1. UK’s commitment to eliminating its deficit remains credible. However, the growth figures that the initial deficit reduction plan was based on now look overly optimistic, which means that cutting the deficit will almost certainly require additional cuts to current expenditure before the next election. But so long as the government commits itself to eliminating the deficit by reducing expenditure – and not threatening growth by raising taxes – we should be able to avoid a Euro-style meltdown.
2. Spending on infrastructure is an accountancy trick. It might boost GDP numbers, but it won’t do much for the real economy – in fact, it might make things worse. A recession is a period where investors reallocate their capital and people reskill to produce things that consumers want to buy. Infrastructure spending delays this, by creating unsustainable demand for skills that the private sector doesn't want. That might make the economy appear to be improving in the short term, but in the long term it gives mixed signals about where people should reskill and move, and makes sustainable recovery even tougher to achieve.
3. The lack of pro-growth tax cuts is worrying. If the last year has proved anything, it is that economic growth won’t come from nowhere. Entrepreneurs are paralysed by employment and business regulation, with high taxes making retirement a more attractive option than reinvestment for many successful businesspeople, and credit markets are reluctant to lend in such a sclerotic business environment. If the Chancellor wants to make the Eurozone crisis into an opportunity for Britain, he should be trying to make Britain the best place in Europe to do business. That means cutting taxes and regulation across the board.
4. Credit easing is a deeply misguided policy that utterly ignores the lessons of the last decade. Packaging together small business borrowing into a government-backed security gives a false illusion of safety to investors. If and when some of those businesses start to fail en masse, bonds that looked completely safe are revealed to be worthless, creating financial havoc. It’s a re-run of the US subprime mortgage policies that led to the 2008 financial crisis. All credit easing does is set us up for another crash in a few years time.
Dr Madsen Pirie, President of the Adam Smith Institute, adds:
“It is good that 'Plan A' to cut the deficit is now 'Plan A-star,' stressing the importance of growth as well. The measures are small beer compared to the things that could really lead to growth. We must be careful not to tread in Gordon Brown's footsteps, trumpeting small-scale schemes by loud announcements.
What is needed is for government to be serious about removing the obstacles to growth posed by high taxation and over-regulation. Small businesses, which provide two-thirds of all new jobs, want to hear that their tax burdens will fall, and that they will be freed from many of the regulations designed for large firms.”
I rejoice in UK Business Secretary Vince Cable's ability to believe in two contradictory things at the same time. One is that the banks should strengthen themselves by putting more money into reserves. The other is that they should lend more to small businesses in order to kick-start economic recovery. The logical problem, of course, is that money which the banks keep in their vaults isn't then available to lend out to businesses – or anyone for that matter.
In his Autumn Statement (or soon after), Chancellor George Osborne is expected to resolve this dilemma by providing government guarantees on loans that the banks make to certain businesses. It parallels his announcement last week that the government would provide guarantees on loans made to first-time house buyers.
Guarantees are cheap. You don't have to shell out the money unless things go wrong. That doesn't stop them being immoral and counterproductive. With the government guaranteeing 95% mortgages, and with interest rates so low, I wonder how many people will be seduced into taking out home loans which – when interest rates rise – they won't be able to afford. Encouraging such sub-prime mortgages is surely immoral. And taxpayers bailing out banks when such loans go wrong…well, haven't we been here before?
The business loan guarantees being planned by George Osborne pose the same moral hazard. And they are bad for business, too. Sure, credit is tight. Curiously, that might be because interest rates are too low, not too high. Why would anyone lend money when the interest they earn doesn't even keep pace with our 5.2% RPI inflation rate? Inasmuch as the new guarantee scheme encourages businesses to borrow – which might be marginal, given the gloom that infects nearly all businesses right now – it will encourage people to make more bad investments. It's surprising, but business failures are lower at the moment than they have been in decades: it's simply cheap credit that is propping them up.
Some time, businesses have to grit their teeth and write off all the over-optimistic investments they made during the Brown Bogus Boom years. Then perhaps their investment cash can be put into things that have a better prospect of returning a profit. Painful, but better than living in a fantasy world underwritten by taxpayers. But giving them cheap credit, and more of it, just prolongs the the illusion, and the slow agony.
What’s more satisfying than bashing bankers to help pensioners? There is something to the Occupy movement’s outrage at the rewards enjoyed by the banking industry but the hue and cry for higher bonus and income taxes and a financial transactions tax misses the point.
The ASI has already explained why a financial transaction tax, aka Robin Hood or Tobin tax, is simply wrong and we won’t go over the details. Suffice to say that bankers are too smart to actually pay it. They’ll either move elsewhere or pass on the tax (like any other corporate tax) to their customers, ie. pensioners and other savers.
A more promising route for dealing with seemingly high-flying bankers is to figure out why they make so much money in the first place, not how to tax it after they’ve made it.
Step forward, David Norman, chief executive of TCF Investment. In an open letter to Prime Minister Cameron, Mr Norman calls for “an urgent and holistic review of the UK retail fund sector.” His literal bottom line is that the retail fund industry is ripping off savers through a complex and opaque system of fees and hidden charges.
Mr Norman is continuing a crusade whose beliefs were spelled out in a paper published over a year ago. It detailed all the charges borne by saversfrom the upfront Annual Management Charge down through admin fees, FSA fees, stamp duty and trading costs, to name just some. He has calculated that an average UK stock market fund investment of £100,000 over 20 years at 7% a year will generate £227,695. Of this total, though, £159,272 goes on all the various charges, not to the saver. (A Robin Hood tax would simply be another component in this overall bill.)
Now, Mr Norman’s figures may be extreme and he has been challenged on many of them by Mark Dampier, head of research at Hargreaves Lansdown. Of course, the two would differ: TCF markets itself as a low-cost investment provider while Hargreaves Lansdown is introducing a new monthly fee on index tracker funds.
All of this is way beyond the comprehension of most so Mr Norman has a solution: “The publication and wide communication of sound research into the total cost impacts on funds would empower self-motivated consumers and act as a standard to hold adviser recommendations to account. It should be an imperative for FSA to publish tables of Total Costs of Ownership (TCO) for all funds sold in the UK.”
For free and open market types like us, a thorough review of the sector may be a good idea as long it does lead to price transparency to foster competitive markets - the only sure route to the best quality at the lowest possible price. The risk is the unintended consequences of letting politicians start poking about. For the government, it really doesn’t require much except a bit of “nudge” work. But will they be able to stop there?
In the meantime, can we persuade the Occupy movement to swap their logo from “I am the 99%” to “I am the TCO”?
Or praising democracy anywhere in fact. An interesting but not surprising finding from Africa:
Africa is poor and its urban population and industrial centers are small, while its rural population and agrarian sectors are large. In the absence of party competition… we should therefore expect economic interests to seek to influence public policies through lobbying by interest groups. Insofar as this is the case, we expect economic policies to be “urban biased.” But when there is a change to party competition… electoral majorities acquire political weight and those seeking office will therefore begin to advocate measures designed to attract rural voters. They should therefore begin to support policies that favor agriculture.
Any ruler must favour the interests of those that keep him in power. A military dictator has to take good care of the Army and everyone, even Roman Emperors, is afraid of the urban mob. And what we saw in Africa after independence was that the urban masses, although only a small fraction of the country, were those who had the political power. Ghana's insanely over valued currency for example, which killed off the cocoa plantations in favour of cheap manufactured imports for the urbanites. And as that first flirtation with democracy faded then things only got worse.
But when the majority of the population is rural, engaged in farming, it's only right that economic policy should be determined by the needs and desires of that majority. Which, with the return of democracy, is what we're seeing happen.
And there's a lesson for us oh so moderns here too. Allowing power, decision making, to float off into the technocracy (at any level, UN, EU or just Whitehall) is going to cause exactly the same problems. As the power base, the support, will come from technocrats to technocrats policy will be decided with the aims and desires of technocrats in mind, not with our.
Which is really why we don't want political power to accumulate in the centre but to keep it close, by us. Doesn't matter which centre, if it gets there it will be deployed to benefit the centre whereas if we have it then we get to exercise it for ourselves.
Oh, dear. A few days ago, worried about flatlining or falling house prices – always bad for politicians – the UK government announced a whizzo new scheme to underwrite 95% mortgages. We warned that this was encouraging just the sort of over-borrowing that got us into this mess in the first place.
Now the Centre for Economic and Business Research predicts that house prices will rise by 15% over the next five years, with the average three-bedroom semi-detached going up over £25,000 to £202,000. But that's nothing to do with the government's latest price-boosting mortgage initiative. No, it is simply because of a shortage of property on the market (planning controls), rising demand (immigration, demographics) and the fact that the banks are starting to lend again thanks to all that money the Bank of England has injected into them by way of Quantitative Easing. And the buy-to-let sector will boost the market too, as worried savers look for hard assets to put their money into.
So – if that is right – the net effect of the government's mortgage-guarantee plan will be to boost a market that is already about to rise. Rather than preventing prices (and the government's electoral prospects) from falling, it will add further to price increases.
The government should read its Milton Friedman. The Nobel economist researched the effects of 'stimulus' packages as a supposed way of smoothing out economic cycles, and concluded that they did more harm than good. By the time government realise business is declining, work out what to do, pass the legislation, and wait for it to have its effect, the trough is usually over and the policy ends up reinforcing the cycles. Today's house-price situation looks much the same: reinforcing the boom, which will mean we will suffer even more painful adjustment in the long term.