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Why not Nationalise Grangemouth refinery?

Twice in the last couple of days, I’ve been asked to talk to the Media about Grangemouth. Twice I’ve been asked the same question by the BBC: Should it be nationalised? The first time I was surprised by the question, and answered with waffle about there not being a case for the refining business, but the petrochemicals plant is important as the centre of a manufacturing hub. The second time I ducked it completely. “not my area of expertise”.

Strategic infrastructure?

This is cowardice on my part. Of course Grangemouth shouldn’t be nationalised. The manufacturing businesses surrounding Grangemouth will have to find other sources of supply or close. Tough, but better than the alternative, even though this manufacturing hub makes up 10% of Scottish GDP. The problem is the refining and petrochemical business suffers from overcapacity accross the whole of Europe. This is in part because Governments sometimes have seen refineries as “strategic” and intervene whenever they get into trouble, and in part because of simple competition from newer, bigger refineries and petrochemical plants elsewhere, particularly in Asia and the USA.

You’ll see a lot of waffle in the media about “fuel security”. The best security is having multiple sources of supply, and being rich enough to afford the prices of market fluctuations. Of course it’s nice if your domestic supply can be exported, but even this has problems. You’ll also see fearmongering about petrol prices. There was little noticable effect on petrol prices from the strike in 2008. While there may be disruptions to supply to forecourts in remote areas of Scotland, the fuel companies are likely to have contingency plans, and any disruption is likely to be short-lived and local. Remember the biggest fuel store in the UK is that in everyone’s car. But the main reason this won’t affect prices is because we already import nearly half the UK’s diesel, and export 20% of petrol. The supply chain is already diversified and robust.

European refineries built after the war produce too much petrol, demand for which is falling thanks to more efficient cars, fewer miles driven and a switch to diesel. They produce too much fuel oil which no longer heats our homes and powers our industry, the cleaner, cheaper gas does. They produce too little diesel and aviation fuel, which the UK must import. We struggle to find a market for our glut of petrol and fuel oil, because everyone’s refineries have the same problem. And there are simply too many of them in Europe.

Grangemouth is not the only European refinery closing this week. Mantova in Italy has also been mothballed. European refineries, old, with a nameplate capacity of, in Grangemouth’s case, 205,000 barrels of oil a day, which is turned into stuff for which there is no market. It’s unsurprising they’re struggling against big, new American and far-eastern refineries which have capacities over twice that. American refineries pay (at present) $15 or more less for their crude (the WTI/Brent spread) too and produce the stuff the market (currently) demands.

If the plant is nationalised, the Government (whichever one, Scottish or British) will have to pick up the tab for a business currently losing £150m a year, with a pension fund £200m in deficit. The plant is said to need £300m in investment to set the plant running to produce what the market actually demands. So we’re looking at a measurable, whole-integer percentages of the Scottish Government’s budget of £27bn, when they’re already running a 10% deficit. Good luck sustaining that.

The difference between Ineos and the Scottish Government is the former has lots of experience in building, running and managing petrochemical plants. The Scottish Government has none. It’s impossible to conceive of Alec Salmond running a nationalised petrochemical business better and more profitably than private sector managers. I doubt the Scottish Government (soon to be independent?) could find the money to wear the inevitable losses in perpetuity without cutting back elsewhere. So everyone in Scotland will have to pay taxes to keep 800 people in jobs and be much poorer as a result of the direct transfers.

Then there’s the precedent. Having secured nationalisation for “key infrastructure”, which is what the unions want, they will want to get the same result for every other big business which starts to find the competitive pressures of the Global economy a bit much. With the back-stop of nationalisation for any factory employing 500 or more Scots, unions will be tempted to drive a harder bargain. Scotland becomes a little less profitable, and receives less and less investment each year as a result.

Because investment drives productivity, and productivity drives wages, Scots will find themselves getting poorer if the Government caves in to Unions’ demands. The laws of compound interest mean this happens slowly at first. But Scotland lacks the resources of the UK’s diversified, trillion-dollar economy to stand the pressure for long. Even with the resources of the UK, it took massive “nationalisation of the means of production” less than 30 years to cripple Britain. The Scots are far, far to the left of the rest of the UK, and British business after the war was profitable to start with. If they get what they, and the BBC appear to want, nationalisation, the Scots will see why nationalisation doesn’t work much, much quicker than that.

So next time I’m asked “should Grangemouth be nationalised?”. I’m going to say “No. Of course not, though there’s a case for helping with the investment needed, but I don’t think even that’s a good idea”.

The Crisis Wasn’t Brown’s Fault. The Slow Recovery Is.

Let’s be absolutely clear. The near-failure of the financial system on Gordon Brown’s watch was not entirely his fault. Thus the rise in the deficit from 3% to 11% of GDP isn’t directly Brown’s fault. At least not in the short term. But the slow recovery is his fault. And here’s why.

It’s not just the defict. A 3% deficit once in a while is ok. No Government can balance the books every year. But running a deficit every year for a decade, that’s wrong. Running a deficit bigger than growth increases the debt to GDP ratio. This is fine, when the stock of debt is low, but doing so during a “boom” is wrong. And increasing taxes to fund increased spending isn’t always wrong either. doing so during a boom is fine in moderation. But increasing  spending, over inflation, and during the biggest rise in peace-time taxation in British history, year, on year, on year (as Brown did) was not just wrong, but insane. It’s difficult to over-state how insane Brown’s fiscal policy actually was. He raised taxes during a boom, then spent it all but it STILL wasn’t enough. So he borrowed more, and more, and more, every year on top of booming tax-receipts to keep illusory growth coming. Gamblers call this approach ‘the martingale‘, and it always results in catastrophic losses, because of house limits. Brown believed there were no house limits. But there are, even for Governments.

The pips were squeaking long before the market blew up. The private sector was over-taxed and barely put on any net new jobs at all over New Labour’s tenure. Squeezed by regulations and crushed by rising demands, business stopped hiring. A group of workers, the non-financial private sector, which were not growing, nor were they enjoying increases in living standards under Brown, were being asked to fund a massive increase in the number of, and payment to the public sector. All Brown’s “end to Boom and Bust” growth was debt-financed public sector spending. All the net new jobs were courtesy of the Tax-payer. And when those massive tax-receipts from the City which had allowed this to appear OK stopped, the wheel came off.

Brown’s regulatory regime failed its first test, but so did every regime, everywhere. The Greenspan put, which I ultimately blame for the crisis was standard political economics everywhere at the time. Doing the standard thing does not make Brown culpable.

The financial crisis may not have been Brown’s fault, and his response to it was (I’ll grudgingly admit) not too bad. It’s not exactly what I would have done, I’d have let the banks fail, secured depositors only (not bond investors) and used helicopter money to bail out PEOPLE not bank. But Brown’s approach certainly wasn’t wrong, and represented one of the better options on the table. But the fact is Brown appeared to believe he’d ended Boom and Bust beforehand, and left Britain with no fiscal wiggle-room at all. The fact the crisis was as bad as it transpired to have been for this country was absolutely Brown’s fault. Financial crises happen. Brown though he’d stopped them for good. That is pure hubris. The Tory charge, that he didn’t fix the roof when the sun was shining is actually quite accurate.

Brown overspent when he should have been saving. He rose taxes when a prudent government should have been able to cut them. He left a huge, bloated public sector, the cuts to which are slowing down the recovery.  (That the cuts are slowing growth does not mean we should stop cutting and miraculously get growth, nor would that growth allow the deficit to fall). Thanks to the grotesque tax-hikes of Brown’s tenure, there’s no scope for further rises to close the gap. In isolation, each of the defences of Brown’s fiscal policy hold water. Together, they don’t.

Like the Irishman giving directions “Well I wouldn’t start from here”, should form the Tory critique of Brown’s time as Chancellor and PM. We should have been running a 1% surplus in 2007. This means the deficit would have been 7%, not 11% in 2010. We should have been a creditor nation by 2007, having almost entirely paid off the net national debt and been sitting on great piles of T-bills, JGBs and Bunds. Our stock of debt would have gone up, but we’d be rapidly approaching 40% of GDP, not 100%. There would be no need for decades of Austerity. The fiscal fire-power the Government could have deployed to keep the wheels moving would have been much greater.

But counter-factuals are pointless. All that’s left, is the long, slow, grinding process of austerity to bring the insane levels of state spending under Brown 2000-2007, back under control. This will take decades. I will be paying more tax, thanks to Gordon Brown, for the rest of my life. For that, I will never forgive him. For cheering him on, I will never forgive Labour.

“Race to the Bottom”

The Coalition has sought to Abolish the Agricultural Wages Board. Labour oppose this, because they think the Countryside is still some Dickensian hell of near-slave labour, and that only State intervention prevents a “race-to-the-bottom” in wages. The phrase appears again in Labour shadow Education Minister Tristram Hunt’s argument about British Skills shortages.

This phrase also underpins the arguments for the Minimum wage, which Labour introduced, and every other intervention into people’s working lives. Of course the UK has been getting steadily richer over the past couple of centuries, with or without government intervention in wages and industrial conditions. Labour like to point to Laws being passed as the point at which things change. It’s not like this of course. The law changes when it becomes acceptable and economically viable to do so. The law reflects change to society. It doesn’t drive it.

The average British worker expects more than 12-hour factory drudgery for tuppence-ha’penny an hour, but in poorer parts of the world this represents a step up from subsistence agriculture, which is 14 hours of drudgery for no pay, with the ever present risk of starvation. He won’t accept back-breaking labour in the fields, which is why we import Polish fruit-pickers and Chinese cockle-gatherers. The native Brit who once would have done these jobs is better off on welfare.

As countries become richer, they take some of the increase in productivity and spend it on better working conditions, wages and so forth. Some people – the kind who become North-sea divers for example, are willing to take on personal risk for a big pay-cheque. Others, those who become HMRC tax-clerks would sacrifice pay-cheque for a near-job-for-life. The difference between socialists is they think GOVERNMENT should decide who gets to decide their working conditions. But it’s clear. The shortage is of skilled Labour.

Unfortunately, Labour cannot follow the logic. If the shortage is of skilled Labour, then skilled Labourers do not need protection. Employers will be competing in wages and working conditions to attract them. Far from being a “race to the bottom” it’s inflationary. Government has decided that there should be a minimum wage, and for those whose labour isn’t worth even that, a welfare state. And with that, you’ve protected people from “exploitation”. It’s now possible to survive in the UK while taking none of the Jobs on offer. This is true of every developed nation, and this limits employers power over people.

Labour seems to think Government is all that stands in the way of employers, who all carry whips and wear top-hats, driving down working conditions and pay. Nothing in economic history supports this view, though it’s a comforting idea, if you see everything through scarlet-tinted spectacles and romanticise the Workers’ “struggle”. If you want decent working conditions for everyone, give them the tools and let them get on with it. People, making the best of what they’ve got will, over the generations, given peace and freedom, drive up living standards.  Decent pay and standards will happen when everyone’s rich enough to afford them. Conditions we now think acceptable will be shunned by our children. There is a case for minimum standards but it’s weaker than most think. “Race to the Bottom” is a left-wing dog-whistle, which should alert you to the fact the speaker is an idiot.

Scrap the Agricultural Wages Board. It makes no difference. It’s a relic of the bygone age. Like most of Labour’s thinking.

The Hows and Whys of the End of the Commodity Super-Cycle

I remember Oil at $14 a barrel back in the early noughties. The conversations I was having then were about the roof in the price due to Canadian tar sands, the world’s largest hydrocarbon repository, which became economic to exploit at $40. The Oil Price, in response to shortages, and anticipated shortages caused by rapid Chinese growth, rose rapidly from 2002 or so. In the short run, the supply of oil is fixed. So, for a decade or so ever cheaper money was chasing a short-run fixed supply of oil. One of the effects of the “Greenspan put” was to raise oil prices. The Oil Price spiked in response to the financial crisis in 2008 to its high and has remained persistently over $100 since. Just as it seemed logical back in the 90’s, following two decades of sub-$40 oil that this was indeed a ceiling through which Oil prices would not go; people though $100 looked like a floor below which the price wouldn’t fall. In markets, the consensus is usually wrong.

This high price led to talk of the “end of the Oil economy”. High prices became built in to people’s thinking, just as low prices had for the decades before that. Soon, Oil executives started to give the go-ahead to projects in deep water or held in deep rocks which are costly and difficult to reach based on higher returns. The result of this is an increase in supply. North Dakota for example is benefiting from an Oil Boom due to rock-fracturing technology, better known for disrupting the Gas market. New technology was developed to extract oil cheaper and more efficiently from where it had been un-economic to extract previously.

This extra capacity in the Oil industry was matched by a focus by the consumer on demand. People started insulating their homes to use less heating fuel. Cars and Air-conditioners became more efficient. People are driving slower, as cars now show the point fuel consumption and people see how much more fuel they use at 85mph compared to 70mph. Remember how cars on motorways used to drive at 80-90mph in the fast lane, and now there are few people breaking the 70mph limit? Accidents have fallen. In the UK, petrol sales have fallen by over 20% from their peak in 2008 thanks to these effects.

So supply has risen in response to high prices, and use has fallen. What’s going to happen to the price? You’ve got bankrupt oil states who are no longer beholden to OPEC, like Venezuela who will need to sell every drop they can produce if their economy isn’t to collapse. So the fall in price may, in the short run lead to MORE production, as desperate producers try to meet forecasts based on higher prices creating a rapid fall in the price, even from here.

Industrial metals are showing the same story. There are no primary smelters of Iron in Europe because we’ve got all the Iron we need, and simply recycle existing metal. China will develop its car economy based on Aluminium chassis, not steel and will demand less steel than did Europe at the equivalent stage of development. Yet there are vast open-pit Iron-ore mines in Australia with robotic 400-ton trucks pulling ore that few will need. The price of Iron and steel are falling.

The writing was on the wall. The top of the market indicator for Metals is AIM-listed start-ups going after “rare-earth” elements in slag heaps. We had plenty of those. Obvious, really, in hindsight.

The point is that a price mechanism in a free market has worked to ensure that there was never a shortage of  Oil or industrial metals. The price rose, capacity rose to take advantage of the high price, supply rose, consumption fell and eventually the price collapses. This is also why free-market systems don’t have famines, as the same thing happens with food. And do you know who prevents famine? The speculator, and most especially the hoarder. As it’s his store that keeps everyone alive. And also why anything a government provides, (Schools, Hospital beds, building permission for houses etc..) we will always be short of, because there is no demand/supply mechanism to allocate resources. There’s no signal saying “invest here, not there” in a planned system.

So. Are the prices of Oil and Metals going to continue to fall? Yes. Probably. But the confidence interval on that statement is no more than 51%. Are we ever going to run out? No. Of that I am certain. Don’t get me started on Gold-Bugs except to say

“Bwahahahahaha. Told you so” 

having been wrong for, um, about a decade.

“The Crisis” was caused by Preventing Recessions.

What’s to blame for “the crisis”? 

By “the Crisis” most people mean, when they ask that question, the recession and financial market crash which started in the USA in 2008 and spread like wild-fire round the world’s financial systems, and is still smouldering in places like Cyprus and Slovakia to this day.
Most people blame “deregulation” by which they mean shouty, shirty men shouting down phones into screens. Poor regulation did play a part, but the financial markets weren’t deregulated, and often the unregulated bits performed best. Certainly much of the ‘deregulation’ happened post Thatcher, where the (Ed Balls-designed) FSA focused on nit-picking about how quickly banks picked up the phone, thinking this was more important than Bank capital adequacy which the Bank of England used to focus on. This blaming of Capital markets is often just fear of that which is not understood. 
Many blame “greed”. It’s comforting to have a deadly sin as one of the reasons for discomfort. But we’re all “greedy”. There’s no blame in responding to incentives. Others blame “neo-liberal economics” because anything prefixed with “neo” becomes the devil’s work. Of course it’s Liberal economics which has brought the world’s poor out of poverty in their billions over the last thirty years.
The real reason for the extent and depth of “the crisis” is the “Greenspan Put”. A ‘put’ is a type of option which gives the right to sell at a given price, thus, for a premium, you can use them to insure an underlying asset. During the 1990’s & 2000’s, following the .com bust, interest rates were repeatedly cut. Every time the housing market wobbled, the markets fell, or GDP growth stalled, the interest rate was cut, aggressively.

The problem with this approach is that by 2007, when the wheel came off the economy, lowering interest rates was, to use a cliché, pushing on string.
So why did the wheel come off the economy in 2007? The reason is that there had been 16 years of uninterrupted growth beforehand. The problem Brown, who’d apparently abolished boom and bust, faced is that recessions are when growth happens. In the run-up to the .com crash, there was an enormous explosion of investment in Internet stocks. Shares would fly out of brokerages because the company announced they were opening a website. Companies in the new .com business were being valued on multiples of ‘EBITDAM’ (Earnings before interest, tax, depreciation, amortisation and …. marketing…). So sales less wages then? This was pure bubble stuff. And there was a massive over-investment in nonsense websites. The .com crash which came with the millenium hangover and lasted for 3 years however did NOT result in a recession. Why? because interest rates kept being pushed down, from 7% just before the bubble burst to under 4 in 2003. 
As the mal-investment was shaken out of the lastminute.coms, and the share-bubble unwound, another was being stoked up in property and debt. One of the effects of lowering interest rates is an increase in the cost of debt securities. (you can argue about cause and effect…). Thus, it became more efficient as interest rates dropped with shares’ Price to earnings ratios, to finance a company through debt rather then equity. This is called “gearing up”. Meanwhile, governments responded to the booming property market by… relaxing controls on how much, and to whom banks could lend. “Getting people on the property ladder” became more important than bank capital adequacy. The laws and rules by which this was done on the two sides of the pond differed, but the effect was the same. Banks were actively encouraged to “innovatively” lend more to people backed by less, and less equity in the home, and less and less tier-one capital in the bank.
Risk compensation ruled the day: When banks were ruled by the Governor’s eyebrow, and the Old Lady of Threadneedle street kept an eye on the balance sheet, banks were safer. In the days of Basel II captial regime, RBS thought it could get away with a Tier one capital ratio of 5%. Nowadays 10-15% is more normal. This was acceptable because “Value at Risk” was calculated with reference to volatility. As volatility falls, the acceptable level of capital needed fell, leaving the system ever more vulnerable to systemic shocks such as the absolutely unlikely event of …. property prices falling….
Banks, which had got used to their being bailed out by the state by means of an interst rate cut, effectively outsourced risk regulation to the regulatory authorities. Whatever the regulator said was OK was OK. The banks then got on with lending “innovatively” to people with products like 105%, self-certification mortgages. Politicians encouraged this. Homeowners are more likely to vote, and vote for the party they credit with their “investment” in housing.
So. One bubble replaced another in the property market. And property market eventually popped, taking the banks with it. This led to the bubble ending up in the last place it can: Sovereign debt which is now so expensive, it’s paying a negative real yield.
Ultimately the reason for the crisis is that the USA and the UK did not have the recession which was needed in 2000. The mal-investment wasn’t purged, just moved. For recessions aren’t things to be avoided. They are inevitable and necessary. Like Eucalyptus needs the fire to germinate, recessions clear dying businesses and free the resources of capital and labour to new, more efficient, faster-growing businesses. The longer you prevent this process from happening, the more zombie companies you have lying around, able to service their debts, but holding onto Labour and capital which could be better used elsewhere. This has been Japan’s curse for twenty years. It remains to be seen whether this round of monetary cocaine (abenomics) will work. Without a cleansing recession to clear the mal-investment out of the economy, mal-investment just builds up until it becomes an intolerable burden of companies doing things of limited use, propped up by the state and banks.
This is ultimately why planned economies fail. Mal-investment can be sustained by political will until the economy’s making steel no-one needs in a gargantuan make-work scheme. This is the reason the USSR measured tractor production by … weight…. Even in the worst free-market system, there’s only so may places it can hide before the wheel comes off. The economic cycle is around 7-10 years. Even the Bible knew this. Mr Brown should have realised, as a son of Presbyterian preacher, he hadn’t abolished the seven fat and seven fallow years (Genesis 41:30) but instead put off the day of reckoning. (Isiah 10:3). It certainly wasn’t Margaret Thatcher’s fault, however fervently lefties wish it. It wasn’t only Gordon Brown’s fault, however much I wish it. The crisis did start in America, but the main people to blame for the crisis, however are idiot regulators and central bankers, who followed Mr Greenspan’s example.

On the Budget Housing Stimulus

The Government is planning to loan people significant money in order to find the deposit on a new-build house. Now. I think the major problem with the UK economy in the long-term is Britons’ habit of seeing a house as an investment, assuming “bricks and mortar” can beat inflation in the long run. Of course, if the supply is held below the growth in the number of households, as it is in the UK, this will be true. The result of this endless house-price inflation is no-one can afford a house big enough for their family, unless they quit work early enough to get on the Council house waiting list.

Thus house-price inflation keeps the existing rich, rich as wealth is transferred from non-home-owners to home owners. It also helps Labour’s client state, as they can never hope to afford to be free of the welfare state, thanks to the cost of putting a roof over your head.

The young, and those in the middle income brackets are forced to spend enormous percentages of their income on housing themselves. In response, houses have got smaller, people are more likely to share. In short, house-price inflation, like all other forms of inflation makes people poorer.

If you’re on the Right, you might point to the massive subsidy at the bottom distorting the market, housing benefit, which mainly transfers taxpayers’ money to private sector landlords. You might see cutting HB as a solution. If you’re on the left, you won’t see beyond Social Housing – basically demanding the council build more estates and manage them as a letting agent.

The real solution is to build more houses, so many in fact that house prices rise by less than inflation and keep doing this for a couple of decades. Unfortunately the two metrics on which a UK government is judged are unemployment and house-prices. Home-owners are vastly more likely to vote than renters, and are enormously exposed to this one metric. For this reason, and others all home-owners always vote against all development, anywhere, ever. So any politician who espouses the policies which will result in enough houses being built, will get voted out.

I am not sure subsidising lending to people with marginal deposits is the right way to go. But at least it’s only for new-build. And the fact that there’s no restrictions – aspiring private-sector landlords CAN apply for this funding (at least until they U-Turn on this) it might actually work to encourage a few more developments at the margin.

Of course what is really needed is a big easing of planning regulations, and a removal of the need for such huge percentages of new developments to be earmarked for Labour’s client state to be provided at cost (for this is what social housing is) which is holding back so much development. Without social housing, building would be more profitable, which means more would be done, without waiting for the land value to rise due to scarcity.

This is being SOLD as a means to “stimulate” the housing market and help buyers with a deposit. What it actually is, is a subsidy for developers and banks who’ll be able to lend at lower risk. I will result in a few more houses being built at the margin. It wouldn’t be my way of doing it. But it isn’t totally insane.

High Speed 2

There are plenty of reasons why High Speed 1 made sense: The Channel Tunnel should be linked to London by an equivalent high-speed line if the rail is to compete with City-Paris-Orly air route. I of course remain devastated that the trains from Paris no longer arrive at Waterloo station, which used to be a calculated and wonderful middle-finger to any Frenchman visiting London. However the new St Pancras international station is quite magnificent and streets ahead of le Gare du Nord, and it’s an easy change for me, as my London trains get into Kings Cross. This puts Paris closer for me than Leeds, Manchester, Edinburgh or even Birmingham. This sounds like an argument for HS2. It isn’t

The reason HS2 is going to be given the go-ahead are not the same reasons why it might be a good idea.

HS2 aims to link the North of England with high-speed rail links, putting Birmingham 2 hours, not 3 from London. The argument goes that this will save business time and money, and help the regeneration of Northern shitholes. This is utter bollocks. The evidence from Lyon and Osaka is that provincial cities have the life sucked out of them by fast rail links to the capital, as it reduces the importance of regional offices of national companies. It’s easier to do business in Birmingham with a London base. And unfortunately for Birmingham, the greater rewards of London mean that as it’s easier to do business in London, at the Margin, jobs and capital will be further sucked from the provinces to the capital as a result of high speed rail.

It will end up moving the commuter belt farther out along the rail corridor, to the detriment of the local job and economy. So HS2 will suck jobs and capital out of Birmingham leaving empty industrial parks and office blocks surrounded by sterile commuter “communities”.

HS2 will wreak this devastation at a cost vastly greater than increasing the capacity or extending the regular trains. Of course ministers and mandarins know this. So why is it going ahead?

  1. Mandarins and Ministers are overconfident in their analysis (guesswork) and think they know better than experience of other countries.
  2. Mandarins and Ministers are the kind of people who benefit from a shiny new train to and from London, as are the ‘business leaders’ who are also said to be in favour. They benefit, the cities don’t.
  3. Ministers need to do “something” about the economy and capital spending is seen as something. HS2 is therefore ‘something’, so it will get done.
  4. High speed rail is shiny and high-tech, and Ministers like to be photgraphed next to shiny modern and expensive bits of engineering.
These are not good reasons to spend billions of taxpayer’s money, especially when it makes the poor bits of the country poorer and the rich richer. 

Growth is NOT going to end.

In “Perfect Storm” the head of Research at Tullett Prebon, Dr Tim Morgan predicts the end of Western Growth arguing that the last 250 years were an anomaly of the industrial revolution, which is now over.

To summarise the argument, Morgan identifies four trends which will mean Growth is going to be anaemic or non existent for the long-term, all coming together in the perfect storm. These trends are 1) The benefits of the move away from human muscle as a primary source of power have been largely spent, and there are no further equivalent gains to be had. 2)We are at the end of a credit super-cycle which has been inflating a bubble for the last 30 years. 3) Policy-makers have been blind-sided by rubbish data, and 4) the west is vulnerable to globalisation.

He’s not even half right.

Let’s look at his trends in detail: First he suggests that the debt bubble is equivalent to the south-sea bubble or the Tulip-mania. The UK and US are enormously endebted. There was not just a vast increase in public debt, but also private debt too over the past 30 years.

Gordon Brown, for example, proclaimed an end to “boom and bust” and gloried in Britain’s “growth” despite the way in which debt escalation was making it self-evident that the apparent expansion in the economy was neither
more nor less than the simple spending of borrowed money. Between 2001-02 and 2009-10, Britain added £5.40 of private and public debt for each £1 of ‘growth’… Asset managers have a very simple term to describe what happened to Britain under Brown – it was a collapse in returns on capital employed. No other major economy got it quite
as wrong as Britain under Brown, but much the same was happening across the Western world…

While he is, of course right our economies are more indebted than ever before, the damage to the economy (or at least growth) from this has already happened. There was almost no private sector growth during the Labour years. Almost all the growth was due to immigration and increased public spending. Brown’s “boom” was merely a public spending spree, masking a recession which was already happening.

Much is made of the collapse of investment returns over the period. It’s almost as if that huge increase in public debt sucked investment out of the private sector!

That process reversing would explain the no growth, but rather solid employment numbers that we’ve seen recently. Meanwhile the private and corporate sectors have been busily using the low interest rates to deleverage faster than at any time in history. The good news is the UK and USA are not going to go the way of Japan, because instead of committing to ever more “stimulus” we’re all agreed on Austerity. Japanese debt now stands at 250% of GDP and they’ve enjoyed little growth in the last 20 years as a result. The Anglo-Saxon economies, in contrast have instead purged the bad debt from bank’s balance-sheets (incompletely, but better than Japan in the 90’s), refinanced, and hit the monetary nuclear button (Quantitative Easing) after 6 months, not 6 years.

Yes there’s a 30-year asset bubble to unwind. That’s not what drives real wealth. There is capital for innovative technology, so this isn’t going to stop the long-term driver of growth: productivity. Yes, we’re at the top of a 30-year bond bull-market driven by falling interest rates and falling risk appetites, and yes, interest rates will rise over the next few years. But the overall debt burden (including public, private and corporate) has already started to fall. Let’s not forget the South-Sea bubble and Tulip Mania didn’t derail western growth because the shape of balance sheets don’t ultimately drive long-term growth. Technology does. There’s no reason to suppose the credit crunch will do so in the long-run.

Next up, Dr Morgan channels the Socialist Workers’ Party by suggesting globalisation is a disaster for the west because it’s sucked “production” out of our economies. This is pure “manufacturing is special” wibble. Globalisation has, of course been a boon for Chinese wages, and as a result the phenomenon of offshoring jobs has run its course. Western manufactures now cost about the same, when the extra transport and extended supply-chain of Chinese manufacture is taken into account. Meanwhile, the Chinese, vastly wealthier than they were a decade ago thanks to offshoring, are now clamoring for Jaguars. We’ve created a market for the high-value manufacturing and services which never existed before. We in the west aren’t producing less – the UK is a net exporter of cars for example – we just employ fewer people to make more.

The big problem with globalisation was that Western countries reduced their production without making corresponding reductions in their consumption… 

Morgan makes the standard pessimist mistake. Making things we can drop on our feet with fewer people means those people not hammering metal in Birmingham car-plants can train to be lawyers, or web-designers instead. We get cars AND websites. We’re richer. We don’t need to cut our consumption, or at least not as much as Morgan thinks we do.

In the interface between these first two trends Morgan identifies, there is a glimmer of truth. Because much of the growth in the noughties was debt-financed and ephemeral, we simply weren’t as rich as we thought we were in 2008. The recession is the process by which we cut our expenditure to meet our income. Great. The economy is healing itself, and has been doing so for the last four years.

Any economic historian could tell you that recoveries from balance-sheet recessions are always slow. The credit crunch was the mother of such, and so the slow growth subsequently is not exactly unexpected, however unwelcome. The enormous private and corporate deleveraging, combined with public sector Austerity should, if the Keyensians are right trigger a depression. The fact that growth is merely flat should be grounds for optimism.

Trend 3) is that the financial statistics used are a grand exercise in self-delusion.

The critical distortion here is clearly inflation, which feeds through into
computations showing “growth” even when it is intuitively apparent (and evident on many other benchmarks) that, for a decade or more, the economy has, at best, stagnated, not just in the United States but across much of the Western world. Distorted inflation also tells wage-earners that they have become better off even
though such statistics do not accord with their own perceptions. It is arguable, too, that real (inflation-free) interest rates were negative from as long ago as the mid-1990s, a trend which undoubtedly exacerbated an escalating tendency to live on debt.

I’ve long argued the current recession’s seriousness is the direct result of Governments’ efforts here in the UK and in the USA to use public debt to prevent a recession which should have happened in response to the .com crash in 2000. There has been little private sector growth in the UK from when Gordon Brown turned on the spending taps in 2000, to the crash of 2009. Furthermore, the use of CPI (which doesn’t include house-price inflation in the inflation number) and failure to deal with the known problems with RPI, left were handy fictions in the public data. This probably massaged the true figures down, helpful to government, which stealthily cuts people’s real incomes. There’s more: open abuse of the disability benefits and education system was used to massage the unemployment numbers.

But you’re not really surprised that I’m sympathetic to the idea Government and bureaucracy will indulge in self-serving self-delusion, are you? The good news is the Coalition has addressed some of these problems.

Because of this tendency for bureaucracy to indulge in self-serving lies, they pose the biggest risk to western growth. Increases in wealth are, as Morgan correctly observes, all about productivity growth. Where is productivity growth weakest? In the public sector which operates without competitive pressure. And which part of the economy has been growing the most for the last 15 years? That’s right: the Public sector. It may take a decade of cuts and austerity for this trend to be reversed, but that’s why I’m optimistic. Europe, the USA and UK have all made a start on trimming the burdens a much-derided but absolutely correct policy of Austerity. The EU is imposing Austerity on the nations with the biggest deficits, and the US fiscal headbangers of the Republican party are using the debt ceiling to impose a modicum of sanity on an unwilling president and the coalition is making cuts to services.

Shrinking public sector headcounts may be hurting GDP growth in the short term, but this is bringing the economy back from the debt-financed insanity. It may take a while, but unlike Japan, we seem to be willing to face the reality. Japan’s experience shows clearly the party cannot be made indefinite.

It’s the final trend: that the growth engine is winding down which is the weakest in the whole piece, yet forms the basis of the conclusion. Morgan suggests the growth which started with the industrial revolution is spent. He’s wrong. The heat-engine: Steam and internal combustion power, hasn’t even been fully deployed around the globe when a billion people are still using the ox-plough or digging stick. We’ve not deployed the technology of the 18th century to the world. There’s still economic growth from crop-rotation, something which was cutting edge when Europe was recovering from the Black death.

Furthermore Morgan suggests there is no further equivalent growth to come. He’s wrong. We’re only just scratching the surface of what telephones for example can do for growth, let alone computers. Less than 10% of humanity has access to the internet, and that 10% hasn’t yet worked out how to use pocket devices with access to all the world’s knowledge available generate money.

The idea there’s no growth to come is just laughable. The agricultural revolution and industrial revolution aren’t even over. The telecoms revolution has barely started, and the information revolution is just a glint in the milkman’s eye. There’s two-centuries of growth for humanity right there. And that’s before we start harnessing fusion power, driverless cars, abundant solar energy or whatever we come up with next.

Anyone who says “this time it’s different” on the way up is wrong. The same is true on the way down.

The only unlimited resource is human ingenuity. That’s why I’m an optimist, tempered by cynicism about Government’s motives and competence. Simply by applying what we already know to those who don’t, we can drag the billions currently in poverty out of it. Even better, when Governments facilitate rather than control the process, we can all get rich doing so. Globalisation isn’t a zero-sum game. Innovation is happening. The credit super-cycle is being addressed (everywhere except Japan). The only thing I’ll agree with  Morgan, is that the public data is rubbish and so too was Gordon Brown.

The Economics of Online Dating, Poker & Bingo.

One of the things that interests me about economics is how people make money out of new technology. The printing press was used at first for political pamphleteering  one sheet arguments, easily produced and distributed; and Bibles in the vernacular. This led directly to the reformation and the subsequent two centruries of war, as the people, rather than just monks, debated how many angels could, in fact, dance on the head of a pin.

This power to distribute ideas, previously the preserve of an ecclesiastical and political elite, was enormously disruptive. The same is true of all other information distributive technologies – Radio and TV were at first controlled tightly by the powers that be, then regulation relaxed. People started hearing what they wanted – rock and pop rather than what the authorities wanted them to hear. The same is true with TV. ITV started the rot, and we’re complete with the broadcast of ‘Celebrity wedding planners’.

Finally we come to the internet. And the triumph of the medium over the message. The money is made by the owners of the forums, not the people producing the content. Other than that it’s a free-for-all with a distinct winner-takes-all flavour. Why did Amazon win the battle of the online retailers? Probably more luck than judgement  Why did Facebook beat MySpace? What happened to Friends re-united? Once dominance is established though, can we really predict how long it will last. Perhaps the cool kids are already migrating to Twitter. Perhaps the dominance of Facebook is already over. Who knows? The shares have certainly responded to Facebook’s challenge to Google in search, so perhaps even Google’s dominance there might be ephemeral.

I suspect the real losers of the internet will not be the established newspapers and retailers, whose online brands may well survive, and whose brand equity will be useful in maintaining market share in a ‘goods unseen’ environment. The real losers will be casinos, crippled by regulations which simply don’t apply to online poker or bingo. Interesting the cost of doing business is probably the cost of acquiring players. You can tell this by the amount of advertising they do. Once scale is achieved, then payouts can improve, in a virtuous circle of scale vs. relatively fixed costs. Judging by the adverts for online Bingo in particular, I guess the barriers to entry are low.

The other joyous thing about the internet is that much of the stuff that makes money – online dating, gambling, networking, and advertising does so without much interference with regulations. They provides a beautiful resource for economists and sociologists to see what people actually do, rather than what the powers that be or enforced social norms want them to do. We can explore people’s propensity to take risk – financial and otherwise – with huge volumes of anonymised data. We can see what people’s mating preferences are as opposed to what they say they are. Possibly the greatest gift the internet will give is the data to better understand ourselves.

Chancellors and Recessions

The greatest lie in politics is that economic growth is in the Chancellor’s gift.

Because the economy is usually growing, it pays for chancellors to claim credit for it, but this is just Game Theory. As soon as it starts shrinking, the opposition start shouting about how the “chancellor’s failed”. They’re both lying to you (and probably themselves too). Chancellors do influence the economy, but more subtly than the simple -/+ve GDP growth number.

I did not credit Brown for the boom, which was global, I did not blame him for the recession, which was global. I do blame Brown for the deficit, or at least that part of it which isn’t automatic stabilisers and bank-bail-outs, but that is NOT the same thing as the recession. I do not blame Brown for the boom and bust because in the main, I don’t think the business cycle is particularly amenable to manipulation by chancellors. And insofar as they are able to influence GDP growth, I don’t think this is the Chancellor’s main role.

So what are chancellors for? Even Gordon Brown knew this: to balance the budget (or nearly so) over the business cycle. This was his “Golden Rule” (remember that?). In this, he failed, spectacularly. This is not about the bank bail outs – that bit of the deficit from 2008/9 is fine. While I disagree with Brown’s policy to bail the banks out, but I don’t regard the policy as idiotic: it’s certainly one of a number of possible solutions to a genuine problem. My problem is with the growth in state spending from 35% of the economy to 50% in 13 years, the over-complex tax-code (which is giving so much wiggle-room to “avoiders” right now) and the borrowing during the boom to fund a worthless army of state apparatchiks, which is causing so much pain now. In running a structural deficit to fund a massive expansion of state employment, Brown weakened the economy, removed the room for manoeuvre when the inevitable bust came, and arguably made the inevitable recession deeper when it did, and the resultant recovery slower.

So Chancellors do have an effect on the economy, but it’s far more subtle than “is the economy growing?”.

The longer the boom, the more painful the bust, and the UK enjoyed 16 years of economic growth (which started under the Tories…). Some of Brown’s policies may have prolonged the boom – the UK version of the Greenspan Put certainly contributed to financial recklessness, but it was an approach shared by the USA and elsewhere. I doubt a Tory chancellor would have done much different. Ever cheaper money certainly contributed to the housing price bubble which has arguably not yet deflated. Even with all that cheap money, the biggest boom was in the state sector, where almost all the net new jobs of 13 years of Labour rule were created.

It is this army of state apparatchiks which kept the boom going, giving the impression of growth, where the private-sector had stagnated long before 2008.. Cheap money and diversity outreach-coordinators can only manipulate the GDP numbers for so long. And it it this Army of state apparatchiks being culled en-masse which forms the biggest component of “austerity”. Yes it hurts for the PCS and UNITE to lose so many members, but those UNITE members are handing in their membership cards and joining the growing Private sector. Even during a slump, which Labour will tell you is the worst since the war, as soon as the Public sector stopped hiring, the private sector started. It’s almost as if there was something in this “crowding out” theory. True many of these new capitalist running-dogs are “under-employed” self-employed or part-time workers, but these are the seed-corn of the next generation of small businesses.

So. Gordon Brown can arguably have made the current recession worse with his policies. And George Osborne’s austerity might at once be slowing growth in the short term, and also be necessary. Just because sacking civil servants depresses GDP, it does not follow that not sacking them is the right thing to do. GDP growth does NOT generate lower deficits when that GDP growth is simply deficit financed spending on worthless, return-free state prod-noses.

In the parts of the economy where the state is dominant, the recession is brutal. Jobs are non-existent. In London and the South-East where the state is relatively small, people are saying “what recession?”. Just as Labour’s boom was an illusion created by a chancellor gaming (deliberately or accidentally) the GDP number by splurging money at the public sector, this “double dip” is the result of a chancellor (in my view) doing the right thing in attempting to balance the books and reign in a state-sector which had been growing over-mighty. When winds of austerity stop blowing through the public sector, we will be left with an economy carrying a much, much smaller burden of state jobsworths, with a lot of under-employed people in the private sector. This sounds like a recipe for growth to me.

The other lie politicians tell is the deliberate confusion (by both sides, when it suits), of debt (the size of the mortgage, if you like) and the deficit (the amount extra borrowed each year to cover income shortfalls). The deficit is falling, yes, slower than expected or desired, but it is falling from nearly 12% in 2010, to 6% now. This doesn’t look to me like “failure” on reigning in the debt. However thanks to Ed Balls’ former master, we still have a deficit therefore the debt is rising. Pointing out that the UK is borrowing more now than it did 5 years ago is just dishonest. It is obscene chutzpah from Balls to blame Osborne for failing to deal with what was, and remains the biggest deficit in the western world in just two years,when the biggest part of the extra borrowing is … wait for it… debt interest. The solution to this growing part of Government expenditure is not Ed Balls’ solution of “investment” (by which he means ‘spending’). It involves driving interest rates down, and hoping inflation does the work for you.

The point is the boom pre-2008 wasn’t as good, and the bust post 2010 isn’t as bad, as the politicians or the GDP numbers would have you believe. GDP numbers are a lousy way to judge a chancellor’s performance.