a proportion of GDP by the year 2015-16 as well.

The latest (and now out of date) OBR forecasts show debt/GDP peaking at 70.9% in 2013/14 and falling to 70.5% in 2014/15 and 69.1% in 2015/16. In other words Osborne (on the OBR numbers) will hit his second fiscal target a year early but with very little room for error.

The OBR’s forecast of 1.7% growth in 2011 now looks like a potential error. It’s 2012 forecast of 2.5% is above the independent consensus of 2.1% for that year.

If growth misses the OBR forecast in both 2011 and 2012 then the second half of Osborne’s mandate would be under threat – he would have to either abandon it or push through more spending cuts and tax rises.

Vince Cable may well be right on his central point – that the recovery is very weak – but wrong on his more reassuring point that Osborne’s plans have the flexibility to deal with this.

The Poor UK Outlook

Posted in Uncategorized by duncanseconomicblog on July 21, 2011

Ahead of Q2 GDPnext Tuesday I have a post on False Economy, noting how our economic prospects are worsening.

This echoes the important points made yesterday by Chris Dillow.

But it’s not just me and Chris noting this – yesterday’s Bank of England minutes were filled with gloom.

Whilst much attention has been focussed on the cuts in government spending, and the prospects for Osborne’s preferred drivers (investment and exports), the Bank notes the problems facing the consumer and crucial importance of the savings ratio. A point I have made in the past.

As the MPC say:

The outlook for activity in the medium term would depend in part upon the prospects for consumption and its major determinants. The level of consumption over the past year had been significantly weaker than the Committee had previously expected. Over the same period, households’ real post-tax disposable incomes had fallen by more – reflecting the impact of increased VAT, and higher energy and other commodity prices – and the household saving rate had declined by about 1.5 percentage points. It was possible that households adjusted their spending patterns only gradually, suggesting that the past decline in real incomes could continue to weigh on consumption growth for some time to come and that the saving rate would tend to rise. Alternatively, it was possible that households had already largely adjusted their spending in response to the past shock to their income, in which case there would be less upwards pressure on the saving rate in the future.


And we also now have the latest update from the Treasury of the views of independent forecasters – the chart below shows how the average 2011 growth forecast has changed over time.

It isn’t a pretty picture.

Forecasters now estimate growth in 2011 will be 1.3% and the trend is towards more downgrades.

Whilst attention is rightly on the potential calamity in the Eurozone and the prospect of a partial US default – our own economy is weakening before the disaster hits.

A Political Interlude: Blue Labour

Posted in Uncategorized by duncanseconomicblog on July 20, 2011

A brief political interlude – usual (economic) service will be resumed tomorrow.

A few weeks back I spoke at Compass Conference on Blue Labour’s Political Economy. I spoke about productive capital, private sector & regional growth, corporate governance and the nature of globalisation and how New Labour dealt with this.

I didn’t speak about immigration.

Speaking alongside me was Maurice Glasman and whilst he made the left wing case against immigration (it’s be often operated as a de facto incomes policy for working people – a point made by Ed Miliband amongst others), the whole question of immigration was in no way central to the debate.

I disagree with Maurice’s comments in the Telegraph this week. I think zero (or close to it) net migration makes little to no economic sense. Britain (and London in particular) needs immigrants to function.

But that doesn’t mean New Labour got immigration right. Even if the overall impact of migration on wages was muted – the regional and sectoral impact may have been much higher.  Whilst I think Maurice is wrong on the specifics – I don’t think calling his views ‘toxic’ is especially helpful.

As Sunder Katwala argues excluding people from the debate, as opposed to just disagreeing, helps no one.

As Marc Stears’ two contributions today demonstrate Blue Labour is about more than just Maurice Glasman. But Maurice Glasman (who has actually retracted the remarks (see bottom of the post)) still has a great deal to offer Labour. Let’s allow him this mistake and move on.

Europe needs a Eurobond

Posted in Uncategorized by duncanseconomicblog on July 20, 2011

The outlook ahead of Thursday’s crucial Eurozone summit is bleak. The policy makers seem set to only talk about Greece and ignore the Spanish and Italian elephants in the room.

I first set out my three step Eurozone crisis resolution plan in November last year.

Broadly put – I suggested:

(i)                  Conduct genuine stress tests of all Eurozone banks (including their ability to withstand a partial default by periphery countries)

(ii)                Recapitalise those banks that fail

(iii)               Allow a partial default inGreece,Portugal,Ireland– both writing down the principle and modifying the interest rate on outstanding debt.

Throughout this process huge liquidity support would be needed from the ECB to keep periphery banks functioning.

Whilst I welcome today’s call from several leading European economists to use the EFSF to recapitalise banks, I think we may now beyond this point.

I recently set out why all the conventional resolutions (inflate, deflate, devalue or default) to the Eurozone problems where either unavailable or unattractive.

The Eurozone now has a simple choice – break up (and it will be messy) or move to a common European bond – i.e. work to ultimately pool all the different Eurozone sovereign debts into one asset class.

If taken as a bloc then Eurozone government debt to GDP is around 80% – high but very manageable.  

I see no reason why the spread over US treasuries would be especially high, to me it seems perfectly reasonable to envisage a common 10yr Eurobond trading around  3.5-4.0% – higher than current French & German yields but vastly preferable to the 6.0%+ the Spain & Italy are now facing and well below the 16%+ that the market is offering Greece.

Two and a half years ago I suggested that a Eurobond was one possible solution to the problem. It now seems the only workable solution – as George Irwin argues at CiF.

Some say that defaults will not be the end of the Eurozone. The analogy is sometimes made with the USA which has a common currency but state governments which are perfectly able to default without endangering that currency.

I think these analogies falls down when one looks in detail at the European banking system. Despite the existence of major international players, the banking markets are still mainly ‘national’.

If, say, Delaware defaults that doesn’t risk collapsing most of the banks in Delaware in the way a Greek default does in Greece.

And, as we learned in 2008, the banking system is incredibly inter-connected – if Greek banks fail, this hits French and German banks – which in turn hits UK banks.

Be under no illusions – a common bond means a huge step towards further political unification for the Eurozone. EU oversight over government spending and deficits would have to become much stricter.

The German public fear a ‘fiscal transfer union’ – perhaps forgetting that for much of the decade 1995-2005 the transfers would have flowed from the then booming South to a struggling Germany. That said, it should be noted that former Social Democrat Finance Minister Peer Steinbruck favours Eurobonds. But higher interest rates on a common Eurobond and some fiscal transfers might well be a good deal cheaper than a messy break-up with bank failures and rapidly depreciating Southern currencies threatening German export markets.

This is all a fiendishly difficult political sell for German (and Austrian, Dutch and Finnish) politicians. For this reason it will probably not happen, but it seems the best way out.

RBS may require £4.5bn of extra capital

Posted in Uncategorized by duncanseconomicblog on July 20, 2011

Yesterday was a news heavy day in a heavy news week. Whilst the political media is concentrating on the ongoing hacking fallout, the financial media is focussed on the Eurozone. All of this means some potentially significant UK politico-economic news risks being buried.

As both Bloomberg and Director of Finance magazine have reported, following the stress tests RBS may require additional capital:

Royal Bank of Scotland Group plc needs to find an extra £4.5bn in capital reserves say analysts at Morgan Stanley

The crucial factor, and what transforms a financial story into a potentially political one, is that I can’t envisage much private sector appetitive for providing this capital – especially given the coming ICB report (which is likely, even if weak, to reduce future profitability at UK banks).

So if RBS requires more capital it’ll probably have to come from the largest existing shareholder – i.e. the UK government.

Whilst this capital is required, and a failure of RBS would be catastrophic for the UK economy, I bet George Osborne isn’t relishing the headlines that advancing another £4.5 billion to the bank will generate at a time of public sector cuts.

Euro Crisis – Getting Worse

Posted in Uncategorized by duncanseconomicblog on July 18, 2011

I might be premature (always the risk when commenting on markets) but…

It looks to me like the Eurozone Bank Stress tests have utterly failed.

They are only two reasons for doing these tests – either the aim is to genuinely test if the banks are healthy enough to take possible losses and identify which banks require more capital OR the aim is simply to reassure the markets that the banks are fine.

The second type of tests can work – the US stress tests of 2009 served this purpose, even though the ‘worst case’ they tested tended to be better than the actual out turn in economic data.

It looks like this is what the Europeans were trying to achieve with these latest tests – not testing for even a Greek default (let alone Portugal, Ireland, Spain, Italy) is simply incredible.

The market reaction today suggests that the markets have not been reassured.

I’ve long favoured proper stress tests and recapitalisation of the at-risk-banks before a managed default of debt by heavily indebted governments.

That now seems unlikely – the Eurozone authorities are divided and seem unable to agree to anything until the very point of crisis.

Kicking the can down the road is fine for a while, especially if the time bought is used to recapitalise banks and prepare for the inevitable. However the time bought is not being well spent and the authorities are rapidly running out of road to kick the can down.

This won’t end well.

Osborne’s Corporation Tax Failure

Posted in Uncategorized by duncanseconomicblog on July 12, 2011

Amid the ongoing News International fallout and the developing Eurocrisis, yesterday’s FT carried quite an important story on the likely failure of a key component of the government’s growth strategy.

Osborne has made boosting investment a core pillar of his economic strategy – something I entirely agree with. I have written at length on the need to boost business investment and also on the problem of the corporate surplus.

The problem is that Osborne’s preferred strategy is simply to cut corporation tax and hope for the best. Something I feel is unlikely to work. Especially when it has been largely funded by slashing investment allowances.

Significantly the OBR appears to agree, writing that the most recent cut will have a ‘minimal impact’.

Yesterday’s FT reported on some new analysis by the Centre for Business Taxation at Oxford’s Said Business School. The story – entitled ‘Osborne corporate tax plan will fail’  – is well worth a read. As it notes:

The researchers said that the main problem for the UK was that allowances for capital expenditure were the lowest in the G20. Few countries had pursued the policy of cutting allowances to recover revenue losses caused by lowering the tax rate as aggressively asBritain, it said. So while theUKhad the fifth lowest tax rate in the G20, the rate was applied to a broad definition of profit, implying that the effective tax rate was much higher.

As the report itself says:

Reforms which reduce allowances as a way of paying for rate reductions mainly redistribute the tax burden between companies, rather than making the tax system as a whole more competitive.

This was a point repeatedly made by the manufacturing trade body, the EEF, in 2010.

Cutting corporation taxes but reducing investment allowances isn’t a tax cut for business – it’s a transfer from businesses that invest heavily (i.e. manufacturers) to those who don’t (i.e. financials/banks).

As such it is likely to be ineffective as a growth plan as it totally at odds with the talk of an investment led recovery and rebalancing.

A proper, business friendly growth plan, would focus on increasing investment allowances  rather than going for headline grabbing moves like cutting corporation tax whilst hammering productive businesses in the small print.