Aamer Sarfraz: Other countries have started work on digital currencies. It’s time the UK got going too.

13 Apr

Lord Sarfraz is a Conservative member of the House of Lords and a Member of the Science and Technology Committee.

Today in the House of Lords, I will be speaking about a digital pound. Specifically, on this occasion, I will be asking the Government what assessment it has made of a UK Central Bank Digital Currency (CBDC).

There is already much thinking that has already gone into this. The Bank of England’s CBDC discussion paper, published last year, started the ball rolling for a digital pound.

A digital pound, backed by the Bank of England, could be a major win for individuals and businesses. With a digital pound, held in an electronic wallet, many bank fees could be eliminated, and foreign currency exchange risks substantially reduced. Importantly, such a currency could compete with Bitcoin’s market share, which currently stands at approximately US$1 trillion. It is estimated by the FCA that 1.9 million adults in the UK already own cryptocurrencies, and this number is growing.

A successful digital pound will need to be built with the right technology. The Bank of England has several options, including using a decentralised distributed ledger, like other cryptocurrencies. However, the very principle of “decentralisation” will not come naturally to any “central” bank. Most importantly, central banks will need to work with each to ensure their various CBDC’s operate on the same technology standards. Otherwise, we will have the same problem we have with fiat – a pound note doesn’t fit in a US vending machine.

Other countries are already forging ahead with plans for a digital currency. Japan’s Central Bank has launched a one-year digital currency trial this year. Furthermore, this week the Chinese government has officially started to issue digital yuan to 750,000 recipients. Other central banks around the world are also experimenting with digital currencies of their own. There are already several GBP-pegged stablecoins in the market. We now need to pick up the pace on a Bank of England issued digital currency.

Alongside issues of supply, there is clear demand for stable digital currencies. Tether, a stablecoin pegged to the US dollar, already has a US$45 billion market cap. However, CBDC’s will not mark the end of Bitcoin, nor should that be our objective. Bitcoin will still be the “people’s digital currency”, uninfluenced by central banks or governments. Without the success of Bitcoin, we would never have been thinking about a digital pound in the first place.

The rationale for the emergence of a digital pound is that the current banking system has several drawbacks. Over the past few decades, commercial banks have diversified their revenue sources.  As a result, “non-interest income”, mostly in the form of bank fees, have become an important source of income. Bank fees are charged on all sorts of things – account maintenance, overdrafts, cashier checks, reference letters, returned cheques, and wire transfers to name a few. There are entire online comparison sites helping consumers navigate bank fees.

Individuals making or receiving overseas payments, and those travelling overseas for both business and pleasure, get hit especially hard. They are faced with foreign currency losses (often twice during a trip – on departure and return), foreign ATM fees, traveller’s cheques issuance fees, fees for sending or receiving money, and fees for overseas transactions. Similarly, businesses that are buying and selling overseas, have to manage foreign currency risks and pay substantial transaction fees.

While some challenger banks are doing a good job reducing transaction fees, many still earn considerable non-interest income. They would say, quite rightly, that regulatory and compliance costs have skyrocketed, which result in the need to find additional sources of revenue.

A digital pound could be even more powerful when combined with smart contracts. Take the example of trade finance. In today’s archaic system, international trade is entirely dependent on banks, without whom costly letters of credit – the principal instrument in import and export – cannot be opened. Letters of credit were used by the Medici Bank in the 14th century, and are still in use today.  A smart contract, programmed into a digital wallet, could mean importers and exporters could use their digital pounds to conduct trade without banks.

Any solution afforded by the emergency of a digital currency would be part of the UK’s burgeoning fintech sector. The UK has already established a strong fintech sector and it could become even stronger. It has built on the UK’s historic strengths in financial services, which contributes an estimated £132 billion to the UK economy, corresponding to 6.9 per cent of the economy. The UK’s fintech market generates over £11 billion in annual revenues, and claims 10 per cent of market share globally. It is no surprise that 71 per cent of all British people interact with at least one fintech, which is higher than the global average of 64 per cent.

The Kalifa review reported in late February proposed five key recommendations. One of those was focused on creating a new regulatory framework for emerging technology, and this would include virtual currencies. The report’s author explained: “Fintech is not a niche within financial services. Nor is it a sub-sector. It is a permanent, technological revolution, that is changing the way we do finance.”

Fintech has already brought benefits for people in everyday life, and the UK has become a particularly strong hub for its development. Looking ahead, a digital pound could bring benefits for both consumers and businesses and the UK must move faster in exploring the mechanics and regulatory system of such an innovation.

Matt Kilcoyne: Vaccine certification is an idea that should be allowed to sink or swim in a free market

31 Mar

Matt Kilcoyne is Head Of Communications at the Adam Smith Institute.

Since vaccines started being approved by British regulators at the very end of last year, the country has undergone a psychological transformation unlike any in my lifetime.

From fear of an unending cycle of lockdowns and limited freedoms came news from one Kate Bingham. Her work gave purpose to the privations that were coming, helped all of us that kept faith that there would be end to this disease by human ingenuity and within time to mean our actions to save lives, avoid economic scarring and adaption to a non-normal economic situation that would then have to be readjusted to soon after at even further cost too.

Given the mortality rates we’ve seen across the world and even here with extensive curtailment of our ancient liberties, it is reasonable to say the number of lives Bingham has saved alone will number in the tens if not hundreds of thousands and given greater evidence to the rightness of the choice to retain the jobs held in stasis by Bank of England furlough scheme.

These people and jobs saved through her tight and spread-bet pre-purchase agreements and the use of Britain’s comparative advantage in legal agreements, trade credit and other forward payment mechanism, and experience dealing with and preparing for rogue states that shut down exports or expropriate private property mean I fully back calls for Bingham to be elevated to a Duchess should it please Her Majesty.

The change in the psyche and morale of the British people her decisions enabled means that Cabinet can take positive decisions of true gravitas in a time of true national and international crisis. This requires careful and assured action. It might require prompt, wide impacting, and sensitive personal and national topics.

It could, let’s say for the sake of argument, include things like vaccination certificates for Covid. The idea hits all the right buttons to rile everyone in such divergent ways that they’ll talk past one another and fail to see the issues that are being discussed, why, and what is actually being proposed.

The first thing to say is that you personally have a right to full knowledge of medical data and records that are kept on you, assuming you are of appropriate age and sound mind. The governments within the UK have a near monopoly of service provision for healthcare save for all the private GPs that actually have a local duty of care to you to hold and maintain your personal records. They also can, via their contracts of supply and commissioning of care of other services with the NHS and associated parts, pass data onto third parties with your consent.

The lack of a series of principles over the free use of data between consenting individuals and third parties, and the lack of direction even by government towards the suitability or otherwise, never mind the likely legal consequences of using the data of vaccine take up to determine suitability of access to new or existing roles.

In the space provided by a lack of determination in good time, trade associations burned by huge restrictions announced against their members’ interests and often provided with evidence after the event with the scope and scale of restrictions decided by committees rather than parliament in the primary role.

All action must now and in future, and should’ve been the case throughout the pandemic, be based upon scientifically testable hypotheses, all the reasoning deduced and relied upon and all assumptions set out.

It is telling of a lack of trust between governed and government that pubs do not trust the word of a party that prides itself as being one of business to promote policies as we get back to the business of living that would enable them as far as possible now they’ve jabbed enough arms to reduce risk of reinfection and mortality.

Laws from now should be freedom-oriented to remind Tory voters that actively value the ability to enjoy the things that make life worth living they will be able to enjoy them. Around 20 per cent of publicans say they want to access punters and staff for proof of vaccines to ensure their, their staff and all of their families’ health.

The Government’s role here is to ensure that individuals have access to the ability to consent to their records being displayed by an accredited source (whether just their GP signing and by word of their bond confirming, or a company that facilitates access that across multiple GPs in a usable format for other firms without contravening data protection rules).

We know well the issue of mission creep with ID cards a totemic Tory issue after the defeat of Tony Blair’s flagship policy and David Davis’ whole career centred around civil liberties. But this is a facilitation not a coercion or anything mandated. Even if Blair is a principle agent of the campaign to promote their use — and I share concerns about the number of meetings he has had with serious ministers and civil servants on the topic given a the financial gain any company could get from providing either national or international accreditation of such valuable information on behalf of an individual. And elsewhere yellow fever and rabies certificates are in use regularly when crossing borders. Nigeria could teach us a thing or two about digital storage and transfer of said data and forgeries still emerging.

Government can signal intent on rejection of mandate by declaring it will not check status upon leaving the country or ahead of access to existing NHS services. The areas where people will encounter officialdom most keenly.

Liberalism demands freedoms to associate and self organise, and Conservativism demands the liberties of the individual by upheld by institutions acting in their care. Vaccine certification is actually a simple idea that should be allowed to sink or swim in a free market. Let’s let them, and keep an eye on vested interests with cosy relationships benefiting friends for sure. But let’s enable anything that let’s us live our lives again.

Ryan Bourne: Are fears of a return of inflation overblown?

16 Mar

Ryan Bourne occupies the R Evan Scharf Chair for the Public Understanding of Economics at Cato, and is the author of Economics In One Virus.

“Inflation is coming” has been the perennial warning of conservative commentators over this past decade. After the financial crisis, it was feared that quantative easing would generate a sharply rising price level. Now, Rishi Sunak is kept up at night by the prospect of an inflation spike. Columns forewarning of one are increasingly common. Even some of the high priests of macroeconomic dovishness, such as Larry Summers and Olivier Blanchard, are sounding the alarm.

s this time different? And how worried should we in the UK be? When thinking through the economics we must unpack three related but different issues: Covid-19 price changes, the overall level of prices, and ongoing “inflation.”

Covid-19 price changes

As the economy reopens, certain sectors will see pent-up demand meet constrained supply. A lot of entertainment venues have gone out of business following a year without activity, for example. A freshly vaccinated public may suddenly be keen to go out and spend after June, despite less capacity in the sector than pre-crisis.

The flexible prices in such industries could therefore see sharp upward price volatility, with new entry taking time to reverse these relative price spikes. The scale will depend on whether demand peaks in a “big bang,” or if there is a gradual transition to whatever “normal” now is. But for a returning public, this will feel very much like a substantial cost-of-living increase.

The Price Level

“Inflation,” though, is “an ongoing rise in the general level of prices.” It is, as Milton Friedman famously said, a “monetary phenomenon,” seen when the money supply increases more quickly than the supply of goods and services. Here, the risks do look different to after 2008.

During the global financial crisis, the money base increased more than four-fold, but broader money supply measures (e.g. M2) barely changed.

Since the beginning of the Covid-19 pandemic, however, not only has the money base increased dramatically, but M2 has increased by over 25 per cent. This hasn’t “stimulated” higher overall nominal spending, since people have been unwilling or unable to engage in certain activities, leading to a sharp fall in money’s “velocity.” As velocity rebounds, extra funds circulating again will likely raise the price level as activity begins (i.e: we will see a “one-off” increase in prices, feeding through over a number of years).

This could see inflation temporarily running above the Bank of England’s two per cent annual target. Indeed, despite current CPI inflation at just 0.7 pe rcent, British macroeconomists believe the forecasts tilt upwards.

Asked which scenario was more likely to hold “on average” for the next decade, 37 per cent of Centre for Macroeconomics economists surveyed said inflation would be on target. But 41 percent said that the Bank of England would either “allow” or “wouldn’t be able to avoid” inflation exceeding its target (just 15 per cent thought inflation would be “allowed” or would inevitably remain below two per cent).

Whether inflation exceeding that two per cent target is considered a “bad thing” really depends on two individual judgments:

  • Whether “inflation targeting” is really the appropriate goal for monetary policy, or instead whether a level target for prices or nominal GDP is preferable, and;
  • Whether a period of significant inflationary pressure could or would be swiftly eliminated by the Bank of England afterwards without negative consequences.

The UK experienced a very dramatic collapse in nominal GDP last year, including a fall in inflation below the Bank’s inflation target. If one believes optimal policy maintains steady increases in the price level or in the level of nominal GDP over time, then a post-crisis overshoot of the inflation target in the service of returning to trend may be desirable. The Bank wouldn’t therefore need to drastically adjust policy, but could “look through” this price level uplift, aiming for the two per cent inflation target in the longer term.

Longer-term inflation

What would obviously be problematic is were the broader money stock to continue growing faster than trends in nominal GDP or desired inflation, generating sustained higher inflation. Few doubt the Bank of England would have the tools to choke this off.

So the questions that arise from this possibility really are,

  • How much damage would be done if above-target inflation altered inflation expectations in the interim? an
  • Would the Bank of England be willing to bring inflation back to target even if it meant the government’s debt service costs spiking?

Economists such as Summers, scarred by the 1970s and early 1980s, believe it “naïve” to think the alternative to a low inflation world is a modest inflation world with the promise of future low inflation.

Playing with significantly above-target inflation for a time can instead help create a high and variable inflation world. If people feel and so come to expect higher inflation, they start shortening contracts, demand cost-of-living adjustments, alter the balance of their portfolios away from non-interest bearing assets, and delay certain investments. This can make the economy less efficient, and entrench the combination of slow growth and high inflation.

It previously took painful efforts to “re-anchor” inflation expectations and cement central banks’ monetary credibility. So is this credibility at risk again?

There have been some recent jitters, but as yet little sign of widespread concern here. Inflation expectations jumped swiftly to 3.8 pe rcent in December, but have since fallen back to normal levels. Expectations implied by inflation-protected gilts predict inflation will exceed its target over the coming decade, but again are not historically abnormal. Recent increases in gilt yields are more likely to reflect the expectation of a more robust recovery than large inflation concerns.

Obviously, we should be cognisant of fears of how high government debts, or political pressures to change central bank mandates, can corrupt price stability. Certain historic episodes have led to “fiscal dominance,” with central banks prioritising keeping governments’ debt servicing costs low over price stability. The U.S. has officially changed its mandate with an asymmetric bias towards lower unemployment. Any change to the Bank of England’s official mandate, or even just prolonged above-target inflation, could risk fears of monetary policy here being driven by fiscal concerns about debt servicing costs or 1970s-style desires to try to push unemployment lower too.

But as yet, again, should the UK doubt its institutions? Andrew Bailey hasn’t said anything suggesting that the Bank would ignore sustained inflation. The Chancellor, if anything, is too eager to close the deficit through damaging business tax hikes because he fears the inflation risk—something that paradoxically could worsen near-term price level pressures by choking off investment in productive capacity as spending rebounds.

All this means that I think the current fears are overblown. But, yes, the broader context requires longer-term vigilance – the balance of risks on inflation, driven by economic and political trends, has definitely shifted.

Ryan Bourne: A reassuringly conservative speech from Starmer’s Shadow Chancellor. The Tories will need to up their game.

20 Jan

Ryan Bourne is Chair in Public Understanding of Economics at the Cato Institute.

Just in case the Conservatives hadn’t got the message: Labour under Keir Starmer is a very different beast to the party under Jeremy Corbyn.

Dueing the past fortnight, the Labour leader has parked his tanks on conservative lawns, talking first of Labour as “the party of the family,” then setting out a foreign policy vision of the UK as a “bridge between the U.S. and Europe.” Annelise Dodd’s Mais Lecture on economics was perhaps more striking still in the break of tone and type of criticisms made of Conservative policy compared with the last leadership.

Gone were the unhinged attacks on “neoliberalism” that characterised Corbynite bloviating. The fault-finding was specific and targeted. Dodds acknowledged the difficulties any government would face in a pandemic. Her surgical critique was that the UK’s Covid-19 outcomes were worsened by government foot-dragging on tightening lockdown restrictions, and Treasury attempts to fine-tune the balance between economic and public health.

Specifically, she claimed that its mixed-messaging on financial support to businesses, first delivering it and then threatening to withdraw it based on firms’ “viability,” created needless uncertainty. With the vaccines hopefully soon ending the pandemic, she argued that supporting firms until reopening was now more prudent than letting the chips fall when furlough ends in Spring. On the balance of costs and benefits, most economists would probably now agree.

There was little Corbyn-like wailing about past “austerity” either. Dodds’ criticisms of the last decade of government fiscal policy were restrained, and more plausible for it. She claimed that some spending cuts may have adversely impacted the pandemic response; that 16 fiscal targets coming and going since 2010 has created instability; that there should be more focus on the long-term public finances rather than the short-term; and that rapid deficit reduction coming out of the pandemic (including tax hikes, as Rishi Sunak reportedly wants) would be economically destructive. All these criticisms, individually, would not be surprising in ConservativeHome op-eds.

Yes, Labour still wants a bigger state than the Conservatives. Yet unlike many on the Left, Dodds appears under no illusions that running up debt is riskless or a free-lunch. “…it would be an irresponsible economic policymaker who planned on the assumption that low interest rates will continue indefinitely,” she said, while musing about a longer-term inflation risk. Her new “fiscal framework,” focused on planning to balance day-to-day spending and tax revenue, would be based on the recommendations of the Institute for Fiscal Studies.

Now none of this is particularly exciting. The speech was littered with boilerplate progressive assertions and the usual touching faith in the power of government. But it’s telling that Dodds actively shirked the opportunity to announce some glitzy new retail offer to grab newspaper headlines. There was no promise even of a Labour government “creating” high-wage jobs, or “transforming” the economy.

Instead, the speech was quintessentially small-c conservative. Labour, we were told, would protect the independence of the Bank of England, be “responsible” with the public finances, embrace free trade, protect businesses from Covid failure, focus policy on thorny structural problems rather than chasing day-to-day media coverage, and deliver “value for public money” from government spending.

Indeed, peer through the mundane parts of the speech, and you see a rhetorical critique of the current government that wouldn’t have looked out of place coming from Conservatives a decade ago. Dodds’ subtle message was that government decisions on infrastructure and procurement contracts were often determined more by short-term, pork-barrel political considerations than sound economic judgment, bringing with them at least a whiff of crony capitalism.

The speech highlighted waste and mismanagement through Covid-19, for example, including on the test-and-trace programme and the purchase of faulty antibody tests. Any errors are more forgivable in a pandemic when there were potentially huge returns on such investments and time is of the essence.

But those types of criticisms will likely amplify with Conservatives’ newfound penchant for large regional infrastructure projects (prone to massive cost overruns) and place-based revival packages (prone to political cronyism). Again, the argument that Conservative economic decisions are politically-motivated and wasteful is a very different attack than the more ideological opposition from Corbyn and McDonnell.

None of this is to say that all of Dodds’ analysis is coherent or correct. The theme of the speech was “resilience” – that is, how the pandemic shows the need for an economy robust to future shocks. Mercifully, Labour has not jumped on the bandwagon of saying the pandemic proves we need the government to actively re-shore a whole bunch of medical manufacturing production—the braindead, yet widespread “fight the last war” recommendation of those unable to conceive of shocks originating here. Yet there was still a bit of a “this crisis proves much of what I’ve always believed to be true” about her analysis.

Dodds suggested, for example, that a lack of savings among the poor, job insecurity among gig economy workers, and “socio-economic inequality” all help explain Britain’s poor Covid-19 outcomes. Perhaps on the margins those factors did make things worse. But the overwhelming reason why the UK has performed badly so far relative to countries such as South Korea, Taiwan, Australia, and New Zealand, is surely little to do with the labour market or macroeconomic policy, and almost entirely explained, to the extent that policy can actually explain things, by public health decisions at various times.

It is within Labour’s comfort zone to say reducing inequality and strengthening workers’ rights would have mitigated the costs of this pandemic. It would have been braver for them to expose failures in government bodies: say, Public Health England, whose centralisation of testing proved a disaster; or the NHS, with its systemic rationing reducing the incentive for spare capacity; or government scientists, who downplayed the early need for tough measures and told people mask wearing was unnecessary. If they really want “resilience,” they would surely explore the future case for deregulation in medical innovation. Earlier human challenge vaccine trials, for example, could have sped up delivery or a working vaccine, negating much of the last year’s pain.

Such a broad evaluation was perhaps always too much to hope for. But this speech proved that Labour is developing a more refined critique of the Conservatives. This is not the sort of emotional “blood on their hands” or anti-capitalist screeching we saw from Corbyn’s Labour.

Instead it is a crisp focus on the need for decisiveness, competence, and propriety in delivering effective government. The upgrade in opposition may well, in time, sharpen government decision-making. But a party with half-baked plans to rebalance the economy through massive infrastructure projects and shifting around government departments, led by a Prime Minister known for making late calls, may find such criticisms difficult to shake off.

Neil O’Brien: How can we make the economy grow faster?

14 Dec

How can we make the economy grow faster? That’s going to be a big question in 2021 as we bounce back from an unprecedented recession, and start trying to make up lost ground.

There’s lots of things we need to look at. Obviously the big questions are about whether we get an EU deal and how fast we recover from the virus. But one of the other places to look is how we turn our savings into investments.

Rishi Sunak’s clearly interested. Recent weeks have seen him announcing a new infrastructure bank; reviewing Solvency II (regulating insurance firms investments); creating Long Term Asset Funds and extending a tax break to encourage investment. During his first weeks as Chancellor, he mandated the Bank of England to work on “the supply of productive finance, in all regions and nations of the UK” to “assist the Government’s levelling up agenda.”

They’re all welcome moves, because this is a huge issue for the UK.

One recent review noted that “the proportion of UK start-ups which scale into large businesses lags significantly behind the US”, and lots of start ups complain about access to finance. From a macro point of view, Britain has long had a lower stock of capital than other similar countries – at least when it comes to tangible, physical stuff. More machinery, better IT, more automation and stronger infrastructure would help us be more productive.

These are long-running challenges. Previous attempts to address them include the Myners Review (2001), Kay Review (2012), and Patient Capital Taskforce (2017) plus various select committee reports.

So what might be getting in the way of successful matchmaking between opportunities and funding?

1) Regulation and market structures

Riskier, longer term investments have higher returns. Pensions, banks and insurers face complex rules governing their investments, to control the share of their investments in such things.

In some cases, UK investors are putting less of their money into these growth areas than firms elsewhere. As Anna Sweeney from the Bank of England notes, “UK insurance companies only allocate around two per cent of their assets to unlisted equity. This is a smaller share than many of their European peers.”

By reviewing regulations like Solvency II, as the Chancellor is, we could refine the rules to safely enable more growth, not least because it was designed to fit the EU as a whole, not tailored to each country. We could also reshape regulations to make it easier to invest in long term funds. That’s the thought behind the plan to create Long Term Asset Funds.

And on top of the regulations, there might be related factors we could fix. As the Bank of England Financial Stability Report notes, the current industry norm is to value pensions (a long term investment) in ways that force them to behave like short term investors: “Daily trading and pricing is also common practice for [Defined Contribution] schemes, which is another constraint on investment in illiquid assets.”

The Bank should be prepared to act radically: tackling these barriers could mean more money for long term investment and more in your pension because of it.

(2) Public listed companies & short termism

We shouldn’t be too doomsterish about short termism. Plenty of money is being piled into tech firms that have never turned a profit, so clearly there are investors out there prepared to wait and accept risk in the hope of a good return.

But there is a real problem, particularly for public companies. It’s striking that privately owned companies invest somewhere between four to eight times more than public listed companies of the same size.

There’s long been concerns that relentless quarterly scrutiny of returns faced by public firms pushes managers towards short-termism: cutting investment in R&D or entry into risky new markets means profits will be better today, but worse tomorrow. But if your remuneration is based on your share price today, its tempting to go short term.

Managers agree there’s a problem: A survey of over 400 executives found three quarters would give up a project with a positive value in the longer term to smooth out earnings.

Investors agree too: in a CFA Institute survey of European investors 70 per cent said short-period evaluation cycles by asset owners are an impediment to long-term investing. Two-thirds of members of the National Association of Pension Funds said investment mandates encouraged short-termism.

If the investment gap between public and private firms reflects short termism, the economic costs of it would be pretty huge. As a paper by Andrew Haldane, the Bank of England’s Chief Economist and others, notes: “the elimination of short-termism would then result in a level of output around 20 per cent higher than would otherwise be the case.” That’s a big number.

Trying to escape short termism has led to two trends.

First, more and more public firms being taken private. “Public-to-private” deals where publicly-traded firms are taken private, plus fewer public listings (at least until this year), has been leading to “de-equitisation”. Across the US, UK and Eurozone the number of public listed companies has declined. But publicly listed firms remain a huge part of the economy, so if there is a short-termism problem there, it’s still going to have a huge economic impact.

Second, in the US new tech firms increasingly set up voting structures to keep founders in charge through dual-class share structures. Mark Zuckerberg has special shares with ten times more votes than ordinary shares. US firms like Google, Lyft, Pintrest and Snap use this kind of structure, allowed there since the 1980s. But in the UK dual class structures aren’t able to get premium listings. If this model particularly suits tech firms with hard to value intangible assets, perhaps that should change?

3) Tax?

One of the biggest, but hardest to fix distortions is the differential taxation of debt and equity. The fact that you can get tax relief on debt but not equity means firms load up on debt more than they otherwise would, and invest less overall. The Institute for Fiscal Studies’ landmark Mirlees Review suggested creating an “Allowance for Corporate Equity” to fix this.

But the cost to the Exchequer of such taxbreaks would be huge. Alternatively, any rebalancing by reducing the tax relief on debt would probably have to grandfather this debt somehow, as firms have borrowed heavily on the assumption of relief. It’s a very, very hard problem to crack, but that doesn’t mean a (very) long term solution is impossible.

4) Small business lending and equity

The most common financing problems MPs hear about is bank lending to small businesses. The problem’s a long running one.

The truth is that it’s a low-margin business for banks to analyse the finances of zillions of small firms, yet the provision of such loans has wider benefits to the economy. That’s why over decades governments have created a succession of bodies to support lending: from ICFC to 3i to the British Business Bank (BBB) we created in 2012. With the Bank of England predicting large numbers of unlisted firms will need to raise equity to grow (given their post-pandemic debts), it’s encouraging to see the BBB now growing its role in providing equity too. It’s a success story, and we should continue to support its growth.

As the economy bounces back next year, lots of firms will be in debt. But there are also real opportunities to reform regulation and market structures to help money flow into new opportunities. It’s a great place for the Chancellor to be looking to get growth going.

Liam Fox: Today, the Chancellor should aim to boost an unambiguously private sector-led recovery

25 Nov

Liam Fox is a former Secretary of State for International Trade, and is MP for North Somerset.

The successful development of vaccines by the world’s largest – private sector – pharmaceutical companies brings much-needed optimism as we look forward to 2021. Yet, any political respite for the Government is likely to be short lived, as the focus inevitably shifts towards the seismic economic impact that the coronavirus has created at home and abroad.

As the Chancellor said at the weekend “people will see the scale of the economic shock laid bare”.

The UK’s overall debt has now reached 100.8 per cent of gross domestic product (GDP) – a level not seen since the early 1960s. It is terrifying to imagine where we would be if the public finances had not been improved to the extent they have over the past decade. The most recent Bank of England forecast estimates that unemployment may peak at around 7.7 per cent in April to June of next year but could be as high as 10 per cent.

The key to the post-Covid-19 recovery will rely on the ability of Britain’s small businesses to create jobs on the scale that we have seen in recent years. At the beginning of 2020 there were 5.82 million small businesses (with 0 to 49 employees), 99.3 per cent of the total business population.

Despite the unprecedented support from the Government through the Coronavirus Job Retention Scheme (the furlough) which has been extended to the end of March 2021, the Business Interruption Loan Scheme and the Self-Employment Income Support Grant, many small businesses fear that they may not survive the transition to the economic “new normal”.

The unprecedented government assistance has masked the fact that this group has suffered more than most in the varying degrees of lockdown that we have experienced since March, with some still struggling to get lenders to support them.

The longer that lockdown continues, the more that demand for their goods and services is likely to be depressed and their viability threatened. Many fear they may not survive to see the recovery. That is why, in his spending statement this week, the Chancellor must make clear the Government’s commitment to Britain’s SMEs, for this must be an unambiguously private sector-led recovery.

While there are understandable demands to pump more funding into the public sector, we must restore the habit of making sure we have the money in the bank before we start spending it.

Unless we are able to grow our economy through the private sector and generate more national income, then we will be back in the territory of having to choose between damaging tax rises or unpopular spending cuts.

Our ability to borrow heavily during this crisis has maintained the viability of a large part of our economy but an inability to control future borrowing will be deeply damaging to our long-term prosperity and our ability to fund the quality public services on which we depend.

I would like, in his financial statement, to see the Chancellor replace or at least add to David Cameron’s policy test which was “how will this affect and be perceived by every family in Britain”. The new test would be “the entrepreneur test”. This is in line with his natural instincts.

We must assess how every bit of legislation and every regulation will affect the wealth creating part of our economy and our every statement and every speech should be mindful of the message it sends to our small business community.

We must ensure that we are not only a great place for business start-ups but that we can deal with the lack of capital that often results in a failure of scale ups. We must ensure that the elements that make the United Kingdom such an attractive place for foreign direct investment continue – a stable regulatory framework, an attractive tax environment, flexible skills in our labour force, access to quality higher education, access to tech and gold standard protection for intellectual property. As the world’s third largest destination for foreign direct investment, we are already strong in all these areas.

In the 1980s, the Conservatives demonstrated our commitment to the ownership society through our totemic policy of council house sales. The Conservatives must now be seen as the natural ally for every white van man and woman, every tech entrepreneur and every corner shop owner. The Chancellor must make us unequivocally the party of small business.

David Gauke: If Johnson goes for a Brexit trade deal, as he should, he should also go for a further implementation period.

7 Nov

David Gauke is a former Justice Secretary, and was an independent candidate in South-West Hertfordshire at the recent general election.

It is time to talk about Brexit again.

Understandably, the country’s attention has been focused upon the second wave of Covid-19 and the Government’s response to it. And in the past few days, many of us have welcomed the chance to change the subject and follow every twist and turn of the US Presidential election. But it is all too easy to miss the fact that the next week will be one of the most important in the protracted saga of the UK’s departure from the European Union. Just this afternoon, the Prime Minister is speaking to the President of the EU Commission.

We are so used to deadlines whooshing past with little or no practical consequence, there is a temptation to be complacent about the EU’s position that, for a free trade agreement between the UK and the EU to be ratified in time to take effect by the end of the transitional period, such agreement would need to be concluded by 15 November. After all, the Prime Minister has previously said that talks would need to conclude by 15 October in order to reach a deal and – save for a brief and rather unconvincing walk-out – the parties carried on talking.

This time, however, the difficulty is that we are not dealing with a deadline imposed for political reasons in order to focus the minds. We are now at the stage of running out of time to go through all the practical hurdles to ratify any agreement amongst member states and the European Parliament.

The stand-off remains as it has been for months. The two sides remain some way apart of the level playing field provisions, particularly on state aid, and how any agreement is enforced. In addition, the economically irrelevant issue of fish continues to be contentious.

Progress has been made on many of the technical issues, but on these fundamental points the talks have stalled. Both sides have given some ground, but will have to move further. And the side that is going to have to move the furthest will have to be the UK. If Boris Johnson wants a deal, at the very least he will have to accept something which recent leaders of the Conservative Party would consider to be desirable regardless of the EU implications – a robust and independent state aid regime.

I do not know whether the Prime Minister will decide to go for a deal. As far as I can see, it is not clear that he knows himself. Making decisions is not always a strong point for Johnson, and he made one big difficult decision a few days ago by re-imposing a lockdown. Now he has to make another.

At one level, the decision should be straightforward. The right to waste public money by subsidising loss-making businesses has never been a demand of most Eurosceptics, save for a few Bennites, and was a non-issue in the 2016 referendum campaign. (Johnson has praised the EU on this point.) He went to the country in 2019 promising he had a deal: failing to conclude an FTA looks like a failure of competence and a breach of trust. An already fragile economy will suffer a further blow.

However, it has been reported that the Prime Minister is ‘emotionally drawn’ towards a WTO Brexit. Why might that be? It is possible that he believes that any constraint on decision is an unacceptable suppression of sovereignty, but that suggests a purity of view that would make a free trade agreement with anyone impossible.

The politics and the Prime Minister’s perceptions of his own self-interest may tempt him to turn down a deal. Nigel Farage is relaunching himself (again) and is ready to cry betrayal (again) which will panic plenty of Conservative MPs (again). Johnson will also be aware that he has taken on many of his Parliamentary colleagues over the Government’s response to Covid-19 – he might not want to take on many of the same people on a second issue. And – a point I made back in February  – even a deal will cause economic disruption. If the Prime Minister agrees to a deal in the next few days, he will have to proclaim a triumph, but also explain to businesses that time is running out to prepare for it being much more difficult to trade with the EU.

The evidence that – even with the thin deal we may get – the end of the transition period will damage the economy is growing. On Thursday, the Bank of England pointed out that the UK’s trade and GDP will be adversely affected in the first half of 2021, even with a deal. On Friday, the National Audit Office published a report expressing concerns that UK business will face widespread disruption in 2021 because of failures to prepare for post-Brexit borders. A deal will help because it might provide an opportunity to ease rules in particular circumstances but the fundamental problems remain the same.

The approach of the Government has been to blame businesses for not being prepared. Some businesses may have been complacent about the consequences of the end of the transition period, but they can hardly be blamed when the Government, until relatively recently, has not been able to provide details of our future relationship and presented this moment as an opportunity. It simply is not. At a practical level, leaving the Single Market and the Customs Union only makes it harder to trade with the EU.

The Prime Minister might be tempted to try to escape responsibility for the predicament that he, more than anyone, has got us in. He could collapse the talks, and blame the EU for the consequences that the country will face in January. We saw how Brexiteers rather enjoyed the prospect of the talks collapsing in mid-October. A bitter dispute with the EU which could last for years would be truly thrilling to some. And quite a lot of the public would swallow mendacious claims for the reasons of the negotiations breaking down. In terms of the next few weeks, walking away from the talks might be the easier path to tread.

It would also be grossly irresponsible. In the medium term, it would not be possible for Boris Johnson to escape responsibility for a decision that will have a major impact on many people’s lives and livelihoods. The timing could not be worse with the economy already shrinking and businesses restricted in what they can do because of Covid restrictions for at least four of last nine weeks until the transition period ends.

If the Prime Minister wants a soft landing for Brexit, he will need to make concessions, but he needs to do more. Time has run out to prepare properly for 31 December. Even at this late stage, he should ensure that his deal has a further implementation period of another 12 months. A combination of Covid and the Government’s failure to prepare the nation for the realities of Brexit means that ending the transition period at the end of the year will cause even greater problems than necessary. A responsible Prime Minister should seek to prevent that from happening. He should get a deal that gives everyone time to implement it.

Steve Baker: Ministers should reject a second lockdown and prepare for Plan B

19 Oct

Steve Baker is MP for Wycombe, and served as a Minister in the former Department for Exiting the European Union.

“We have not overthrown the divine right of kings to fall down for the divine right of experts” – Harold Macmillan

The public are rightly concerned. Daily, they are warned of disaster. “Coronavirus is deadly and it is now spreading exponentially in the UK,” said Matt Hancock last week.  No wonder poll after poll shows consistent public support for stricter measures, even as the economy tanks and mental health sinks.

The omniscient SAGE has spoken. The Government drags along. The language of fear cows the public. Cases soar. Truly, we have fallen down for the divine right of experts.

But this is not working. We need experts and expertise, but we must beware of experts with counterproductive incentives, and of the structural problem of the division of expertise among fields and individuals.

Ministers and experts have worked hard in good faith, but the pandemic has asked the impossible of them. We must not blindly follow whatever strategy is put forward by scientists with a monopoly on advice. We now know that SAGE has suggested another national lockdown, but calling it a “circuit breaker” cannot make it costless. The immense economic, social and non-Coronavirus health damage that the first lockdown caused means that we cannot allow another.

Many of the problems we are experiencing boil down to fundamental issues in how we use experts to inform social policy. We need a better system of expert influence on social policy without tearing down the edifice, but we must avoid the monopoly rule of experts. Thankfully, there is a literature of expert failure showing how government can more safely and effectively take advice.

Scientists respond to incentives like everyone one. Pressures bear on even the most sober, scientific and impartial person. Knowledge in a pandemic is incomplete and uncertain. Suppose an epidemiologist provides the Prime Minister with a low estimate of the number of deaths, and there is no lockdown. Perhaps there are many more deaths than predicted. The epidemiologist will be blamed as a bad scientist. Shame and guilt will follow: a bad outcome.

Suppose our expert provides a high number and there is lockdown. However many people die, it can always be said it would have been worse without lockdown. A high estimate therefore implies credit for saving lives. Praise, pride and innocence follow: a good outcome.

Expert failure also arises when incentives create uniformity of opinion. Professionals earn livings from the official recognition of their profession’s knowledge, enforcing orthodoxy. We think experts do not disagree over “the science” so we are quick to follow their advice.

Moreover, all experts only give a partial perspective. We must recognise that epidemiologists are not economists, GPs, mental health practitioners, cancer specialists or social workers. Their narrow expertise must be complemented, and not at the ministerial level.

Furthermore, since the start of the outbreak, scientists, politicians and the media have treated untested and uncertain theories as certain. When scientists speak of the risks of coronavirus, they do not speak of certain knowledge. Risk is not certainty – as Professor Neil Ferguson’s now infamous record of predictions illustrates. Confusing the two is damaging.

Government expert advice requires four important reforms.

First, we must simulate a market for expert advice using competing expert groups in the same field.

Second, ministers should require three independent expert opinions on critical policy.

Third, the partial perspective of experts should be exposed by bringing together complementary fields.

Finally, employing “red teams” (advocati diaboli) is a good way to challenge and test prevailing expert opinion.

Meanwhile, a Department of Health and Social Care report has shown the lockdown leading to more cancer deaths, deteriorating mental health and many other social harms that can make the cure worse than the disease.

Breast Cancer Now has estimated that around 986,000 women have missed mammograms in the UK after screening services were paused because of coronavirus. The charity has also estimated that around 8,600 women could be living with undetected breast cancer.

Earlier this month, 66 GPs wrote to the Health Secretary to urge him to consider non-Coronavirus harms and deaths with equal standing beside coronavirus deaths. This complex optimisation problem of saving the most lives deserves more public debate.

Dr Raghib Ali, an epidemiologist and consultant in acute medicine, recently highlighted on this site that lockdowns can need to be repeated until a vaccine or fully effective treatment is found. They postpone rather than prevent infection, and a vaccine may not come.

Even if it does, it may not be as effective as people hope. A vaccine may take longer to be rolled out than people wish. No wonder in response to my question last week on when the vulnerable may be vaccinated, the Prime Minister stated that he cannot say by when he expects a vaccine to be produced. He admitted that a vaccine may never come.

But the Government’s strategy remains to supress the virus until vaccination. That has petrified sections of our economy, propped up by £745 billion of quantitative easing and ultra-cheap credit. In evidence to the Treasury Select Committee, the Bank of England has made it clear that such extraordinary monetary policy is only possible because of the independence of the Monetary Policy Committee, and that it is not its job to fund government.

The implication is clear: if inflation were to rise above target, then the Bank would have to act under its mandate. With QE at about the level of Government borrowing today, that could have the effect of pulling the plug on public spending.

The Government’s finances and our broader economy are in a precarious position. Even without an inflation, such extraordinary monetary policy is bound to create misallocation of resources: the longer we prop up our economy like this, the deeper the distortions and the longer and harder our economic recovery will be.

The economy is, of course, closely related to the health of the nation: poverty shortens lives. That’s why Ministers must move now to reform the structure of expert advice, publish serious analysis of the costs of the options they face and prepare for plan B. It is time for Conservatives to relieve experts of unreasonable burdens and reject a second national lockdown.

Charlotte Pickles: Ten million people are at risk of becoming unemployed. They must be Sunak’s priority this week.

5 Jul

Charlotte Pickles is Deputy Director and Head of Research at the Reform think tank.

The Chancellor’s economic statement next week may be his biggest test yet. During the last few days, UK firms have announced 12,000 job losses. John Lewis, Upper Crust, Topshop, Airbus, WH Smith, TM Lewin, Easy Jet, Accenture are just some of the household names cutting jobs. Small businesses will be doing the same; you just won’t hear about them.

This is the start of the wave of redundancies Reform predicted back in April when we called on the Government to extend the furlough scheme and make it more flexible. The Government stepped up then; they need to do so again. The alternative is the worst unemployment crisis since the Great Depression.

Some readers will be sceptical. Great swathes of the economy reopened this weekend. Across the pond, the American economy added almost five million jobs in June, and the rise in the Eurozone’s unemployment rate in May was lower than expected.

At home, Andy Haldane, Chief Economist at the Bank of England, announced that consumer spending had “risen both sooner and materially faster” than predicted, meaning the GDP hit could be half that predicted in May. Very good news indeed.

However, underneath these headline green shoots is a much starker picture. Haldane also says that the labour market outlook is not as encouraging – that unemployment could be worse than the Bank’s May forecast. As in much of Europe, where more than 40 million people remain supported on furlough schemes, we have no idea if furloughed workers will return to work or join the unemployment rolls.

So while it is promising news that the UK economy appears to be bouncing back, it would be dangerously foolish to assume a jobs recovery at the same pace. Indeed, vacancies last week were down 24 per cent on the previous week.

Next month, businesses are required to start contributing to the cost of their furloughed workers. That’s reasonable, over nine million people have had their wages subsidised and the Government cannot continue this £10 billion-a-month support indefinitely – not least as it risks keeping people in ‘zombie jobs’, delaying their move into new roles and damaging the economy further.

But the phasing out of the furlough scheme will trigger more redundancies. Hundreds of thousands of businesses have gone for three months with little to no revenue. The Government’s loans and grants provided a lifeline for many, but social distancing measures and people’s fear of the virus will mean suppressed revenues for some time.

Expenditure will have to be cut if businesses are to stay afloat – half of companies expect to make redundancies in the next few months.

Which is precisely why the Chancellor must use his statement on Wednesday to announce a comprehensive and ambitious plan for averting mass unemployment.

Because while it might be reasonable to see how consumers respond to the further lifting of lockdown before taking a decision on something like a VAT cut – which would be pointlessly costly if the issue isn’t demand – delaying decisions about investment in employment and skills could be catastrophic.

In a new report this week, produced jointly by Reform and the Learning and Work Institute, we estimate that around ten million people are potentially at risk of unemployment. Those at greatest risk are in areas that already had high unemployment, have low qualification levels and are currently in low paid work. In other words, they will be least resilient to losing their jobs. The result of inaction, even delayed action, will be a levelling down.

The Conservative manifesto pledged to undo the decade-long underinvestment in skills; to help workers “train and retrain for the jobs and industries of the future”.

This recession is unique for its sectoral nature, meaning a large number of workers will not only need to find new jobs, but to switch careers. But it is also unique in that the Government has a direct line to those most vulnerable to unemployment – the furlough scheme.

The Prime Minster should deliver on his manifesto promise with a bold offer to anyone on furlough, or in an at-risk sector like retail or hospitality. This should include universal entitlement to funding for a qualification, or modules of a qualification, up to and including level three, as well as online advice and support.

For those needing to change careers, which we estimate will be up to 200,000 people, the Government should provide a £5,000 learning account for accredited training. They should also receive a time-limited, means-tested maintenance grant to help mitigate wage drops as they start over in a new sector. Eligibility could be linked to an individual’s history of National Insurance contributions.

And to incentivise employers both to hire apprentices and career changers, and to pay living wages, the Government should allow firms to use a proportion of their apprenticeship levy to support wages, with an equivalent grant for SMEs.

On Wednesday, the Chancellor must show the same bold thinking that delivered the furlough scheme. Failure to act now could mean mass unemployment with its sky-high social and economic costs. That’s a legacy the Government should do everything to avoid.

Alan Mak: Reform capital allowances and R&D tax credits to fire up investment and create jobs

1 Jul

Alan Mak is MP for Havant and Founder of the APPG on the Fourth Industrial Revolution.

Improving Britain’s productivity is key to both our economic recovery after Coronavirus and enhancing our global competitiveness post-Brexit. The best lever for firing up Britain’s productivity is incentivising more investment in the latest IT and software, new plant and advanced machinery – all proven catalysts of growth and efficiency. Failure to direct billions of pounds into these fundamental building blocks of our economy will hold back our recovery.

The State cannot be expected to do all the heavy lifting, especially given the Government’s substantial spending commitments to help the country through the lockdown and beyond. Instead, it must be businesses that take the lead, especially SMEs who have traditionally made up the “long tail” of unproductive companies.

Rather than a safety-first approach of hoarding cash, postponing investment and hunkering down, businesses must be incentivised to invest more in the coming months. This must be an economic recovery powered by bold investment decisions that create jobs, upgrade technology and boost productivity.

The dampening effect on capital expenditure (capex) and investment caused by Coronavirus is already large and destructive. One investment bank estimates that £23 billion has been slashed from this year’s capex budgets already, whilst the Bank of England predicts a 26 per cent drop in business investment for 2020. In 2009, as the financial crisis erupted, the fall was 16 per cent by comparison. Some of the country’s biggest employers such as BP and HSBC have already started cutting investment.

In practice this means IT systems and software – now at the heart of every business – being used for longer. Machines normally replaced every decade will have their life extended. Trucks and vans will be allowed to age. Outdated buildings that offer no room for new employees will be kept on. Research and development (R&D) could stall.

Reductions in investment not only have negative consequences for our country’s GDP, jobs and productivity, it also damages our capacity for R&D and our reputation as a nation that innovates for the future – key to our leadership of the Fourth Industrial Revolution.

Reforming and adapting two existing incentive schemes – the Annual Investment Allowance and the R&D Tax Credit – would have a major impact in reversing this decline in business investment and productivity.

Introduce a new Annual Investment Allowance ceiling for green or digital investments

Capital allowances enable a business to deduct the cost of qualifying items from their profits, lowering their corporation tax bill. This incentivises investment in key productive goods from machines to laptops.

The Annual Investment Allowance (AIA) is the annual cap on such deductions and its level has varied dramatically in recent years from £25,000 in 2012 to £500,000 in 2015. Until December 2018, the AIA was £200,000 but it was raised to its current £1M level from January 2019. The £1 million level is due to expire this December.

To encourage a green recovery and investments that focus on digitisation, the AIA could be allowed to fall back to the previous £200,000 ceiling, except for certain types of capital expenditure that achieve environmental or digital goals which would still benefit from the £1 million special ceiling. Replacing a diesel-powered machine on the factory floor with one powered by electricity, or digitising a production line by adding new software powered by artificial intelligence (AI), could be examples of investment that would be rewarded by the new special AIA ceiling.

Alongside the introduction of a special £1 million ceiling, the scope of what can be claimed through capital allowances should also be expanded to take account of the growing digital dimensions of every business. For example, digital tools purchased on a subscription basis (such as monthly website hosting costs) should benefit from relief not just one-off investments in physical goods (such as buying a new machine).

Increase R&D tax relief rates for SMEs and widen the scope of the reliefs

R&D tax reliefs support companies that work on innovative projects in science and technology, and enables the cost of qualifying projects to be reclaimed from HMRC. They’re especially effective for digital start-ups, who get a tax break and much needed cashflow back for critical work.

From April this year the relief rate is 13 per cent, but the lion’s share of R&D tax relief is claimed by large, research-intensive businesses. SMEs can currently claim up to 14.5 per cent in certain circumstances, but incremental increases such as this do not have a dramatic effect on investment appetite.

Often the most cutting-edge innovation, especially in the digital sphere, is carried out by small teams and growing start-ups – not just multinationals. To encourage more micro businesses and SMEs to pursue more R&D, new and much higher rates of relief should be introduced. For example, a rate of 25 per cent for SMEs with fewer than 150 employees, and 35 per cent for SMEs with fewer than 50 employees.

What qualifies for relief must also be broadened to include more of the digital tools that software developers use, including software testing tools and data analytics software. In addition, cloud storage fees, user experience development work and the cost of buying data sets needed to train algorithms for AI-driven start-ups should also be tax deductible.

Britain is currently 19th out of the 37 industrialised nations in the OECD when it comes to R&D investment, spending 1.7 per cent of GDP against the OECD average of 2.4 per cent. To match world leaders including Germany and Japan, who invest over three per cent, we must urgently update and expand our R&D tax relief regime.

This is the second in a three-part series on how to boost our economy after Coronavirus.