It's not possible to say what will happen after Brexit

We're rather encouraged by this little report into the effects of Britain leaving (or not) the European Union:

British companies could be forced to put up prices to the consumer or even be forced out of business by a ‘Brexit’ from the European Union, according to a report by Oxford academics.

No, not that bit, this bit:

It added that the overall economic impact of Brexit through changes to the country’s immigration policies were “not possible” to predict with certainty ahead of the referendum. The report said “confident predictions about the economic effects of migration after Brexit should be treated with caution”.

Some of us here have very strong views indeed about this Brexit process but we'll not inflict them upon you here. However, that point strikes us as being exactly correct. For it is impossible to state with any certainty what the economic effects of Brexit would be.

For what those effects would be, will be, depend upon the economic policies that are adopted once free of the shackles of Brussels*. If Britain adopts unilateral free trade then, as Patrick Minford has pointed out, the economy will grow. If immigration of low wage workers is curtailed then businesses which employ low wage workers will have a hard time of it, indigenous workers will start to see higher wages. What happens after Brexit depends upon the policies adopted after it, not on the leaving itself.

Thus all reports predicting either disaster or nirvana from the leaving itself should be regarded with the utmost suspicion.

*It could be that you could divine the views of one of us on this subject.

Five questions for scaremongers

Let’s be real. No-one knows what the economic effect of Brexit will be. Anyone who says they do is either kidding themselves or trying to kid you. But we do owe it to ourselves to make intelligent estimates and to set out our assumptions for scrutiny. So here goes. To start with, we break down the UK economy into sectors, using government definitions. No controversy there. Next, we make a couple of estimates.

First, an estimate of the shock for each sector of leaving the EU. This is a big part of what no one knows. This leads us to capture the vulnerability of each sector with the most punishing figures from the record: the collapse in output after the global financial meltdown of 2008 which was worse than any since WW2.

Second, an estimate of the recovery for each sector after five years. Once again we start with the post 2008 recovery after the financial meltdown. This provides a sense of the inherent resilience of each sector. And here is a good place to argue with us: we also include a small factor to reflect the policy response of government and the benefits which experts in international trade have observed from less restrictive trading arrangements. In fact we take only half of the benefit the experts have observed, erring on the side of caution.

Goods

The pie chart shows that the UK’s output of goods is made up of five more-or-less similar-sized elements: the most important ones are finished manufactures, oil and food. Basic materials are not as much in international trade as once they were; and “other” consists of the small sectors of semi-manufactures together with spares & repairs. Our figures are for 2013, but little has changed since.

Chart 1. UK goods

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Source: ONS (2013)

Charts two to five below show the position, sector-by-sector, starting with trend growth from over the ten years from 2002 to 2011, that is including the financial crisis. Our estimates for these sectors, together with our estimates for the goods sector as a whole, show an hit from Brexit after one year (save for food etc, whose complement of entrepreneurs make it particularly resilient), with all recovering by the end of five years.

Charts 2 to 5. Outlook for selected UK goods sectors after Brexit

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Sources: Authors, ONS (2013), Andriamendjara et al (2013), Berden et al (2007), Erixon and Bauer (2010), Helble et al (2007) and Petri, Plummer and Zhai (2011).

Services

Our pie chart for UK services is simplified by drawing like sectors together. We’ve followed Douglas McWilliams’ recent coinage, the “flat white economy”, bringing together professional services, culture/recreation, communications and technology services. Finance, insurance and real estate are self-explanatory. T&T is transportation and travel. The sectors not involved in international trade are utilities, distribution, healthcare, education and public administration.

Chart 6. UK services

Screen Shot 2016-03-10 at 15.39.50

Source: ONS (2013)

Our estimates for the traded sectors - together with our estimates for the services sector as a whole - show smaller initial hits from Brexit (in the case of finance etc, none at all), with all making excellent progress after five years.

Charts 7 to 10. Outlook for selected UK services sectors after Brexit

Screen Shot 2016-03-10 at 16.01.05

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Sources: As charts 2 to 5.

Boris Johnson spoke of charts like these as “Nike ticks” and putting this all together we get the “Nike tick” for the economy as a whole.

Growth stays positive throughout, despite falling in the first year. The premium after five years should be seen as a spike on the benefits of deregulation and new markets.

Chart 11. Outlook for UK GDP after Brexit

Screen Shot 2016-03-10 at 16.05.05

Sources: As charts 2 to 5

Conclusion

Is it wrong to find these estimates encouraging? We make no apology for doing so, while fully admitting that ultimately all such estimates can only be a quantitative and graphical expression of assumptions. So are they dead right? Of course not. Are they a misleading basis for discussion? We don’t think so. Scaremongers who wish to dismiss them from consideration need to answer five questions:

• Why would the shock of Brexit be worse than the shock of the financial crisis?
• Why would UK firms be less resilient in bouncing back after Brexit than they have been since the 2008 turmoil?
• Take a look at our companion paper “Five questions for stayers”; why wouldn’t the UK and its trading partners benefit from relief from what the WTO shows as the world’s most complicated tariff regime, what the World Bank reports as a system of nontariff barriers second only to Russia, and priorities which put trade with the rest of the world at the back of the queue?
• Why would the UK government sit on its hands for five years after Brexit rather than develop new trading relations?
• Why would the benefit of those relations be less than the figures we are using, one half of the benefits from less restrictive trading environments attested by experts in the field?

To our way of thinking, our figures illustrate that the scare stories about Brexit are just that - scare stories. Do they prove it? No more and no less than the scare stories themselves!

The ASI's 2016 Budget Wishlist

Ahead of the Budget next week, here are the key reforms and tax cuts we hope to see the Chancellor announce: Scrap stamp duty on shares to boost investment

Stamp duty on shares may be one of the most harmful taxes we have despite raising relatively little money (£2.9bn in 2014-15). By making it costly for people to sell their shares, stamp duty interferes with price signals and raises the costs of investing overall. That hurts both savers and businesses’ access to investment financing. Scrapping it would be a cheap way of making stock markets direct money where it will be used best, give a boost to businesses in need of investment – and cement the City’s status as the world’s financial capital.

Pensions tax relief should be left alone

Abolishing the upper rate of pensions tax relief sounds like an easy way to save money, but it would be a huge mistake. Upper rate relief exists to help people smooth their incomes if they will only be in the upper tax bracket for a small part of their lives. Because people are taxed on pension withdrawals, abolishing upper rate relief would introduce double taxation to the system: people in the upper tax rate would be taxed for putting money in to a pension and again when they take money out of it. This would discourage some people from saving for their retirement and unfairly penalize the ones that do.

Alcohol duties should be merged into a simple alcohol tax

The alcohol duty system is amazingly complicated and confused, with entirely different rates per unit of alcohol for wine, beer, spirits, cider and sparkling wine, and strange kinks in the system that, for example, favour strong wines and ciders over weaker ones. This whole system should be replaced with a simple, flat per-unit tax on alcohol (as currently applies to spirits). That would stop the preferential treatment for selected drinks, like cider, and end the preferential treatment for stronger drinks. It might also make life a bit easier for Britain’s growing craft alcohol industry.

Phase out Housing Benefit altogether

Housing benefit should be phased out and eventually scrapped. In a property market where supply is tightly constrained, increases in housing benefit go mainly into higher rents. The empirical evidence suggests that about 70p of every £1 of the £26bn system goes into the pockets of landlords in the form of higher rents. Much of this benefit comes from renters who don’t even get the benefit, who are competed out. What’s more, the system encourages people with less means to move to the most expensive areas, since the level of payment is tied to prevailing rents, which means that the bill is artificially inflated. The government should use the money to supplement low incomes, by raising the employee NIC threshold and making the Universal Credit withdrawal rate less steep, so work pays more for UC recipients.

Stop business rates from taxing capital

Because business rates tax property values, they effectively tax both the land a property is built on, and the value of the bricks, mortar and some machinery on top of that land. Taxing land values is a relatively good way of raising revenue, because it does not discourage production. But taxing property discourages construction, improvements and investments in new machinery. The government should not exempt new machinery from business rates, as it is rumoured to be considering. This would add even more complexity to the system and increase compliance costs. And why should machinery, but not other improvements such as redecoration or refitting, be exempt? Instead, it should reform business rates so that they are based only on the unimproved value of the land the property sits on – and there is no reason not to improve the property itself.

As we've been telling you about house prices

As we've been telling you for some time now a goodly portion of the house price problem in Britain is because of the insanities of our housing planning system. As the Royal Economic Society is now pointing out:

House prices in the South East of England would have been roughly 25% lower in 2008 and perhaps 30% lower in 2015 if the region had planning regulations of similar restrictiveness as the North East of England.

This really is what we have been telling you:

Today housing space in England – particularly in London and the South East but also in other urban centres and large pockets of rural England – is among the most expensive and unaffordable in the world. Hilber and Vermeulen’s study shows that this is in large part due to supply constraints imposed by the planning system.

According to the research, the problem is clearly that there is too little supply given the strong demand for housing in parts of the country. But why? The study explores three possible types of supply constraints:

• The first type is regulatory and dates back to the Town and Country Planning Act of 1947. The UK planning system since 1947 is extraordinarily rigid by world standards. Urban containment through ‘green belts’, strict controls on height, lack of fiscal incentives at the local level to develop and ‘not in my backyard’ (NIMBY) behaviour facilitated by the planning regime all make it very difficult to build new homes.

• The second type is physical. Local scarcity of brownfield or greenfield land makes residential development in desirable locations very costly.

• The third type is uneven topography. It is very difficult to build new homes in places with steep slopes.

So which of the three types is most important in the case of England? The researchers use data from over 350 local authorities from 1974 to 2008 to explore this question. Their findings strongly suggest that regulatory constraints are the main culprit.

As we have indeed been saying.

So, abolish the Town and Country Planning acts and return us to the 1930s, the last time the private sector kept up with housing demand. The point being that markets really do work and regulation of them often does not.

The Wealth of Nations, 240 years on

On this day in 1776, exactly 240 years ago, the Scottish philosopher Adam Smith finally published his best-known work, An Inquiry Into The Nature And Causes Of The Wealth Of Nations – the book which Smith himself called his Inquiry but which is known to us today as The Wealth of Nations. It was fifteen years in the making. So long, indeed, that Smith’s friends eventually ganged up on him and urged him to finish it before someone else did the job for him. The final chapters (gleefully cited by Owen Jones in his talk to the Adam Smith Institute’s Next Generation Group last night) in which Smith talks about the need for governments to subsidise education and other services, show every sign of being rushed and given less of the lengthy consideration that he gave to earlier chapters.

Perhaps too much consideration, in fact. “It is a clumsy, sprawling, elephantine book,” wrote Leo Rosten; and he is not wrong. One “digression” alone, on the price of silver, takes up 70 pages, fully a tenth of the whole work. Smith seems to have found a place in it for every stray fact that came into his capacious mind – from the diamond mines of Golconda through the fisheries of Holland to the market for Irish prostitutes in London. As if that were not exhausting enough, even native English speakers have difficulty with the studiously elegant, but now very dated language; to others, it is unreadable, or nearly so.

It is for these reasons that I wrote The Condensed Wealth Of Nations. But that is not to downplay Smith's magnum opus. It is in every sense a great book. Some modern critics say that much of The Wealth of Nations was not original. But Smith’s achievement was to take the disparate ideas and facts in circulation at the time and weave them into a coherent intellectual system – indeed a new science, of economics. Overcrowded with facts it may be, and yet (as Joseph Schumeter remarked) it “lights up the mosaic of detail, heating the facts until they glow,” making it (says Rosten) "one of the towering achievements of the human mind: a masterwork of observation and analysis, or ingenious correlations, inspired theorising, and the most persistent and powerful cerebration.”

Yet Smith did not see his Inquiry as a mere textbook. It was a polemic against the suffocating regulations on trade and commerce in his time. Monarchs granted their friends monopolies, even in essential goods. The guilds restricted entry to every profession – and kept up prices. Exports were subsidised and imports were restricted because it was thought that the wealth of a nation was the amount of gold and silver it could get into, and keep, in its vaults. But Smith, audaciously, pointed out that both sides benefit from a voluntary exchange: they would not bother if they didn’t. Buyers may end up with less money, but they get, in return, goods or services they value more. Any restriction on trade necessarily reduces the value that such free exchange generates for both sides.

The Wealth Of Nations was hugely influential; the leading politicians on both sides of the Atlantic all read it, and took its advice. Taxes and tariffs were cut, monopolies and restrictions abolished, and the world enjoyed a century of free trade, enterprise, innovation, growth, and improvement. Too often today, we forget Smith’s advice; but it remains there to guide us. It is a book that has profoundly shaped our world.

Finally, even the TUC gets with the program

We've been arguing for a near a decade around here that the UK does not in fact have a gender pay gap. Rather, we've a motherhood, or perhaps a parent, pay gap. In line with Madsen's idea of our function when we started saying it people were shocked at our stupidity. It's now becoming the conventional wisdom, so much so that even the TUC appears to be getting up to speed on it:

Women who become mothers before the age of 33 earn 15% less than similar women who haven’t had children, according to new analysis published by the TUC on International Women’s Day today (Tuesday). The pay penalty for younger mums comes about as they are more likely to have had a significant period out of work or working part-time, before returning to full-time work when their children are older.

Yes, very much what we've been saying. And there's other research which shows that earnings decline for women (on average of course) by 9% or so per child they bear. Other research published for this special day:

A separate study by The Fawcett Society said the motherhood penalty still existed in the UK because mothers were judged to be less committed to their work. Its survey of 8,000 people found almost half believed women were less committed to jobs after having a baby, compared to just 11 per cent for men. Chief executive Sam Smethers said: 'It is clear that when a woman has a baby she is overwhelmingly perceived as becoming less committed to her job, while a dad is much more likely to be seen as more committed. 'This drives inequality and forces women and men into traditional male breadwinner, female carer roles.'

We agree with the evidence there but not with the logic. We're absolutely fine with the idea that anyone can adopt any gender role they desire. But it does remain that most parents do choose to adopt what we might call traditional gender roles concerning their children. Mothers as the primary carer, fathers as the primary provider. If it is people being forced into this then of course we're against it. If people are choosing this then we're just as happy as Larry: liberalism is about people being able to enact their own choices.

And the truth does seem to be that it is those choices made as parents which drive what some call the gender pay gap. After we account for age, education, time in the workforce and all that, mothers make, on average, less than non-mothers and fathers make more than non-fathers. It's in the 8-10% or so range either way. And given that the majority do become mothers, the majority fathers, that's around and about enough to explain that 10% or so gender pay gap that ONS and others report.

Again, if this is imposed upon people then we're agin' it. If it's emergent from peoples' free choices about how to live their lives then not only why would we object but why would anyone want to do anything about it?

Five questions for the “stay” campaign

The “stay” campaign is making much of the purported risks of leaving the EU. They seem reluctant to defend the EU on its merits, apparently taking the view that it’s a disagreeable necessity. Let’s explore this with five questions about risk. 1. Political risk

As a defender of the EU, do you deny that

• the EU is an inherently political project?
• its political capital and administrative energies have been focussed on continental unification?
• despite this, everyone acknowledges the EU’s longstanding “democratic deficit”, with multiple and confusing executive and judicial bodies which are not held to account?
• one, the ECB, has been at liberty to inflict a classic “bankers ramp”, penalising Greece as a creditor, without regard to the political reasons for its default, in which the EU itself is as much an offender as Greece itself?
• another, the ECJ, conceives of itself as an instrument of unification, leading to judgements which are arbitrary, intrusive and unpredictable.

In consequence, how happy are you about the risks which the EU poses to basic stability for itself and the UK?

2. Administrative or performance risk

How do you look away from the evidence that

• twenty one years of failed audits attest to the EU’s administrative dysfunction at the most basic level?
• the EU’s trade policy is hampered by its focus on the problems of the past, specifically tariffs on goods, rather than the future, that is services and nontariff barriers?
• the EU’s nontariff barriers give rise to harmonisation which is unnecessary and intrusive, with the World Bank describing its restrictions as second only to Russia?
• trade policy is also hampered by the EU’s emphasis on deepening its own internal market - in particular its headline currency policy - rather than opening it up to global commerce?
• this has diverted political capital and administrative resource from less dramatic but more effective measures, stalling its FTA programme, slowing growth in output and external trade, and adding nothing to the UK’s exports?
• the EU’s treatment of the free market in labour gives rise to uncontrolled migration and prevents national control over entitlement to welfare?
• the EU’s internal decision-making is so opaque as to give rise to the newly invented word of “comitology”?

How comfortable does this leave you when you think about the risks which the EU’s way of doing business poses to meeting its own objectives?

3. Economic risk

How can you shrug off concerns that

• the EU’s inherent corporatism has led to its “regulatory capture” by continental producer interests, especially manufacturing and agricultural interests, giving rise to intrusive harmonisation to the detriment of the UK?
• the EU has de facto given up on free markets in the matters most important to UK, capital and services?
• the EU’s passporting arrangements for banks risk contagion?
• the EU’s treatment of the free market in labour has given rise to intrusive regulation on employment conditions?
• the CAP has led to higher food prices and has restricted supply?
• the EU’s Internal decision-making (comitology) is barrier to the conduct of business?
• the UK has suffered from its loss of independent representation in international trade bodies?

How does this leave you as to the risks which the EU’s policies pose to economic welfare for itself and the UK?

4. Reputational risk

How easy do you find it to look away from the spectacle of

• a prolonged currency crisis threatening disruption among our neighbours?
• the EU’s treatment of migrants adding to chaos on its borders and doing nothing to ease turbulence in the Middle East?
• the EU’s tariff walls restricting supply of entry-level manufactures (eg, clothing) from emerging market suppliers?
• the CAP raising restricting agricultural supply from emerging market suppliers?
• the EU presiding over the highest level of nontariff measures among major traders but for Russia?
• the EU admitting to the world’s most complicated tariff regime?

What do your answers suggest as to the risks which the EU’s policies pose to its reputation in the global community, as well as the collateral damage to the UK’s reputation as a member?

5. Finally

Tell the truth, now: are you proud of the EU? do you admire what it’s made of itself? what it has achieved for this country? does its pattern of conduct and outcome sit well with your own standards and values? Or to revert to the formula to which stayers seem to be committed, what necessity justifies the nation’s continued commitment to a body showing such dysfunction?

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We should apologise for the “and another thing” character of these relentless questions. But the rhetoric does enable us to go beyond the commonplace that the “stayers” have given up defending the EU on the basis of its good intentions. We can now see that they are challenged to do so on the pragmatic basis that remaining makes for risk-avoidance.

What Should Be the Absolute Minimum Pass Standard in the Bank of England’s Headline Stress Test?

[For the previous blog posting in this series, see here.] Consider the following question: according to the Bank of England’s own guidance documentation, what should be the absolute minimum pass standard in its headline stress test, the test based on the ratio of Common Equity Tier 1 (CET1) to Risk-Weighted Assets (RWAs)?

The Bank of England used a 4.5% pass standard in the test, but I assert that it should have used a pass standard of at least 7% instead.

Why does this matter? Well, if you use 4.5% as the pass standard, the UK banking system performs fairly well under the stress test, but if you use 7% as the pass standard, it doesn’t. [See End Note 1]

This is a big deal because it undermines the Bank of England’s narrative that all is well with the UK banking system.

So what do the Bank’s own guidelines indicate that it should use as the absolute minimum pass standard?

We can break this question down as follows.

First, what is the relevant Bank of England guidance document?

Answer: the guidance document is the Bank’s October 2013 Discussion Paper “A framework for stress testing the UK banking system”.

Then there are two further questions. According to this guidance document:

1. What is the connection between the pass standard in the stress test and the minimum capital requirement(s) imposed on banks?
2. What exactly is/are these minimum capital requirement(s)?

On 1:

Page 28 of the Bank’s October 2013 Discussion Paper contains the following statement:

Interpreting these [stress test] results, and reaching a judgement about bank capital adequacy, requires a view on the level of capital that regulators want banks to maintain in the stress scenario. This is often referred to as the ‘hurdle rate’.

This ‘hurdle rate’ is the same as my ‘pass standard’. To continue:

Ultimately, this is a policy decision by the FPC [Financial Policy Committee] and the PRA [Prudential Regulation Authority] Board. But there are a number of considerations the FPC and the PRA Board might take into account in considering the level of capital banks should maintain in a stress.

A key consideration will the minimum level of capital required by internationally agreed standards. Banks need to maintain sufficient capital resources to be able to absorb losses in the stress scenario and remain above these minimum requirements.

My interpretation: leaving aside the judgmental override caveat in the second paragraph, the pass standard should be at least as high as the minimum capital requirements.

This takes us to the second question: what is/are the minimum capital requirement(s)?

The Discussion Paper continues further:

Minimum capital standards have been set internationally by the Basel Committee on Banking Supervision and transposed into European legislation under the Capital Requirements Regulation and Directive (CRD IV).

For example, under the PRA’s proposed implementation of CRD IV, the minimum Pillar I common equity Tier 1 capital requirement will be set at 4.5% from 1 January 2015 onwards.

If you didn’t read any further, you might conclude that the pass standard should be 4.5% because the Bank’s Discussion Paper claims that the minimum Pillar 1 CET1 requirement [note the singular] is 4.5%.

But this is to presuppose that there are no other CET1 minimum capital requirements and this is not so.

In fact, the 4.5% minimum is only one component of a set of CET1 minimum capital requirements [See End Note 2] [note the plural] and the overall minimum capital requirement is the sum of each of the components in this set.

The second component of this overall minimum capital requirement is explained in footnote 2 on the same page:

Consistent with the Basel III Capital Accord, CRD IV [also] requires banks to have at least a 2.5 percentage point buffer of capital [the Capital Conservation Buffer or CCB] above the 4.5% minimum.

Thus, the CCB is an additional minimum requirement on top of the 4.5% minimum capital requirement.  

Therefore, the overall minimum capital requirement is the sum of these two minimum capital requirements and 4.5% + 2.5% = 7%.

And since the pass standard in the stress test must be at least as high as the sum of these minimum capital requirements, i.e., the overall minimum capital requirement, the pass standard should also be at least as high as 7%.

QED.

The Bank’s position seems to be that they can ignore the CCB in setting the pass standard because the CCB is a different type of minimum requirement and because the failure-to-comply sanctions associated with the two minimum requirements are different: failure to meet the bare minimum 4.5% requirement could lead to the bank being put into resolution, whereas failure to comply with the CCB minimum requirement would merely lead to the bank being required to file a capital plan with its supervisor who may limit payments of dividends and bonuses.

Such thinking would fail any logic test.

The Bank’s point about the CCB being a different type of requirement is correct but irrelevant; what matters is that the CCB is a requirement nonetheless.

Nice try, but the blind-them-with-an-irrelevant-difference-defence doesn’t work.

Conclusion: according to the Bank’s own guidance document, the absolute minimum pass standard for the CET1/RWA stress test should be 7%.

I also consulted a number of experts for independent opinions. Not a single one was willing to defend the Bank’s interpretation of its own rules.

Consider for example this response from my friend, the Canadian economist Basil Zafiriou:

I read the standard the same as you, Kevin. The CCB is a mandatory buffer, so it has to be added to the CET1 minimum for an overall capital requirement threshold. Suppose a fire safety code requires commercial establishments to have a front and back exit plus a sprinkler system: having a front and back exit meets the exits requirement, but an establishment would not meet the fire code standard unless it also had a sprinkler system.

Still, I doubt you can win this argument with the BoE. You’re relying on logic and they rely on argument by assertion. And since they make the rules, like Humpty Dumpty they can make any rule to mean “just what [they] choose it to mean.” [See End Note 3]

Basil’s analogy with a fire safety code is spot on, ditto the Humpty Dumpty – and we all know what happened to him. The Bank’s interpretation of its own document is like Humpty himself, scrambled.

To give another view on the matter, on p. 24 of his authoritative book on the Basel III system, Safe to Fail: How Resolution will Revolutionise Banking (Palgrave Macmillan, 2014) Thomas F. Huertas states that

Strictly speaking, the capital conservation buffer does not constitute a minimum capital requirement.

At first sight, this statement might seem to support the Bank’s position, if read alone and out of context. But now consider the sentence that follows:

Instead, it represents the level at which the bank has to conserve capital by limiting dividends and distributions and by liming bonus payments in cash to management and employees – ample reason in the eyes of many to regard 7 percent as the effective minimum requirement.

Put another way, his view seems to be that “strictly speaking”, the minimum is 4.5%, but “effectively” it is 7%.

Furthermore, after the end of his first sentence there is a flag to a footnote in which it becomes clear that he is not citing the Bank’s ‘framework’ document at all. Instead, he is citing the Basel Committee on Banking Supervision (BCBS) in its original Basel III framework document, “Basel III: A global regulatory framework for more resilient banks and banking systems.” This footnote refers to pp. 54-57 of the Basel III framework document and an example of what it says is the following, which appears on p. 55 of that document:

129. A capital conservation buffer of 2.5%, comprised of Common Equity Tier 1, is established above the regulatory minimum capital requirement.

This language and the use of the term “minimum capital requirement” in the singular suggest that the BCBS might have seen the CCB as something apart from the minimum capital requirement [sic]. This is a one reasonable interpretation of the BCBS document but the underlying ambiguity in that document (e.g., over whether there is one or more minimum capital requirement(s) etc.) is regrettable.

Be this as it may, Huertas’s statements cannot be cited in defence of the Bank of England’s ‘framework’ document as he was referring explicitly to the BCBS ‘framework’ document and he made no reference at all to the Bank of England’s ‘framework’ document. Nor can there be any ambiguity here: Dr. Huertas was crystal clear what he referred to.

So when is a minimum capital requirement not a minimum capital requirement?

The Bank’s answer: a minimum capital requirement is not a minimum capital requirement when the Bank doesn’t use it as the pass standard in its stress tests, even though it promised it would.

I am tempted to say that this is truly Clintonesque hair splitting, but it is not: it is simply wrong.

The credibility of the Bank’s stress tests should be out there unchallengeable and shining bright for all to see, not dependent on a misreading of its own guidance documentation – and a misreading that just happens to underpin the Bank’s preferred narrative that everything is fine with the UK banking system.

If the UK banking system is as strong as the Bank of England maintains, surely the Bank can build a stronger case that this?

Kevin Dowd

February 29 2016

End Notes

End Note 1:

To be precise, with a 7% pass standard, the average surplus over the pass standard is less than 100 basis points, 2 banks fail the test, 2 scrape through by very narrow margins over the pass standard, 2 banks get small margins over the pass standard, and only 1 performs well.

End Note 2:

To clarify, the other components are the Capital Conservation Buffer (CCB), the Counter-Cyclical Capital Buffer (CCyB) and the Globally Systemically Important Banks (G-SIB) Buffer. I believe that to be convincing, these should be set at the maximum plausible levels they might take under fully phased-in (‘fully loaded’) Basel III. (And I am ignoring the new Systemic Risk Buffer announced in December 2015.) However, for present purposes I focus on the CCB as I am only concerned here to make the point that the Bank should never have used 4.5% as the pass standard in its stress tests.  

End Note 3:

For those of you who forgot your Lewis Carroll, "When I use a word," Humpty Dumpty said, in rather a scornful tone, "it means just what I choose it to mean—neither more nor less."

The Guardian's big new series about the iniquities of modern life

The Guardian has just started a big new series exploring how incomes have changed over the past decades, how income distribution has changed. Everything is terrible, of course. and there's going to be weeks of this dreck apparently. To give you a flavour:

The full scale of the financial rout facing millennials is revealed today in exclusive new data that points to a perfect storm of factors besetting an entire generation of young adults around the world.

A combination of debt, joblessness, globalisation, demographics and rising house prices is depressing the incomes and prospects of millions of young people across the developed world, resulting in unprecedented inequality between generations.

A Guardian investigation into the prospects of millennials – those born between 1980 and the mid-90s, and often otherwise known as Generation Y – has found they are increasingly being cut out of the wealth generated in western societies.

Where 30 years ago young adults used to earn more than national averages, now in many countries they have slumped to earning as much as 20 percent below their average compatriot. Pensioners by comparison have seen income soar.

that pensioners have seen incomes rise if because government policy has been to deliberately and specifically try to raise pensioner incomes.

We might not be too hard on The Guardian. They have gone to the right place, the Luxembourg Income Study, to get their data. They're looking at the right concept too: disposable incomes. However, on every other point they're following the precepts of that Daily Mash t-shirt above, being wrong about everything.

Have a look at the more detailed figures here. Run through the age groups and countries. And those young'uns in this country:

Compared to the national average, you are poorer than people of your age in the past.

Terrible, eh?

In real terms, your disposable income is about $5,130 more than in 1979.

Sorry, what? they're saying that a higher real income means you're poorer? Ahhh....they're not talking about poverty at all. They're talking about inequality. And as it works out, most age groups in the UK have had real income rises of $10,000 to $12,000, except for those young'uns bring up the rear with only $5,000. Which, if we're honest about it, wouldn't surprise us all that much given the vast expansion of the student body (from some 10-12% of the age cohort to 50% or so now) over that time period.

But obviously the neoliberal, in hock to plutocratic capitalism, UK will have performed much worse than those much more caring social democracies like Germany or France? Nope: there the young'uns have seen real disposable incomes actually fall (by $600 and $1,200).

That is, by the measures that The Guardian themselves have chosen, that neoliberal, in hock to plutocratic capitalism, UK has done better than the more liberal and more to Guardian economic tastes social democracies of Europe. Let's hear it for neoliberal plutocratic capitalism then.

And in case you think the Daily Mash is too harsh in declaring the paper wrong about everything, all the time, consider this. They can't even manage to manufacture their own propaganda properly.

One final point. UK real disposable incomes have about doubled since 1979. Let's hear it for neoliberal plutocratic capitalism just one more time.

Ten questions for the “leave” campaign

Let’s ignore the fake alternatives of HMG’s recent papers - the scare stories about the UK’s position with third countries . Let’s also ignore the threadbare character of the government’s “renegotiation” with the “reformed” EU. No-one with a ha’porth of sense pays any attention to either. We can’t however, ignore the fact that the “leavers” need to come up with a crisp account of what they expect the electorate to vote for. Let’s orient ourselves by looking at the table of alternatives below.

Chart 1: Alternative trading arrangements for the UK

table 1

Sources: ASI, Global Counsel, David Campbell Bannerman MEP, HMG

This table is largely based on material from Global Counsel, a “stay” outfit, but it succeeds in illustrating the political character of the alternatives. The top row shows the present position, ie, that of the “stayers”; the bottom row attempts to capture the objectives of those advocating leave. The colours for the “stayers” at the top more-or-less reverse those for the “leavers” at the bottom. No surprise: the “stayers” are willing to tolerate the current sacrifice of sovereignty to maximise trade access; the “leavers” want to maximise “sovereignty” and will tolerate a bit less trade access. The five rows in the middle set out alternatives, with a rainbow of colours showing their various combinations of trade and sovereignty.

In the event, the “leave” campaign is currently engaging with four alternatives, of which only two show up in the table. All have strident proponents, strengths and weaknesses and unanswered questions.

1.The “Norway option” is advocated by Christopher Booker, Richard North and Robert Oulds. They say that this is the only realistic option, as the tangled web of UK/EU/third-party relations will take years to unravel and that it violates international law and common sense to accept the view (heard from, eg, Bernard Jenkins) that UK could legislate unilaterally so that “with one bound, Jack was free”. They argue that this option takes advantage of the precedent of Norway itself and the existing institution of the European Economic Area, which gives its members greater influence over EU policy than the UK has at present. It gives rise to the following questions:

• As this option involves accepting almost all of the EU’s existing acquis, ie, its existing complement of policies (in particular, including free movement of labour and a financial contribution to EU funds), how is the leave campaign to communicate it to the electorate as more attractive than the prevailing position?
• Do these arrangements really hold out the prospect of more influence than that enjoyed by the UK at present?
• Is it realistic to accept the contention that this option alone conforms to the Article 50 timetable of 24 months?

2. The “Australia option” has been mentioned by Richard North largely as a fall-back from the “Norway option”, but possibly as a more attractive alternative. Australia and the EU have negotiated a “Mutual Recognition Arrangement” (MRA), which eases the supply of goods and services between the two without obliging either to engage in intrusive harmonisation. At first sight, this scheme looks attractive but it has been little examined and gives rise to the following questions:

• Isn’t it the case that the Ozzie MRA is limited to a small number of technical rules in restricted areas?
• Does the bargain struck between the EU and Australia (or something realistically within the compass of negotiators) address the UK's reasonable objectives?
• Is such an arrangement realistically on offer or can negotiators realistically put it on the table within an acceptable timescale?

3. “WTO-plus” is pushed by David Campbell Bannerman in several books including a new one out later this month. The scheme’s attractions are that a minimum (ie, no more than compliance with the “Most Favoured Nation “ [MFN] rules of the World Trade Organisation [WTO]), it requires no assent from the EU. The idea is that after notice has been served under Article 50, negotiations between the EU and the UK will improve trading conditions above the WTO minimum. It gives rise to the following questions:

• Would such arrangements actually give sufficient access for UK exports (including re-exports) to the EU, in particular those involved in “just-in-time” supply-chains operating on a continental scale?
• How would such arrangements address services, the largest and fastest growing part of the UK’s economy and the sector in which we have greatest comparative advantage?

4. “Vote ‘out’ to renegotiate ‘in’ ” is no longer favoured by Boris Johnson but remains the objective of Michael Howard. The idea is that this would minimise disruption by giving the UK the best of both worlds. Two questions arise:

• How is such a scheme to attract those for whom “leave” means “leave”?
• How would such a scheme avoid accusations of preparing to break trust with the electorate, as political leaders are said to have done in 1975 and since?

We can’t answer every question but here are some preliminary conclusions.

a) Every alternative is imperfect. The question before the “leave” campaign is how they compare to each other. The question before the electorate is how the “leave” campaign’s selected option compares what the “stay” campaign is defending. We address the latter in a companion note, “Five questions for ‘stayers’.“

b) The alternatives on offer are better seen as journeys rather than destinations - in the grim jargon of government, a “direction of travel”.

c) HMG should be working up its own "plan B". It may make for fine campaigning polemic not to do so, but it also feels irresponsible and disrespectful to the electorate.

d) Unilateral legislation may not be able to resolve relations with the EU or others for all time but it can certainly freeze them with third parties for renegotiation at leisure. This is also perfectly consistent with international law. In general we warm to a programme of “freeze, then reform”.

e) Finally, negotiations may proceed better for the UK from an assumption of nothing (ie, WTO/MFN arrangements) rather than an assumption of the current state. After all, psychologists tell us that our species is constitutionally risk-averse: we prefer avoiding loss to making gains. If Brexit comes, better to apply that pressure to our negotiating counterparts!

The “leavers” need to nail their colours to the mast before campaigning officially kicks in, with the Electoral Commission’s decision on “designation” in mid-April. To get there, they need to work up good answers to these ten questions.