Jonathan Portes2013-05-22T02:27:47-04:00Jonathan Porteshttp://www.huffingtonpost.co.uk/author/index.php?author=jonathan-portesCopyright 2008, HuffingtonPost.com, Inc.HuffingtonPost Blogger Feed for Jonathan PortesGood old fashioned elbow grease.The Deficit is Falling!tag:www.huffingtonpost.com,2013:/theblog//3.31372772013-04-23T05:57:38-04:002013-04-23T07:43:47-04:00Jonathan Porteshttp://www.huffingtonpost.com/jonathan-portes/
So is the plan on track? Certainly not against the government's original intentions. The Chancellor's first "benchmark for Britain" was to cut the deficit at a faster rate than that set out in his predecessor's plans. But under those plans the deficit was supposed to be now about 1% of GDP - £15billion - lower than today's figures show. Of course that would never have happened - those plans too would have proved undeliverable. But describing them as insufficiently ambitious - indeed as likely to lead to a debt crisis - and then making even less progress than they implied, can hardly be described as policy success.
But where we are now is more important. And here the key point is that, as Robert Chote, chair of the independent Office of Budget Responsibility, has pointed out, deficit reduction "appears to have stalled". Here's his chart:
So what's going on? As I noted earlier, most of the deficit reduction has come from cutting public sector net investment (spending on schools, roads, hospitals, etc) roughly in half. Pretty much all the rest came from tax increases (note that the investment cuts and tax increases were both, to a significant extent, policies inherited from the previous government). And we can see when it happened - between 2009-10 and 2011-12.
But these sources of deficit reduction stopped in 2011-12, because the government belatedly realised that cutting investment was a major mistake and that the economic imperative was actually to do precisely the opposite (not that there was much investment left to cut); and it stopped putting up taxes overall. So we can see also what's happened since - with the impact of the weak economy on tax receipts reducing revenues, the deficit has been flat and is projected to stay flat. As the IFS puts it:
The bigger picture is the same: the Government has implemented a combination of tax rises, welfare spending cuts and cuts to spending on public services and brought about a reduction in the deficit between 2009-10 and 2011-12. However, while 2012-13 also saw further austerity measures being implemented, weak economic performance has meant that the deficit was largely unchanged from its 2011-12 level. The same is forecast to be true in the current financial year: the OBR's forecast is that borrowing will fall by just £0.9 billion to £120 billion in 2013-14. This would leave the deficit largely unchanged for three years.
Of course, contrary to the rhetoric, there was an alternative. In fact there were (at least) three.
The first would have been to listen to the growing economic consensus - now finally joined unequivocally by the IMF, where economic analysis is finally overriding political expediency - that, with borrowing rates at historic lows, ample spare capacity, creaking infrastructure, and a chronic shortage of housing supply, now is the time to borrow and invest. This might raise borrowing in the short term, but at no great short-term cost and with substantial short-term benefits to growth and longer term benefits to the economy.
The second would have been to follow the example of eurozone policymakers, and react to the lower economic growth and hence weaker public finances that have resulted from premature fiscal consolidation with still more, and more damaging, austerity; the death spiral in which several eurozone countries remain trapped. This option has been tested to destruction in Greece and Spain; it would have been a disaster.
The third would have been to listen to what I describe as the neo-Hayekian approach of cutting taxes, but cutting spending even more. This has the merit of intellectual consistency - and of course it is perfectly legitimate to argue, on either political or economic grounds, for a much smaller state over the medium term - but would again, in my view and that of most mainstream economists, be catastrophic in current circumstances.
The government has chosen none of these alternative approaches; instead, it is simply muddling through. A year ago I described the government's refusal to change course as the "Macbeth" approach to policy: well, although the blood is still up to his waist, Macbeth has now decided to stop in the middle of the river. There is literally no economic rationale, theoretical or empirical, behind the particular - very odd looking - trajectory of deficit reduction set out in the chart above. There's nothing in economic theory that says you pause a third of the way through a deficit reduction programme which has gone way off track; nor does the fiscal framework, now effectively defunct with the abandonment of the debt target, dictate this approach. As Matt O'Brien puts it, austerity - such as it is - is "a policy without a justification". We're here because we're here because we're here.
So what happens next? Eventually, assuming that reasonably healthy economic growth returns, as both we and the OBR do indeed forecast, deficit reduction resumes at a fairly rapid pace, although this to a large extent depends on what Paul Krugman in the US context describes as "magic asterisks" (that is, future spending reductions that are simply assumed in advance of actually having policies to deliver them).
One thing we can be reasonably certain of is that the budget will in itself do little or nothing to boost growth; the OBR has gone through all the significant policy measures in the budget (box 3.1) and concluded that while some will have very small positive impacts, and others equally small negative impacts, the overall impact is negligible. That's not to say we won't get a proper, sustainable recovery at some point; the UK's underlying economic strengths remain, as the current health of the labour market illustrates. But it won't be thanks to macroeconomic policy.
To sum up; an honest and accurate description of the progress on the government's deficit reduction plan would be:
"We reduced the deficit by a third in our first two years in government, mostly by massive cuts to public investment, which we now understand were a big mistake and have damaged the economy. We've also now realised that trying to reduce the deficit further while the economy isn't growing is self-defeating, so we're not even going to try to get back on track until it does grow. We won't miss our fiscal targets, since we no longer really have any. If the IMF understood that we're not really going anywhere, perhaps they would stop telling us to change course."
]]>'We've Cut the Deficit by a Third' - True - Here's What the Chancellor Didn't Saytag:www.huffingtonpost.com,2013:/theblog//3.29268422013-03-21T19:00:00-04:002013-05-21T05:12:01-04:00Jonathan Porteshttp://www.huffingtonpost.com/jonathan-portes/
"We've now cut the deficit not by a quarter, but by a third".
This might be surprising to anybody who read my earlier blog here, which pointed out that the deficit had (measured on a rolling twelve- month basis) been rising, not falling, for the last year or so. Nor does it chime very well with the statement made by Robert Chote yesterday, Chair of the independent Office of Budget Responsibility, who stated that deficit reduction "appears to have stalled". How to reconcile these figures?
The problem, as Chris Giles has observed, is that the deficit figures reported by the Treasury have now become so distorted by a variety of special factors and accounting gimmicks - from the Royal Mail Pension Fund transfer, to the winding up of the Special Liquidity Scheme, to the interest payments on the gilts the Bank of England has bought - that it's almost impossible to make sense of them. The best way to do this is to look at this chart from Mr Chote, which excludes the most egregious of these distortions:
This shows, that as a percentage of GDP, the deficit has indeed fallen by about a third; the Chancellor is correct. But the interesting thing is when and how that has happened, and what happens now. As I noted earlier, most of the deficit reduction has come from cutting public sector net investment (spending on schools, roads, hospitals, etc) roughly in half. Pretty much all the rest came from tax increases (note that the investment cuts and tax increases were both, to a significant extent, policies inherited from the previous government). And we can see when it happened - between 2009-10 and 2011-12.
But these sources of deficit reduction stopped in 2011-12, because the government belatedly realised that cutting investment was a major mistake and that the economic imperative was actually to do precisely the opposite (not that there was much investment left to cut); and it stopped putting up taxes overall. So we can see also what's happened since - with the impact of the weak economy on tax receipts reducing revenues, the deficit has been flat and is projected to stay flat. As the OBR says:
"We forecast underlying deficits very close to £120 billion in 2011-12, 2012-13 and 2013-14".
After that, assuming that reasonably healthy economic growth returns, as both we and the OBR do indeed forecast, deficit reduction resumes, although this to a large extent depends on what Paul Krugman in the US context describes as "magic asterisks" (that is, future spending reductions that are simply assumed in advance of actually having policies to deliver them).
One thing we can be reasonably certain of is that the budget itself will do little or nothing to boost growth; the OBR has gone through all the significant policy measures in the budget (box 3.1) and concluded that while some will have very small positive impacts, and others equally small negative impacts, the overall impact is negligible. That's not to say we won't get a proper, sustainable recovery at some point; the UK's underlying economic strengths remain, as the current health of the labour market illustrates. But it won't be thanks to macroeconomic policy.
Finally, while it is of no economic significance, it is also worth noting that the deficit is projected to fall in cash terms this year and next. Indeed, the OBR projects that it will fall from £121billion last year to £120.9billion next. This seemed somewhat suspicious to many, and it has now been widely observed that the explanation lies in paras 4.118 of the OBR's Economic and Financial Outlook, which notes that
"Our overall forecast of under-spending has a number of elements... [including] payments (for example to some international institutions) that were due to be made late in the current financial year, but which are being delayed into 2013-14. In the last of these cases, departments have assumed that these payments will be accrued to 2013-14 rather than 2012-13, although we see some risk that this may not always be the case and some could be accrued to the original date".
Anthony Reuben for the BBC translated this into: "The cheque is in the post". As Paul Johnson, Director of the IFS, put it:
"There is every indication that the numbers have been carefully managed with a close eye on the headline borrowing figures for. It is unlikely that this has led either to an economically optimal allocation of spending across years or to a good use of time by officials and ministers".
To sum up; in my earlier blog I stated that an honest and accurate description of the progress on the government's deficit reduction plan would be:
"We've reduced the deficit by a quarter, in line with the plans we inherited, despite the fact that the misguided policies we and others implemented have made deficit reduction much more difficult. We've done this mostly by massive cuts to public investment, despite the fact that the economic circumstances are more conducive to public investment than at any time in living memory. On the bright side, however, we've learned that during a period of prolonged weak or zero growth, with businesses and households seeking to raise saving and lower investment, it is possible to continue to finance very large deficits at very low interest rates".
Much of that remains valid, but not all. I would now suggest:
We reduced the deficit by a third in our first two years in government, mostly by massive cuts to public investment, which we now realise were a big mistake and have damaged the economy. We're trying belatedly to correct this. We've also now realised that trying to reduce the deficit further while the economy isn't growing is self-defeating, so we're not even going to try to get back on track until it does grow. Meanwhile, since we have no actual growth strategy, and we need to be able to say that the deficit is still falling, we've adopted the proven and time-honoured strategy of putting off paying the bills.
.]]>Speaking English Does Matter, But Almost All Immigrants to the UK Dotag:www.huffingtonpost.com,2013:/theblog//3.28177162013-03-06T07:44:34-05:002013-05-06T05:12:01-04:00Jonathan Porteshttp://www.huffingtonpost.com/jonathan-portes/
As I've pointed out before, this ignores the fact that pretty much all the evidence about the impact of this decision is positive: the new migrants get jobs, contribute to the economy, pay taxes, don't use many public services, and don't take jobs from natives.
Nor, as I explain in the Guardian, do they pose a significant threat to the benefit system.
But Mr Miliband will emphasise another aspect of the current debate, saying:
I think everyone who comes to live and work here should learn English. ...we'd also have a very simple rule, which says if you work in the public sector, in a job face to face with the public, you need to be able to speak English.
Others have been more blunt: for example, The Sun claimed:
In some parts of the UK, 40 percent don't speak English as their main language, says the 2011 Census..For all the waffle at Westminster,no effective policy has ever been in place to persuade migrants to learn English. It is hard not to conclude that many migrants have no interest in learning English because they simply don't want to integrate.
While in the Guardian Jackie Ashley argued:
there are apparently around a million households that speak no English.These are dramatic numbers
But what does this really mean? The statistics used by both The Sun and the Guardian come from the 2011 Census; the Office for National Statistics have just published an excellent summary of what the figures tell us about language knowledge and use. The bottom line is that there are indeed a lot of people in the UK whose first language isn't English: 4.2 million, although that's still less than 8% of the total, rising to a high of 41% in Newham (hence The Sun's number).
But, as the ONS is at pains to point out, "a much smaller percentage [1.6%] of the total population said they could either not speak English well or not at all." The bottom line is that only 134,000 people - 0.3% of the total population - don't speak English at all. Even in Newham, where well over half the population was born abroad, and The Sun seems to think that people "simply don't want to integrate", fewer than one in 10 of the population can't speak English well.
Overall, of the well over seven million people in this country who were born abroad, less than a million can't speak English well, and most of those appear to be at least making an effort. So much of the comment on this simply confuses, deliberately or through carelessness, not speaking English as a first language or not speaking it at home, true of very large numbers of UK residents, with not speaking it at all or not wanting to learn it, true of very few indeed. [Note: the Guardian did subsequently correct Jackie Ashley's error].
A similar confusion applies to schools. The Daily Telegraph claimed earlier this year that "in secondary schools, at least one-in-eight children have a relatively poor grasp of English, it emerged." In fact, no such thing "emerged" at all. Indeed, amazingly, pupils in Inner London whose first language isn't English actually significantly outperformed the national average for all pupils at GCSEs this year.
Nor, contrary to the arguments made by government Ministers and Migration Watch, is there any evidence that the presence of pupils with English as a second language damages the attainment of native pupils. [Incidentally, it should be noted that - in contrast to some of the media misrepresentation noted above - the Daily Mail has produced a number of balanced and informative stories on this particular issue. Here's the latest]
So should we be relaxed about immigrants not speaking English? Absolutely not. English clearly matters, both for the labour market and for broader issues like integration and social cohesion. Immigrants who don't speak English, not surprisingly, are less likely to be in work and get much lower wages. This is bad for the immigrants themselves and bad for the economy as a whole. So when Mr Miliband argues that:
What was really striking to me was talking to the women in the classroom about learning English. They said to me overwhelmingly, "Look, we've got to be able to learn English, because otherwise," as one of them said, "how can we be part of our society?" ..so we'll make English language teaching a priority, and the priority it deserves to be.
This makes a lot of sense. This is the sort of practical policy measure that could improve outcomes both for immigrants and the wider economy and society.]]>The Austerity Delusion? (Or, 'Cuts? What Cuts?')tag:www.huffingtonpost.com,2013:/theblog//3.25633442013-01-27T16:45:33-05:002013-03-29T05:12:01-04:00Jonathan Porteshttp://www.huffingtonpost.com/jonathan-portes/
It is obviously impossible to argue that an economy that has grown less than one per cent in the period since the fiscal consolidation was introduced, compared to the approximately six per cent that the government forecast at the time, is performing acceptably. So some commentators who supported the government's programme - or indeed, argued that it did not go far enough - are taking a different approach, arguing that economic weakness cannot be attributed to austerity because, in fact, there is no austerity.
Two notable examples are Fraser Nelson, who argued at the time that the 2010 Budget put us "on the road to recovery", claiming here:
"George Osborne's policy is not working - but for reasons that the Guardian can't quite bring itself to accept. It's not that his evil cuts are retarding the recovery. It's that he's slowly abandoning his deficit plan. The figures show that core government spending is going up, along with the debt and (last month) the deficit."
"Instead of constantly asking questions about the 'cuts', the question that needs to be asked about the UK economy is why hasn't the huge public sector stimulus injected since 2008 succeeded in pushing the economy back into growth?"
Many people will think that they are obviously talking nonsense and can simply be dismissed. But I thought it was worth examining their arguments in detail, for two reasons. First, both are intelligent people; and second, some of the points they make are indeed accurate - although they get the implications wrong - and deserve to be addressed. So, while their overall argument and hence conclusion is wrong, it is useful to go through what they get right and what they get wrong.
First, however, it would be useful to have a definition of 'fiscal stimulus' and hence of its opposite, fiscal consolidation or 'austerity', so we know what we're talking about. It is easy to get hung up on technical issues here, but abstracting from those, the FT has a nice simple one, which makes intuitive (and economic) sense:
"Fiscal stimulus: Government measures, normally involving increased public spending and lower taxation, aimed at giving a positive jolt to economic activity"
With that in mind, let's look at Messrs. Redwood and Nelson's specific points:
1. There has been no austerity, because the deficit remains large and the debt is rising. This is a simple confusion of levels and changes. Indeed, Mr Redwood says:
"Since April 2008 there has been a surge in public spending and borrowing. In 2009-10 the state borrowed 11.1% of our National Income, in 2010-11 another 9.9% and in 2011-12 another 7.9%...The biggest ever fiscal stimulus, Keynesian stimulus, is being tried."
So by Mr Redwood's logic, any deficit is a stimulus. If the government had reduced the deficit from 11 per cent of GDP to one percent, which would have required (say) putting VAT up to 25 per cent, cutting welfare benefits (including pensions) by 10 per cent in cash terms, and abolishing the army (plus a lot more besides), then they would still be trying an (admittedly smaller) "Keynesian stimulus.".This is laughable, of course: a reduction in the deficit, even if the deficit remains positive, is not a 'stimulus' according to the definition above, or indeed any definition used by economists. Any macro model will tell you this, as indeed will common sense.
2. There has been no austerity, because there have been no spending cuts. So Mr Nelson, for example, says that the "figures show core government spending is still going up", while Mr Redwood says "current public spending has been rising in cash and real terms."
This point tends to provoke outrage among people who have been directly affected by public spending cuts. And of course there have been cuts in some specific areas, which have done considerable damage. So, for example, the government cancelled the Educational Maintenance Allowance, despite the strong evaluation evidence that suggested it was cost-effective; and the Future Jobs Fund, before its own analysis showed it to be one of the most effective labour market policies in recent history. These foolish and non-evidence based decisions have rightly been criticised.
But individual spending cuts do not show that spending is falling overall; and on that Messrs Redwood and Nelson have are correct and make an important point. Public sector current spending overall is roughly flat in real terms, with cuts in some areas offset by the operation of the automatic stabilisers. As yet, so far, there has been relatively little (overall) austerity in public services, with health and schools protected, although local authority services have suffered.
But this does not mean there has been no austerity. As we all know, public sector capital spending has been slashed in half, while taxes (VAT on everybody, some taxes on higher earners) have risen significantly. According to the OBR, between 2009-10 and 2011-12 taxes went up by more than 1 per cent of GDP, while public investment fell by 1.7 per cent of GDP. Only in some alternate universe is this not 'austerity', still less Mr Redwood's 'stimulus.' Claiming that, for example, reductions in spending on new social housing and increases in VAT do not represent 'cuts' [in spending and in the deficit] makes no sense.
So what happens if we look at what the government has actually done? Probably the easiest way to see this is to look at this graph from the IMF, which more or less corresponds to the simple FT definition of stimulus (or, in this case, its opposite, fiscal consolidation):
This shows what the Fund rightly describes as a "large and frontloaded" fiscal consolidation. I am not aware of any serious economic analysis that challenges these figures in broad terms (they differ slightly, but not massively, from those of the OBR, for various technical reasons). So on the fundamental point Messrs Redwood and Nelson are simply wrong. The chart does however, show a marked reduction in the pace of consolidation in 2012-13, which leads on to...
3. The government has abandoned its original plan and as a consequence deficit reduction has stalled. The Chancellor is "slowly abandoning his plan" as Mr Nelson puts it, and therefore the "debt and (last month) the deficit are going up."
Actually, I agree with both of these statements; it is the causal conjunction that is incorrect. The government has indeed effectively abandoned its fiscal framework, as I set out here. And the current deficit was indeed higher in calendar 2012 than in 2011, so at the moment deficit reduction is if anything in reverse. But of course the causality goes the other way, as a moment's thought reveals. The government did not adopt policy changes which led to slower deficit reduction. Instead, the front-loaded fiscal consolidation illustrated above (along with other factors, such as the similar, and similarly misguided, policies pursued by our eurozone partners) derailed the recovery, which in turn led to the slowing of deficit reduction, which in turn has forced the government to abandon its fiscal framework. Again, the IMF sets all this out quite clearly.
4. A variant of the error in two is to argue that austerity has failed because it was implemented by tax rises and not spending cuts. Mr Redwood says:
"the high tax rates and the big prices rises put through in the public sector have squeezed people's incomes, cutting confidence and demand. High rail fares, high energy costs, higher VAT, National Insurance, and Income Tax for those pushed into the upper bands have all conspired to cut demand."
Well, these are all indeed contractionary; so by and large this paragraph is accurate. But there is no economic logic in suggesting that austerity measures which take money out of people's pockets and reduce confidence in one way (like VAT or rail fare rises) cut demand, while measures which do so in other ways (cuts to tax credits and benefits, cutting EMA and the Future Jobs Fund) don't. [Note of course that Mr Redwood's first gripe, higher rail fares, is actually a public spending cut!].
So all this paragraph really does is single out some tax rises and spending cuts Mr Redwood doesn't like and points out that they've had a negative effect on demand. As indeed have the other cuts I list, but Mr Redwood doesn't particularly object to those, reflecting his political views, rather than any economic analysis, so he doesn't mention them. Implicitly, he's really making my argument here; contractionary policies are contractionary.
5. Fiscal stimulus cannot work by definition, because "the money must come from the private sector". Mr Redwood argues:
"If the government decides on an extra pound of public spending paid for by a tax increase, that has no overall beneficial impact on the economy. The public sector grows by a pound, but the private sector shrinks by a pound. It is not a stimulus. If the state borrows an extra pound to spend, the private sector cannot spend the pound it lends to the government."
The first assertion is half right, at least as a definitional matter, in that extra spending financed by tax increases is not a (deficit-financed) stimulus. But whether it has an overall beneficial, or expansionary, impact depends on the specifics of the tax and spending. Simon Wren-Lewis has repeatedly pointed out that the theory suggests that in general it will in fact be expansionary, so Redwood is wrong on that, although this is an empirical question.
However, the second assertion is not only wrong, but represents the basic error - the 'Treasury View' from which my blog takes its title - that fiscal policy cannot, as an accounting identity, impact aggregate demand, because the government needs to get the extra money from somewhere, whether through taxes or borrowing. Paul Krugman accurately describes this as "One of the most basic fallacies in economics", while Wren-Lewis merely notes as politely as he can that you'd expect any economics undergraduate to know this. Note that understanding that Redwood is talking nonsense isn't a matter of whether you're a Keynesian or a rational expectations macroeconomist: no model, theoretical or empirical, used or taught anywhere, says this as a general proposition.
I do think it is important not to exaggerate either the magnitude or the impact of austerity in the UK. It explains part, but not all, of our dismal economic performance over the last few years: eurozone austerity, commodity prices, and other factors like the long-term decline in oil production all matter too. Nor are we Greece or Spain, where tax rises and spending cuts have been far sharper and the consequences, predictably, far worse. But any credible analysis suggests that pretending that there has not in fact been a sharp fiscal consolidation in the UK, with predictably adverse consequences, is equally mistaken.]]>The Government's Mid Term Review: Deficit Reductiontag:www.huffingtonpost.com,2013:/theblog//3.24456312013-01-10T05:49:37-05:002013-03-12T05:12:02-04:00Jonathan Porteshttp://www.huffingtonpost.com/jonathan-portes/Midterm Review: Programme for Government Update". This was intended to be a comprehensive assessment of progress against the commitments made in the original Coalition Agreement. The Prime Minister said that this "audit" would be "full, frank and unvarnished."
Naturally, I was particularly interested in how the Review described progress in deficit reduction, particular, given my view (set out here) that the Government has effectively abandoned its initial "Plan A" for deficit reduction.
Here's what the Review says:
Commitment
"We will significantly accelerate the reduction of the structural deficit over the course of a Parliament"
What we have done
"We set out proposals in the June Budget 2010, Budget 2011 and 2012 and Spending Review 2010 to accelerate the reduction in the structural deficit."
Proposals? Yes, but what actually happened? This would seem to be an occasion where a graph is worth, if not a thousand words, at least considerably more than a sentence of bureaucratic process that doesn't actually say anything.
So the graph below shows the Office of Budget Responsibility's forecasts for the structural deficit (the cyclically adjusted current budget deficit, that is the deficit excluding investment spending and taking account of the economic cycle) before the June 2010 Budget, and after the 2012 Autumn Statement. That is, taking account of all the "proposals" mentioned above, as well as everything else that has happened in between.
Let me be clear. I am not criticising the government for their failure to "accelerate the reduction in the structural deficit". Quite the opposite. I have argued repeatedly that even this pace of fiscal consolidation has been too fast, and, as the Director of the Fiscal Affairs Department of the IMF put it last week:
Fiscal adjustment should not be front-loaded..it would be preferable to postpone fiscal adjustment altogether until some future time in which there is too much private-sector demand rather than implementing it at a time when there is not enough private-sector demand.
If the government had tried to actually fulfil its commitment, the UK economy would be in considerably worse shape. So a genuinely "unvarnished" assessment might have read something like this:
Reduction in the structural deficit has proceeded at much the same pace as forecast before the fiscal consolidation programme was announced. We took the view that attempting to accelerate this reduction would have done substantial and unnecessary economic damage, as has been the case in a number of eurozone countries. Like the IMF, we have changed our minds on the wisdom of front-loaded fiscal adjustment. Fortunately, our ability to borrow in our own currency means that we have the flexibility to delay.
I would still argue that the pace has been too fast, and that the very large cuts to public investment (which does not impact the structural deficit in any case) were wholly misguided. But we should at least give the government credit for not making things even worse - which a misguided attempt to stick to the original plan undoubtedly would have.]]>Can We Afford to Uprate Benefits?tag:www.huffingtonpost.com,2012:/theblog//3.22698212012-12-10T19:00:00-05:002013-02-09T05:12:01-05:00Jonathan Porteshttp://www.huffingtonpost.com/jonathan-portes/here. He justified this change thus:
But we have to acknowledge that over the last five years those on out of work benefits have seen their incomes rise twice as fast as those in work. With pay restraint in businesses and government, average earnings have risen by around 10% since 2007. Out of work benefits have gone up by around 20%. That's not fair to working people who pay the taxes that fund them. Those working in the public services, who have seen their basic pay frozen, will now see it rise by an average of 1%. A similar approach of a 1% rise should apply to those in receipt of benefits. That's fair and it will ensure that we have a welfare system that Britain can afford.
David Smith, writing in the Sunday Times, repeated the chancellor's argument verbatim and stated that:
In five years, out of work benefits have risen 20%, earnings 10%. That is unsustainable...
The numbers are correct: but they are highly selective, and David's conclusion is simply wrong. The value of out of work benefits relative to average earnings (and more broadly the incomes of those in work) has fallen steadily over the past three decades, until the recent slight uptick resulting from the recession:
In 1979, unemployment benefit (the predecessor to Jobseekers' Allowance) was about 22% of average weekly earnings; today it's about 15%, a relative decline of about a third. What's going on? Simple: JSA has been indexed to inflation. In normal times, earnings rise faster than prices, as workers become more productive and the economy grows. So indexing benefits to prices has been far from unsustainable, or "unfair" to working people, over the last 30 years. Indeed it has resulted in a substantial reduction in spending on out of work benefits as a proportion of GDP, compared to the alternative of indexing benefits to earnings.
As a result, we already have "a welfare system that Britain can afford", at least for those of working age. Declan Gaffney et al note (table 3) that all out-of-work benefit spending only amounts to some 3 percent of GDP. And even overall benefit spending, which has to accommodate the growing number of pensioners, has levelled off, as Chris Dillow has pointed out. There is nothing remotely unsustainable about any of this.
In the last five years, however, earnings have risen much more slowly than prices, as the Chancellor points out. This is highly unlikely to persist, however, and it is certainly not what the official figures suggest: the Office of Budget Responsibility's forecast, which is not particularly optimistic about growth over the near term, suggests that earnings will rise about 5% faster than prices over the forecast period (table 1.1). So unless we are stuck in permanent depression, even a modest recovery will in time lead to earnings rising significantly faster than prices, and the relative value of out of work benefits will decline again. No policy action is required to ensure this (although economic recovery would help!).
So unless the OBR is completely wrong, and the economy flatlines for the foreseeable future, with no or negative growth in earnings relative to prices (and even at my most pessimistic I don't think that's likely) then the idea that benefits need to be cut in real terms in order to ensure either fairness to those in work or long-term sustainability is nonsense.]]>The Autumn Statement and the OBR's Forecasts: Recovery Postponed, Againtag:www.huffingtonpost.com,2012:/theblog//3.22474822012-12-06T19:53:17-05:002013-02-05T05:12:01-05:00Jonathan Porteshttp://www.huffingtonpost.com/jonathan-portes/ NIESR's forecast. These, further downgraded, forecasts mean the economy won't be growing faster than trend until 2015. So the underlying picture remains much the same as it has for the last two years - slow (or no) growth, and certainly nothing like the sustained recovery we should have seen by now.
What explains this poor performance? The lack of an appropriate policy response to the impaired financial system, both here and globally, is impairing the flow of credit to the real economy, limiting the effectiveness of monetary policy and slowing the necessary deleveraging in the private sector. And this in turns has aggravated the impact of premature austerity, both in the UK and, even more damagingly, in the eurozone. In particular, the very sharp cuts in public investment - down by almost half in the last two years - have clearly had a substantial negative impact.
Nothing in the Autumn Statement materially changes this picture. The increases in infrastructure spending are welcome - not least because they constitute an implicit recognition that the previous cuts (to be fair, largely a continuation of the plans of the previous government) were a damaging mistake. However, the scale of the additional spending - £5 billion, or 0.3% of GDP - is insufficient to provide a significant boost to output and employment in the short term (the OBR estimates the net impact on growth might be 0.1%). As I've pointed out before, at current long-term interest rates, we could fund a £30 billion infrastructure spending programme - 2% of GDP, enough to make a real difference - with the revenues raised from the pasty tax.
Moreover, from an economic perspective, it is unfortunate that the money has been found in part by cutting tax credits and welfare benefits. For obvious reasons, such benefits rise faster in a downturn than when the economy is doing well. And that is one of the main reasons why the deficit has fallen so much more slowly than the government had hoped two years ago. But that's not a bug; it's a feature; the "automatic stabilisers", as they are known to economists, help dampen the economy in booms and boost it in recessions. Indeed, the Chancellor has previously argued precisely this :
"That is why the automatic stabilisers and the ability of monetary policy to respond are key parts of the flexibility built in to our plan."
But cutting welfare benefits deliberately negates, as a matter of policy, the operation of the automatic stabilisers; it is a reduction in flexibility, not an increase. It is unclear why he has chosen to disregard his own advice - and indeed that of the IMF, which has argued repeatedly for the "free operation of the automatic fiscal stabilisers."
So, finally, what about the deficit? The Autumn Statement confirms that ultimately self-defeating austerity is just that. Weaker tax revenues, the result of weak growth, mean that the government's original fiscal targets are now unachievable. The government's original plan was to eliminate the cyclically adjusted current budget deficit in four years, by 2014-15. The OBR now forecast that (adjusting for various accounting changes) this will be achieved in 2017-18 - five years from now. In other words, two and a half years on from the start of the fiscal consolidation plan, we are farther away from balancing the budget than when we started.
Meanwhile, the OBR has also stated that the government is not on track to hit the "supplementary" target of reducing the debt to GDP ratio by 2015-16. Thankfully, the Chancellor recognised that announcing further spending cuts or tax rises in an attempt to hit this target would just do further unnecessary economic damage. But this does have broader implications for the fiscal framework overall. The "supplementary" target is often presented as a less important add-on to the primary target. But, as I've argued before, this is a misunderstanding; the two are closely related. As the 2010 Budget put it:
"At this time of rapidly rising debt, the fiscal mandate will be supplemented by a target for public sector net debt as a percentage of GDP to be falling at a fixed date of 2015-16, ensuring that the public finances are restored to a sustainable path. This fiscal mandate, supplemented by the target for debt, will guide fiscal policy decisions over the medium term, ensuring that the Government sets plans consistent with accelerating the reduction in the structural deficit so that debt as a percentage of GDP is restored to a sustainable, downward path."
So without the debt target, the central element of the fiscal framework - the deficit reduction target - is no longer credible or coherent. NIESR has always argued that, while the government's fiscal consolidation plan was unnecessarily front-loaded, with the damaging consequences now visible, a medium to long term framework to ensure fiscal sustainability was both necessary and desirable. We need a new one; as the IFS has already proposed, it would be sensible for the government to announce a proper consultation on this topic.]]>Faith-based Economics at the Treasury Committeetag:www.huffingtonpost.com,2012:/theblog//3.21403942012-11-15T18:00:38-05:002013-01-15T05:12:01-05:00Jonathan Porteshttp://www.huffingtonpost.com/jonathan-portes/watch. As you would expect, we covered a range of topics: the fiscal framework and fiscal policy, multipliers, the 'productivity puzzle', etc. However, I was rather surprised by the tone of the questioning on one topic: why are long term interest rates (gilt yields) so low?
My views on this are well known, and are set out for example here. To summarise briefly, both theory and a variety of different types of empirical evidence suggest overwhelmingly that low long-term interest rates in the UK reflect economic weakness (domestic and global) and expectations that short-term interest rates set by the Bank of England will remain very low (again, reflecting economic weakness). The empirical evidence, all of which I had to hand for the committee, includes the following:
the fact that long-term interest rates have gone down as forecast future deficits have gone up; we are of course now planning to borrow even more than we thought was likely before the fiscal consolidation plan was announced;
'event studies' of how yields reacted to political or economic developments (this one comprehensively debunks the myth that gilt yields fell sharply in response to political events around the 2010 election);
the observed relationships between gilt yields and equity prices (they move together, suggesting bad economic news leads to lower gilt yields, as theory would predict). I explained this to the committee (at about 11:03:30) ;
and cross-country comparisons; as the IMF has pointed out: "fiscal indicators such as deficit and debt levels appear to be weakly related to government bond yields for advanced economies with monetary independence."
A number of questioners, however, were surprised that I did not attach any weight to the supposed 'credibility' of fiscal policy, resulting from the fiscal consolidation plan put in place by the coalition government in June 2010. Jesse Norman MP, for example, said (at about 10:41:45):
"You don't think there's anything strange about not attributing any aspects of the UK government's long-term debt yield performance to government credibility".
Well, on the basis of the evidence described above, if the alternative is, or was, an alternative fiscal strategy that was significantly less contractionary in the short term, but still aimed at achieving long-run fiscal sustainability, then I don't (the complete absence of any serious long-run consolidation strategy would be a different matter). So I said so (at about 10:42).
Now it is certainly possible to argue against my views on this topic, although far fewer economists are doing so these days (no-one has really quarrelled with the IMF conclusions above, for example). I expected to be challenged and to have to defend my reading of both the theory and evidence; that's why I was there.
But what I found very odd was that none of the questioners on this topic seemed at all interested in why I make the arguments I do, nor were they prepared to put forward any countervailing evidence of their own. They didn't define 'credibility'; they didn't specify what the 'incredible' counterfactual would look like; they didn't try to explain why 'credibility' should matter from a theoretical perspective; they didn't try to present any empirical evidence that 'credibility' had in fact resulted in lower gilt yields.
They simply asserted that 'credibility' must have had something to do with low gilt yields, and argued that it was therefore strange that I wasn't prepared to 'admit' it. Indeed, bizarrely, Mr Norman seems to believe that I must have some, unspecified, 'political' motive for not giving the credibility argument any credit; as opposed to the more simple explanation that at the moment there is simply no significant evidential support for his position.
Essentially, this is faith-based economics. You start by saying something that sounds plausible at the time, and seems to reflect 'common sense'. That's fine, up to a point. What's not fine is to react to evidence that contradicts your theory, not by adjusting the theory but by repeating it, only louder. Eventually you risk ending up in a position, like Mr Norman, where the evidence is neither here nor there. If someone makes a nuisance of themselves by refusing, in the absence of evidence, to accept your theory, then he or she must have some more sinister motivation (to be fair, this was just Mr Norman: none of the other questioners remotely suggested this).
Now, the Treasury Committee is hardly the Inquisition (and I'm no Galileo - although I can just imagine Galileo saying: "I could handle the torture, but then the Florentine Physics Research Council threatened to cut off my funding..."). The discussion on some other issues (fiscal multipliers, 'zombie companies') was much more constructive. And I should also be clear that I have immense respect for the committee chairman, Andrew Tyrie, whose integrity and independence are unimpeachable, and who I believe to be doing an excellent and very difficult job overall (he has a particularly challenging task in chairing the Parliamentary Commission on Banking Standards). But faith-based economics (over the last 10 years, not just the last two) got us into this economic mess; it won't get us out of it.]]>Illegal Migrants: Can't Even Get Themselves Arrested?tag:www.huffingtonpost.com,2012:/theblog//3.21160282012-11-12T19:00:00-05:002013-01-12T05:12:01-05:00Jonathan Porteshttp://www.huffingtonpost.com/jonathan-portes/
The problem with measuring illegal or irregular immigration is that neither surveys nor administrative data get us very far. People are unlikely to tell even anonymous non-government surveys if their immigration status is questionable. And they don't show up explicitly in any official data set (although they will be counted in some). So, while most data on immigrants comes from micro data, attempts to estimate irregular immigration tend to be based on population aggregates, using the residual method: that is, calculating the size of the foreign born population in the UK and working out how many are here legally. Both numbers can in principle be derived from official data. The difference is the estimate of the irregular population.
There are two major problems with this, however. First of all, the estimate of the total foreign born population - from the census, Labour Force Survey, or similar - may well miss some irregular migrants. Second, even if both estimates are reasonably accurate, since the vast majority of the foreign born population are entirely legal, a relatively small proportional error in either (in either direction) leads to a large error in the estimate.
Nevertheless, it's the best we've got, and the last serious estimate in the UK used this method. Research conducted by Ian Gordon (an acknowledged expert on this topic) and colleagues at LSE for the Greater London Authority in 2009 produced a central estimate of about 620,000, with a range of 420,000 to 860,000. These numbers seem reasonable enough: certainly it is difficult to imagine that the true number is vastly larger, simply because our population estimates would be wildly and visibly wrong, and it would show up in other official statistics. But they are clearly very uncertain; it would obviously be good to have a much more accurate estimate.
So what would be the best way to estimate the irregular population? Well, from a research perspective, the best way would be to take a large random sample of the resident population, UK or foreign national, legal or otherwise, detain them (forcibly if necessary) and oblige them to verify their immigration status. That would do it. But, fortunately or unfortunately, depending on your perspective, this is not feasible.
However, with a non-random sample - in particular, people who've been arrested - it is both legal and feasible to do just that. And the Met have. In Operation Nexus, described here, immigration officers have been stationed in every custody suite in London to check the immigration status of everyone arrested:
"When someone is brought into a custody suite for a crime the teams will run identity checks to find out everything they can about the person they have arrested to make sure we take the quickest and most affective action...Now the Nexus teams can run checks to establish if foreign nationals who are arrested are wanted abroad, have previous convictions abroad or are here illegally."
So what are the results? Well, first, it is important to sense-check the data by looking at the proportion who are identified as foreign nationals in the first place:
"In the five week period since the Nexus teams were rolled out in custody suites across London the MPs arrested 25,968 people. 6,988 (27%) were identified as foreign nationals."
Labour Force Survey data suggests that about 27% of inner London residents, and about 19% of outer London residents are foreign nationals; the proportion for those who are of criminal age (ie neither too old or too young to be likely to be arrested) will be somewhat higher. So these data are consistent with foreign nationals being approximately as likely as UK nationals to be arrested in London, which is in turn reasonably consistent with other data (eg prisoner nationality data). If you were estimating the foreign national population in London on the basis of arrest data, you'd not be too far wrong. Can we do the same with the population of irregular migrants?
Well, we have some numbers. The Met say:
"155 of these were immediately detained by the UKBA for immigration matters, 25% of which have already been removed from the UK."
In other words, about 0.6% of those arrested (about 2.5% of the foreign nationals arrested) were found to be illegal migrants. That is a remarkably small number. 0.6% of London's population is about 50,000. The LSE research estimated that London accounted for 70% of the irregular migrant population in the UK. So, at face value, this would translate to a UK-wide estimate of about 70,000 - only a bit more than one tenth of the LSE estimate, and only just over 0.1% of the total population..
Now, there are a number of reasons why it might not be appropriate to simply use this estimate - that is, why we might not have a truly random sample:
irregular migrants might be more or less likely to commit arrestable offences than natives or legally resident foreign nationals. It's easy to see why they might be more likely; they are already on the wrong side of the law in some sense, and their irregular status may make access to employment or welfare more difficult. On the other hand, they have a stronger motive than most for staying out of trouble and the hands of the police. It's not obvious which way the bias goes. But it seems rather difficult to believe that irregular migrants could really be ten times as law abiding as either the generality of Brits or other, but legal, foreign nationals;
it could be that there are far more irregular migrants among those arrested than are detected by UKBA officials. Without knowing exactly what the administrative procedures in custody suites are, it's very difficult to tell. It does seem odd though that having arrested someone, having identified them as a foreign national (and the data there, as we've seen, seem entirely plausible), and having got a UKBA official sitting with them in a custody suite with both the authority and explicit remit to investigate their immigration status, that nine out of ten illegals would go undetected.
perhaps, with some migrants, UKBA had doubts (or more) about their migration status but didn't "immediately detain" them, instead (for example) asking them to report back at a later date to demonstrate they were here legally.
It does seem plausible that UKBA won't have taken immediate action with everyone whose status is irregular; this is common enough with those whose immigration status is found to be questionable in other contexts. But with with those who have actually been arrested it seems considerably less likely (and justifiable), and it's certainly not the impression given by the minister for immigration, Mark Harper, who said:
"I've been clear that we will take all possible action against individuals who pose a risk to the public and remove them from the country at the earliest opportunity. Through our combined work with the police we will use the full force of immigration powers on those who seek to commit crime and damage our communities."
So none of these explanations seem likely to be able to fully explain the discrepancy. It is also useful to compare the data with that from an earlier DWP/Home Office investigation into non-EEA national claiming benefits. This found that "Of those [records] that were fully matched, 98 per cent were matched to an immigration or nationality status entitling them to benefit." That is, only 2% were found to be claming benefit despite not being entitled because their immigration status was irregular. (Even that could be an overestimate; you can be here legally but not be entitled to benefits).
Again, this is an extremely low number; since less than 5% of the working age population is a non-EEA national, this would correspond to somewhat less than 0.1% of the total population. At the time, I assumed this mostly reflected the fact that irregular migrants would generally try to avoid the benefit system (and this investigation was not comprehensive - records couldn't be matched for everybody). However, the numbers are again very low.
What can we conclude? I certainly wouldn't argue that 70,000 is a 'better' estimate of the UK irregular migrant population than the previously accepted, much larger, numbers; it just seems too low. This is very sketchy, preliminary, and difficult to interpret data. But it is striking that when we actually have real, hard data, not guesses, about the topics where you would think we should be most worried about irregular or illegal migration - crime, or fraudulent benefit claims - the numbers of people whose immigration status is found to be irregular is so low. It must be at least plausible that the level of irregular migration in the UK is considerably lower than we thought.]]>Self-Defeating Austerity in Europetag:www.huffingtonpost.com,2012:/theblog//3.20645832012-11-02T10:59:05-04:002013-01-02T05:12:01-05:00Jonathan Porteshttp://www.huffingtonpost.com/jonathan-portes/research from NIESR, published in the National Institute Economic Review (£), makes the first attempt - to our knowledge - to model the quantitative impact of coordinated fiscal consolidation across the EU, using the National Institute Global Econometric Model.
The main conclusion is that, while in "normal times", fiscal consolidation would lead to a fall in debt-GDP ratios, in current circumstances, fiscal consolidation is indeed likely to be "self-defeating" for the EU collectively. As a result of the fiscal consolidation plans currently in train, debt ratios will be higher in 2013 in the EU as a whole rather than lower. This will also be true in almost all individual members states (including the UK, but with the exception of Ireland). Coordinated austerity in a depression is indeed self-defeating. The implication is that the current strategy being pursued by individual Member States, as well as the EU as a whole, is fundamentally flawed. Even on its own terms, it is making matters worse.
Why is fiscal consolidation so much more damaging now? Under normal circumstances a tightening in fiscal policy would also lead to a relaxation in monetary policy . However, with interest rates already at exceptionally low levels, this is unlikely or infeasible. Moreover, during a downturn, when unemployment is high and job security low, a greater percentage of households and firms are likely to find themselves liquidity constrained. Finally, with all countries consolidating simultaneously, output in each country is reduced not just by fiscal consolidation domestically, but by that in other countries, because of trade. In the EU, such spillover effects are likely to be large.
Taking account of these factors makes a large difference to estimates of the impact of the actual fiscal programmes announced and enacted for 2011-13 in the EU. The chart below shows the impact of fiscal consolidation on debt-GDP ratios; scenario 1 shows the impact in "normal" times, while scenario 2 shows the impact under assumptions we consider more realistic in current conditions.
I
The negative impacts of fiscal consolidation on growth in the second scenario are much larger than in "normal" times; and the result of this in turn is that fiscal consolidation increases rather than reduces the debt-GDP ratio in every country except Ireland. In both the UK and the euro area as a whole, the result of coordinated fiscal consolidation is a rise in the debt-GDP ratio of approximately five percentage points.
Of course, one argument frequently advanced in support of fiscal consolidation programmes is that they will reduce government borrowing premia in countries with high debt and deficits. But these simulations show that the opposite may in fact be the case: if we were to allow for feedback from the government debt ratio to government borrowing premia, this would in fact raise interest rates, exacerbate the negative effects on output, and in turn make debt-GDP ratios even worse; truly a "death spiral" .
The direct implication is that the policies pursued by EU countries over the recent past have had perverse and damaging effects. Our simulations suggest that coordinated fiscal consolidation has not only had substantially larger negative impacts on growth than expected, but has actually had the effect of raising rather than lowering debt-GDP ratios, precisely as some critics have argued. Not only would growth have been higher if such policies had not been pursued, but debt-GDP ratios would have been lower.
It is particularly ironic that, given that the EU was set up in part to avoid precisely such "Prisoners' Dilemma" type problems in economic policy coordination, it should currently be doing exactly the opposite.]]>What Explains Poor Growth in the UK? The IMF Thinks it's Fiscal Policytag:www.huffingtonpost.com,2012:/theblog//3.19506962012-10-09T08:16:41-04:002012-12-09T05:12:02-05:00Jonathan Porteshttp://www.huffingtonpost.com/jonathan-portes/today's IMF World Economic Outlook is not that it further explodes the myth - repeated again yesterday by the Chancellor - that low interest rates reflect policy "credibility" rather than economic weakness, or that it again emphasises that the UK and others could and should loosen fiscal policy in the face of that weakness.
The IMF said all this about the UK back in July, as I explained then. Rather, it is that the Fund has radically revised its opinion about just how damaging the impacts of premature fiscal consolidation have been in the UK and elsewhere.
Back in July, the Fund said that fiscal consolidation had knocked about 2.5% off UK economic growth. This estimate was based on an assumption that the "fiscal multiplier" - the reduction in GDP growth resulting from a reduction in the government's structural budget deficit - was about 0.5. This estimate was quite similar to that coming out of macroeconomic models like ours at NIESR. It was somewhat larger than the impact estimated by the Office of Budget Responsibility. But it was much smaller that the impacts that many of the most credible macroeconomists - Brad Delong and Paul Krugman in the United States, Martin Wolf and Simon Wren-Lewis here - thought likely. [See Krugman here, for example]. It was also significantly smaller than Dawn Holland here at NIESR and colleagues at LSE suggest in the analysis here.
Now, in a commendable display of self-criticism, the Fund has gone back and reanalysed the forecasts that it made (as well as those made by the OECD and EU). Its conclusion:
"In line with these assumptions, earlier analysis by the IMF staff suggests that, on average, fiscal multipliers were near 0.5 in advanced economies during the three decades leading up to 2009. If the multipliers underlying the growth forecasts were about 0.5, as this informal evidence suggests, our results indicate that multipliers have actually been in the 0.9 to 1.7 range since the Great Recession. This finding is consistent with research suggesting that in today's environment of substantial economic slack, monetary policy constrained by the zero lower bound, and synchronized fiscal adjustment across numerous economies, multipliers may be well above 1"
That is, the Fund is saying: "Delong et. al. were right; we were wrong". They even have a helpful chart, showing that the bigger the fiscal consolidation, the worse growth has been relative to IMF forecasts - implying that the Fund was drastically underestimating the negative impact of fiscal consolidation.
Why does this matter? Everyone agrees growth since 2010 in the UK has been very disappointing. But there has been much debate about why - was it cutting the deficit too quickly, was it the spike in inflation resulting from commodity price rises, was it the impact on confidence from the eurozone? Here at NIESR, we have taken the view that it was a combination of all of these - fiscal policy mistakes made a large contribution, but the other factors mattered too. However, others - notably the OBR, as well as Chris Giles in the FT - have argued that fiscal policy didn't explain much of the weakness in growth. The IMF have now definitively sided with those who think that tightening fiscal policy quickly and sharply had a very large and negative impact.
Once again, the Fund deserve praise for going back, looking at their forecasts, analysing what went wrong, and saying very clearly "We thought the impact of fiscal consolidation on growth would be relatively small. We got it wrong." Will our government, and those of the eurozone, do the same?]]>Debt, Deficits and the Fiscal Frameworktag:www.huffingtonpost.com,2012:/theblog//3.18769492012-09-12T09:32:01-04:002012-11-12T05:12:01-05:00Jonathan Porteshttp://www.huffingtonpost.com/jonathan-portes/widely reported that the government is considering abandoning the second half of its fiscal mandate - that debt should be falling as a percentage of GDP in 2015-16. My view is that the short term economic impacts of this are limited. It's not really news; NIESR has been saying for well over a year that this target was unlikely to be met. What deficit reduction we've seen so far - largely achieved through cutting investment - hasn't exactly gone according to plan. Nor should we worry about the markets - they certainly haven't reacted yet and I doubt they will. As for the ratings agencies, any policymaker who pays them the slightest attention shouldn't be allowed near economic decision-making.
More importantly, in policy terms, somewhat looser fiscal policy in the short term is entirely sensible and affordable. As Vince Cable said on Sunday, the main problem facing the UK economy in the short term is a lack of demand, which is in large part the result of the government's decision to pursue over-rapid fiscal consolidation. To the extent that any change is an overdue recognition and reversal of this mistake, it is to be welcomed.
However, and this is the main point of this post - dropping the debt target raises wider questions about the government's fiscal framework. Without the debt target, the central element of the fiscal framework - the deficit reduction target - is no longer credible. It is worth reproducing the description of the framework set out in the 2010 Emergency Budget.
"The Budget announces the Government's forward-looking fiscal mandate to achieve cyclically-adjusted current balance by the end of the rolling, five-year forecast period. At this Budget, the end of the forecast period is 2015-16. At this time of rapidly rising debt, the fiscal mandate will be supplemented by a target for public sector net debt as a percentage of GDP to be falling at a fixed date of 2015-16, ensuring that the public finances are restored to a sustainable path.
This fiscal mandate, supplemented by the target for debt, will guide fiscal policy decisions over the medium term, ensuring that the Government sets plans consistent with accelerating the reduction in the structural deficit so that debt as a percentage of GDP is restored to a sustainable, downward path."
What's the logic here? The Treasury argued, correctly, that having a forward-looking deficit target eliminated one of the key weaknesses of the previous, backward-looking regime, the "Golden Rule", that the government could count past surpluses against future deficits. But correcting this weakness introduced another one: read literally, eliminating the deficit (however defined) by the end of the five-year forecast period is not a constraint at all. As we pointed out in our evidence to the Treasury Committee last November, the forward-looking deficit target on its own is no more credible than saying "I'll give up drinking next month"; and, when you ask me next month how it's going, telling you the same thing:
"It is important to note that the fiscal mandate - " to achieve cyclically-adjusted current balance by the end of the rolling, five-year forecast period" - does not ensurelong run sustainability. It would be consistent with the fiscal mandate for the Government to plan, this year, on a cyclically adjusted current deficit of 10 per cent of GDP for the first year of the forecast period (2012-13), 8 per cent for the second, and so on, achieving balance by the fifth year (2016-17), setting out the necessary tax rises and spending cuts to achieve this plan; and then, next year, even if economic circumstances are entirely unchanged, to delay all the tax rises and spending cuts by one year, so again planning on a deficit of 10 per cent of GDP for the first year of the forecast period and balance by the fifth year (now 2017-18)."
So that is why the supplementary target is there. On its own, it doesn't make much sense either; why target falling debt in one specific year? That has little necessary connection with the long-term sustainability of the public finances, since debt could be rising the year before and the year after. But it does stop the government behaving in the way described above.
The point is that, as the Treasury quote above makes quite clear, on its own the primary target does not "ensure that the public finances are restored to a sustainable path." The supplementary target is required as well. They are not separable, but part of a package. Abandoning the debt target will mean, as a matter of economic logic, rethinking the primary target if it is has to have any economic credibility at all.
The government's fiscal strategy always had two flaws; first, a failure to understand the short--term macroeconomic impacts of fiscal consolidation; and second, a misunderstanding of the vital but complex and often misused concept of "credibility". Most of the debate has focused on the former. But the latter is at least as important. The focus needs to be less on second-guessing financial markets in the short-term (still less the ratings agencies) and much more on ensuring that we have a sensible framework that will ensure long-run fiscal sustainability. Dropping or modifying the "supplementary" target, without re-examining the framework itself, will be a short-term fix at best, when what we need is something that will last.]]>Cut Red Tape to Boost Growrth? Start With Immigrationtag:www.huffingtonpost.com,2012:/theblog//3.18239412012-08-23T04:30:17-04:002012-10-22T05:12:07-04:00Jonathan Porteshttp://www.huffingtonpost.com/jonathan-portes/economists that premature austerity has done considerable unnecessary damage, and that there is a strong case for slowing fiscal consolidation - at least to restore some of the unnecessary and damaging cuts to public investment (which have been the source of most of the deficit reduction so far). However, others have instead argued that the problem is not on the demand side, but on the supply side, and that what is needed is a radical programme of deregulation - "cutting red tape" - especially in the labour market.
The argument to focus on the supply side to boost growth is both wrong and right. It is wrong because in the short term, the main thing holding the economy back is lack of demand, the result of misguided macroeconomic policy, both here and globally (especially the eurozone). As the IMF put it it its latest report, upfront and in bold:
"The recovery has stalled... with current policy settings the pace will be insufficient to absorb significant slack in the economy, raising the risk of a permanent loss of productive capacity. Demand support is needed."
But just because the main short-term problem is lack of demand does not mean that we should not worry about the supply side. Indeed, almost all economists would agree that over the medium to long term, what really determines growth, jobs and prosperity is indeed the health of the supply side of the economy. So, even while recognising that they will not be a panacea in the short term, the ideas of the supply-siders should nevertheless be examined on their merits. Increasingly, they focus on the labour market. Liam Fox, for example, said:
"To restore Britain's competitiveness we must begin by deregulating the labour market. Political objections must be overridden. It is too difficult to hire and fire and too expensive to take on new employees."
Subsequently, an independent report commissioned by the government from Adrian Beecroft addressed Fox's point by proposing (in addition to some fairly minor changes) the introduction of a form of no-fault dismissal. It was deservedly mocked (if you haven't read Richard Lambert's brilliant parody, do so!). More generally, numerous more informed commentators (including, commendably, Vince Cable, commenting on the report his own Department had commissioned) have pointed out that the Fox/Beecroft line of argument is remarkably difficult to justify with any actual evidence.
However, this didn't deter everyone: for example, Bruce Anderson argued that the government should implement the Beecroft Report in full, because:
"rights without jobs are a mere mockery, and the excessive emphasis on rights has deterred employers from taking on new workers, unless they are Eastern Europeans, who proclaim their willingness to work with every molecule of their being."
As I explain here, this is utterly ludicrous; perhaps 85% of new hires are British workers. In fact, overall the UK labour market has performed extraordinarily well of late. Hiring - given economic conditions - is surprisingly healthy, and employment is rising, despite weak or no growth . Labour market economists, and international organisations like the OECD, agree that three decades of successful reform have given the UK a flexible and generally well-functioning labour market, by international standards. There is no reason to believe regulation is currently a significant barrier to job creation. This suggests that - while doubtless there are improvements that could be made around the edges - there is little to gain from further wholesale deregulation. Spain and Italy need radical labour market reform; we don't.
But that doesn't mean we should stop looking for areas where we could improve the supply side. And indeed there is one aspect of labour market regulation where sensible deregulation is urgently needed, and could genuinely boost UK growth. This is immigration. Now immigration rules are not generally what either economists or policymakers think of when they talk about labour market regulation. But of course restrictions on those who want to come here, or stay here, to take up employment or to look for a job are exactly that: they are government regulations that change the way the labour market functions.
So the changes to skilled migration introduced by the government - a set of new burdensome and bureaucratic rules and regulations, including a quota on skilled migrants - are new labour market regulations. Indeed, in contrast to almost all other such regulations, which are at least designed with an eye to ensuring that the benefits to employers and employees outweigh the costs, these changes were designed expressly to make it more difficult for businesses to employ the workers they want.
As a consequence, they will reduce growth and make us poorer. And these impacts - áccording to the government's own estimates - are potentially very large. As I said in my testimony to the Treasury Select Committee after the 2011 Budget:
"The extra employment regulation that the Government has imposed on employers wishing to employ migrant workers--the cap on skilled migration--will, using the Government's own methodology, reduce UK output by between £2 and 4 billion by the end of the Parliament."
This is not just be a result of the reduced size of the population; since the regulations are designed to exclude skilled migrants, who tend to be more productive, they also reduce average productivity and hence GDP per capita, as the Home Office Impact Assessment states.
None of this is news to economists; most of us, wherever we are on the political spectrum, think that well-functioning markets usually do a pretty good job of allocating resources. That goes for the labour market too, so it is no surprise that liberal (in the true sense of the word) immigration policies are good for the economy, and restrictive ones are not. So simply reversing the new regulations introduced by this government, let alone further deregulation, could yield large gains. Moreover, in contrast to some other policy changes that might promote growth, the fiscal impact would be positive, not negative; the deficit would be some hundreds of millions of pounds lower.
It is worth comparing these figures with the impact of changes to other forms of labour market regulation. The government's proposed changes to employment tribunals, for example, are designed precisely to reduce burdensome labour market regulation (in the ordinary sense). But the official Impact Assessment estimates the net benefit to be about £70 million per year; trivial by comparison.
More radical changes to immigration policy might have even larger impacts. A recent paper by one of the leading US researchers on the economic impact of immigration suggests that, looking across countries, the impact of openness to immigration on per capita income is large and positive - indeed, larger than the impact of openness to trade. They conclude:
"We interpret these results as consistent with the idea that immigration enriches the skill and idea variety of countries, increases their productivity and efficiency and, in the long run, it is an important contributor to their economic success."
So there is an obvious target for those commentators and politicians who talk about freeing up the UK labour market. If they really want to cut red tape, why not start with the red tape that directly prohibits employers from hiring the skilled workers they want? If they want a more liberal, market-oriented approach to economic policy, why not reduce the most damaging and illiberal restrictions on the operation of the labour market? And if they think that the UK benefits by being "open for business", then act in accordance with the evidence that to realise those benefits means being open to labour mobility as well as free trade and capital mobility.
Of course, changing course on immigration - even in the direction of deregulation and free markets - is politically difficult for the government. But fully a year ago, the Chancellor argued:
"this crisis provides an opportunity to make some difficult trade-offs in favour of growth that might get parked in the "too difficult" box in calmer times."
This is surely exactly what he meant. Now that he's promised to devote "110% attention" to boosting growth, this would be a good place to start.]]>Which (Macro)-Economists are Worth Listening to?tag:www.huffingtonpost.com,2012:/theblog//3.17180952012-07-30T05:19:07-04:002012-09-29T05:12:39-04:00Jonathan Porteshttp://www.huffingtonpost.com/jonathan-portes/here, and which has drawn in a whole host of economics bloggers who know far more about modern macroeconomic theory than I do. However, here I want to address a related, more mundane question, but one which is perhaps more relevant to most non-economists' concerns. That is, when economists argue about the correct stance of policy, who should we (policymakers, commentators, and the general public) listen to?
This question was prompted by a recent exchange I had with Ed Vaizey and Simon Hughes on the BBC's Daily Politics: I pointed out that not only was the government's decision in 2010 to cut the deficit too quickly doing considerable economic damage, but that this was both predictable and predicted by economists such as Paul Krugman and Martin Wolf. Their response was essentially "how were we to know which economists to listen to? Others were saying the opposite".
This is a fair question. My answer to it is that policymakers and the public should listen to economists who fulfill two critera: first, they have made empirically testable predictions (conditional or unconditional - see Krugman here) that have proved, by and large, to be broadly consistent with the data; and second, they base those predictions on an analytic framework (not necessarily a formal model) that is persuasive. In other words, getting it right alone is not enough; it should be possible to show your workings - to explain why you got it right. Otherwise, your predictions may be interesting, but they tell you little about how to formulate policy.
My shortlist (apologies in advance to those I've omitted) of economists commenting on macroeconomic policy who I think qualify is something like the following:
Krugman, Delong and Wren-Lewis on fiscal policy when interest rates are at the zero lower bound;
Adam Posen on monetary policy when interest rates are at the zero lower bound;
Martin Wolf on private sector savings and public sector deficits (the financial balance approach);
Richard Koo on the implications of a "balance sheet recession"
Not all of these economists agree with each other on everything, nor do I necessarily agree with them about everything; for example, Krugman and Wren-Lewis have recently been debating the usefulness of microfoundations in macroeconomic models. But they each have clear analytic frameworks for thinking about the economy, and have used them to make empirically testable claims; and have largely been vindicated.
In each case I've provided links to typical examples of what each was saying a couple of years ago; in each case the analysis stands up well in retrospect. You understand what they are arguing and why, and events since have been consistent with their arguments.
This in turn generates an obvious list of economists or those commenting on economic issues who got it completely wrong, usually because they were using analytic frameworks that were incoherent or lacked empirical evidence. I won't name individuals here, so I leave that to readers, but a short list of influential bodies that should have known better includes those responsible for writing editorials at the Financial Times, macroeconomic forecasters at the OECD, the European Department at the IMF (up until recently - their recent stuff on both UK and eurozone has been pretty good) , the senior leadership at the Bank of England and the Treasury, and probably worst of all senior economic policymakers at the ECB and European Commission. Oh, and the credit ratings agencies, but that goes without saying.
It is worth mentioning two economists who I respect, admire and find interesting but do not in my view qualify for inclusion on my shortlist. They are Nouriel Roubini and Ken Rogoff. In both cases, I - and maybe this is partly my fault - don't understand what, if any, analytic framework they are using, so I find it difficult to impossible to evaluate their advice. Nouriel's predictions, while often accurate, seem to be based largely on instinct and a sense of which data matters and which doesn't. That's fine - and having an instinct for the data is invaluable - but I just don't know how to evaluate the plausibility of articles like this.
With Ken, I am even more confused; one of the finest theoretical macroeconomists of the last two decades has staked much of his reputation on a hypothesis - that there is something magic about a 90% debt to GDP ratio - which as far as I can see has no analytical or theoretical basis. If Ken has an explanation, his paper doesn't let us in on it. I don't see why we should regard this arbitrary number, based on a relatively small number of country examples in varying economic circumstances, as having any useful predictive power for individual countries in the future.
Finally, let me just point out that this is not hindsight on my part. Most of those mentioned above were on the list of economists I read and, whenever possible, consulted when I was still a civil servant involved in policy advice on these issues (2008-11). And I put this specific list together more than a year ago now in preparation for a talk I gave to a group of government economists. And this matters. I don't think there's any doubt that if policymakers, both in the UK and elsewhere (especially in the eurozone) had, during the intervening period, listened to these people rather than their own economic advisers, the state of the UK and world economies would be significantly better than it is now.
This article can also be read here]]>'We've Got the Deficit Down by a Quarter': If This Is Success...tag:www.huffingtonpost.com,2012:/theblog//3.16752692012-07-16T03:12:21-04:002012-09-14T05:12:02-04:00Jonathan Porteshttp://www.huffingtonpost.com/jonathan-portes/Sunday Times article yesterday was deficit reduction:
"We've got the deficit down by a quarter already"
This statement is true. But what the Prime Minister didn't say was that the economic outlook the Prime Minister inherited was for precisely this pace of deficit reduction; that's exactly what the Office of Budget Responsibility was forecasting on the basis of policies in place in May 2010.
At the time, the Prime Minister seemed rather unimpressed by this prospect. Indeed, he argued:
"If we don't deal with this [the deficit], there will be no growth, there will be no recovery. It will be undercut by rising interest rates, rising inflation, falling confidence and the prospect of higher taxes... So on 22 June, we will have an emergency Budget, setting out how we will cut the bulk of our deficit over the course of this Parliament, giving this country what it has been desperately lacking - a credible plan to live within its means."
Indeed, we did have an Emergency Budget in June 2010, announcing major tax rises and spending cuts, followed by a Spending Review in October 2010 to flesh out the detail of the cuts. This was supposed to move us from the trajectory shown in the blue line in the chart to that shown in red.
And, two years on,what has been the result? According to the OBR's March forecast is the line in green. So the deficit is falling at almost exactly the same pace - maybe a bit slower this year and next - as was projected before any of this.
It was both foolish and damaging, as I have argued numerous times, for the Prime Minister and Chancellor to liken the UK to Greece, or to suggest that the path of deficit reduction forecast before the Emergency Budget would have led to panic in the gilts market or soaring interest rates. But it is simply bizarre, having done so, and then having delivered almost exactly that supposedly disastrous path, to describe it as a triumph for government policy.
Moreover, it is also important to examine how that deficit reduction - which is real - has occurred. This chart shows the current deficit (ie excluding investment) and the total deficit, including public investment spending.
What it shows is that most deficit reduction - about two-thirds - has come from cutting investment. Given that even at the peak investment spending was only about a tenth of total government spending, this is astonishing. Moreover, it's getting worse. Last year more than three-quarters of deficit reduction came from cutting investment. Indeed, the current deficit - excluding investment - fell hardly at all, from £102.5 billion to £99.5 billion.
Of course, not all this is the government's fault. The previous government also planned to slash investment spending. Obviously the broader economic backdrop is much less favourable than was hoped in June 2010 - although this is not some unlucky coincidence for which the government has no responsibility. I and many others would argue it is to a very large extent precisely because of the misguided policies of premature fiscal consolidation implemented not only by the UK government but those making policy in the eurozone. So here's an alternative, and more accurate, text for the Prime Minister:
"We've reduced the deficit by a quarter, in line with the plans we inherited, despite the fact that the misguided policies we and others implemented have made deficit reduction much more difficult. We've done this mostly by massive cuts to public investment, despite the fact that the economic circumstances are more conducive to public investment than at any time in living memory. On the bright side, however, we've learned that during a period of prolonged weak or zero growth, with businesses and households seeking to raise saving and lower investment, it is possible to continue to finance very large deficits at very low interest rates. "]]>
