Ryan Bourne: Anti-Truss commentators should try to understand nominal GDP targeting

10 Aug

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

Want an example of economic fatalism? Just read reactions to Liz Truss criticising the Bank of England’s inflation performance.

Truss suggested that rocketing prices necessitates reviewing the Bank’s mandate and learning from countries that haven’t endured double-digit inflation despite global supply-shocks. Shrill commentators react with knee-jerk horror, as if this must mean politicians setting interest rates, sacrificing the Bank’s independence and (heaven forfend) risking monetary credibility. Yes, the current regime might have delivered 9.4 percent inflation and rising, but why hope to do better? To question the Bank is to undermine it!

This is silly, of course. Credibility is earned. For the Old Lady, some soul-searching is necessary. With politicians talking about having to raise taxes to curb inflation, something has gone badly wrong. Whether it’s the Bank’s forecasting models, the 2 percent inflation target, or the tools used to hit it, the alleged advantages of central bank independence haven’t materialised. Autonomy promised to insulate us from wishful forecasts and allow the Monetary Policy Committee (MPC) to take away the punchbowl before the party got out-of-hand. It didn’t this time, on either count.

Team Truss doesn’t have all the answers, but good on them for asking questions. An intriguing staffer’s quote specifically implied she wanted to investigate changing the Bank’s mandate from inflation targeting to a nominal GDP level target. This is something I’m convinced would be an improvement, but one unlikely to satisfy the Bank’s most hawkish critics.

Right now, the Bank has a 2 percent inflation target. When a demand-shock raises aggregate spending and so prices, the Bank should tighten monetary conditions to offset this and keep inflation at bay. So far, so uncontroversial. The difficulty comes when a negative supply-shock such as an oil price surge or a major war disrupts supply-chains and raises costs. If the Bank is strictly targeting inflation, it should similarly tighten policy against this one-off price uplift, so that other non-oil prices fall, keeping annual inflation at bay.

In a world where some money wages are sticky (i.e. not fully flexible downwards), squeezing aggregate demand through tighter money on top of the worsened supply would reduce employment and output sharply. Pure inflation targeting therefore makes output more volatile when supply-shocks occur. The same is true inversely: if a new technology causes productivity to boom, lowering prices, then an inflation-targeting central bank must try to push the price level back up, eroding the consumer benefits of lower prices and exacerbating the business output cycle.

Central bankers are aware of this problem. The Bank’s remit even allows it to give “due consideration to output volatility.” When instances like the Ukraine war hit, the practical consequence is that we essentially abandon inflation targeting, with the Bank instead trying to parse supply-shocks from demand-shocks. They’ve proven poor at doing so arbitrarily, keeping demand policy too loose even accounting for supply problems.

The Bank governor won’t admit this publicly, but we’d have above-target inflation today even if the war and pandemic hadn’t cratered supply. Inflation is caused by too much money chasing too few goods, and we’ve suffered both squeezed production and excess demand. Not only have supply disruptions raised prices and lowered real output within money GDP growth, but the overall nominal GDP level (a good proxy for aggregate demand) has raced ahead of its pre-crisis trend. Monetary policy, by pushing spending higher, has therefore not just failed to counteract the rising price level caused by the war and pandemic, but has actively exacerbated inflation.

That rather uncomfortable truth – that the Bank should have tightened policy sooner to choke off excess demand, even if it tolerated supply-shocks – has not been articulated by Andrew Bailey. Yet last week’s monetary report showed that the MPC will now slam on the demand brakes harder than its forecasts imply is necessary to return inflation to target. Presumably, this is an admission of past failures – an attempt to look tough and strengthen its inflation-fighting bonafides.

A nominal GDP level target is interesting because it would have avoided all this supply-demand confusion by crystallising the trade-offs into one, simpler target.

Rather than inflation at 2 percent per year, the Bank would aim for a steady growth in overall economy-wide money spending (nominal GDP, or aggregate demand). In essence, the Bank would only try to squeeze inflation out when demand was expected to rise above target.

When oil price spikes hit, that nominal GDP target would be composed of more inflation and less real output. Higher prices would be tolerated. In years when productivity growth was strong, such as through the pre-2008 period, nominal GDP would be made up of less inflation and more real output. The Bank would let consumers benefit from lower prices by running tighter policy than under inflation targeting.

Under this mandate, the Bank would have a greater clarity of purpose under supply-shocks, with a mandate that reduced output volatility. By just looking at nominal GDP, the MPC wouldn’t need to second guess what price rises to ignore and what to react to. Overall spending would be its concern.

If this had been in place, the Bank would have been touching the brakes earlier through last year as indicators flashed that nominal GDP was surging and heading quickly above its pre-pandemic trend. Of course, nominal GDP itself is only estimated imperfectly and forecasts of it are often wrong. But issues of estimation aside, the Bank would have only worried about excess demand. To the disappointment of those who detest any periods of  inflation above 2 percent, the Bank still wouldn’t have tried to choke off the higher prices caused directly by the pandemic and Ukraine war.

This, in fact, raises an obvious disadvantage to making this mandate change now. It might risk being seen by markets and the public as merely “going soft” on inflation given our recent experience. Such a mandate would have probably led to tighter policy last year than we actually saw, but in principle it would be more tolerant of rising prices in the face of oil shocks than the inflation target we have on paper.

This nuance is one reason why a knee-jerk defence of the Bank’s performance is so destructive. Mainstream commentators’ wailing about Truss proposing a mandate change have ignored that she’s actually pondering a pragmatic shift that would have aided the Bank to deliver what it tried to achieve, but didn’t. Behind the tough talk and Bank criticism from Team Truss, this proposed mandate would be more forgiving than pure inflation targeting should be when oil prices spike, so is better suited to the difficult situation we’ve faced.

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David Willetts: A Conservative case for welfare spending as well as tax cuts to help working people

5 Jul

Lord Willetts is President of the Resolution Foundation. He is a former Minister for Universities and Science.

It is a key promise of modern market economies that they boost living standards – both for us during our working lives and also for our children who we hope will be better off than us. British capitalism is failing to deliver on this promise. Unless we can raise our game, both our economic model and our politics will face deep challenges.

New research just out from Resolution Foundation shows that the typical non-pensioner income grew by 12 per cent between 2004 and 2019 compared to the previous average of 40 per cent every 15 years since 1961. This shocking decline in economic growth per head and household incomes is a problem which afflicts other countries as well post the crash.

But we have it worse – and one of the most depressing ways in which our situation feels like a return to the 1970s is that dismal sense of relative economic decline. Now typical incomes are higher in France (10 per cent) Germany (19 per cent) and even Ireland (six per cent).

There is one clear overwhelming way of tackling this: increase GDP per head – which means increasing productivity. But although we may endorse that in theory, it is much harder to do in practice. Look at attitudes to reform of planning restrictions. Moreover, a long term growth agenda is not quite the whole story. The working of our labour market and our tax and benefits system matter too.

First, the good news. We continue to enjoy the benefits of a flexible labour market with a relatively high employment rate. One of the protections for household incomes has been the continuing increase in the number of women working. We are now at 75 per cent employment overall. America used to be the model of a high employment flexible economy but it is down to 70 per cent. We can do even better – getting to 80 per cent would be a good target. That means more to get older workers staying in work. And more help into work for people on disability benefits too.

The increase in the minimum wage has also helped. The sceptics – and I was one – were wrong to fear it would cost jobs. But we made another point too: that it could not on its own boost household income and reduce inequality because some low paid workers are in high income households. And there are low income households without an earner at all. Whereas in the past Labour over-claimed for the benefits of the minimum wage, now it is some Conservatives who love the idea that it can raise incomes without having to do anything about benefits. But that is to expect too much of the minimum wage.

It is also hard to tax cut our way to higher household incomes for people on low and middle incomes. One reason is that we have taken so many people out of income tax already – and now national insurance. As a result, average direct rates on low paid employees fell from 13 per cent in 2010 to four per cent in 2019.

They are now rising, but are still very low on any historical measure. I personally have always thought raising income tax allowances is over-rated. It is very expensive, as it is an increase in the tax allowance for everyone, and if the gains are recovered from higher earners it means a messy and very high marginal rate for then.

Moreover, if possible voters should have a real interest in how the Government is spending their money and paying income tax can boost that. (This was of course the old argument for the Poll Tax – so no wonder it has fallen out of favour.)

If there are limits to what can be done for living standards via regulating wages or cutting direct taxes, then benefits have a role to play. There are specific pressure points which need to be addressed. Incomes after housing costs are very low by European standards because rents are so high. And rents are so high because the price of houses is so high. That in turn is because of planning controls and quantitative easing. There could be better targeted help with the cost of childcare.

And, yes, getting rid of the triple lock is one of the ways to pay for this. The total effect of benefit policy changes on the incomes of working-age adults and children since 2010 has been an average loss of £375 per year compared with a boost to pensioner incomes of £510 per year. Shifting the balance of the welfare state like that is very hard to justify.

Is there a Tory case for a fair, balanced welfare state? I think there is.

The classic argument for the welfare state is that the Government is the biggest bearer of risk we have got: it bears the risks we face from sickness, retirement, or unemployment. It is the case made by Bismarck and Beveridge – neither of them socialists. Tories hoped that commercial insurance and friendly societies between them could discharge this role, but there are limits to what they can do – even the US ended up with Medicare and Social Security.

It is not an argument about equality. It is about insurance.

If we don’t have a social security system which protects us from some of these risks, we end up with expensive ad hoc measures in crises. A massive furlough package has now been succeeded by another massive package to help with the cost of energy. They were both bold moves by the Chancellor, but one reason he had to act so boldly was that the tools available in our existing welfare state were so limited.

There is a political argument too. A long term secret of Conservative success is the appeal to people in the middle realistically aspiring to some of the incomes and security enjoyed by the very affluent. There is a real danger if people in the middle instead see their circumstances and their families’ more like the sadly precarious lives of poor people. Then a very different Coalition starts taking shape and one which is much more threatening to Conservatives.

Of course in the long run it is growth and productivity that matters. But there are things we can do now as well to rebalance our welfare state to make it make it more fair and more effective.

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David Willetts: We aren’t getting an explanation from the Government of its pay policy that is honest about the coming pain

21 Jun

Lord Willetts is President of the Resolution Foundation. He is a former Minister for Universities and Science.

Paul Goodman’s excellent piec on this site yesterday admitted that he was so old that as a student he remembered the Battle of Orgreave. I’m even older. I was working for Margaret Thatcher at the time, and remember meetings punctuated with messengers straight from one of Shakespeare’s history plays: “Nottingham is with us.” or “Kent is hostile”.

We wrestled with inflation and pay demands then. There are some lessons which are still relevant today.

First, there is still some truth in the economic proposition that pay increases on their own do not cause sustained inflation which can be brought down by a tight financial policy. Monetarism is often seen as some esoteric economic doctrine, but it was actually a political strategy as well.

If you believe pay demands cause inflation, then the Government has to tackle inflation by doing deals with workers on their pay. Back then, Labour’s links to the trade unions meant they were better placed to do such deals than Conservatives.

So Tories needed a credible way of controlling inflation that did not depend on their relationship with trade unions. The refusal of ministers to get involved even in public sector pay negotiations today is a version of the lesson that was learnt then.

There was a second Thatcherite insight which is relevant today. Inflation is not just a matter of economic theory. It is also deeply political. It is how a society reconciles inconsistent and over-ambitious claims on resources.

Thatcher saw it as the evidence of a moral failure – a failure to recognise we had to live within our means. If we all promised ourselves more than the economy could afford, then one way to reconcile these conflicting claims was to reduce their value by inflation.

Some people and organisations with incomes set in cash without inflation protection lose out. Responsible Government has to deliver the unpalatable but honest message that we are not as rich as we think we are. That is key to Britain’s problem today. We are poorer than we hoped because of a combination of the costs of Russia’s invasion of Ukraine, the higher cost of energy including the costs of the investment to move to Net Zero and the economic effects of Brexit.

So if you were to add up the incomes we all think we are going to get next year, that figure is ahead of the economic reality, and inflation is the only way to make the figures add up. Thatcher’s stern Methodist explanation of these truths barely appears in modern politics.

Apart from these enduring insights the parallels with the 1970s and 1980s are very different from today. Trade unions have much lower membership now. Indeed compared with the 1970s employers and capital are stronger and workers are weaker. That is one reason a lower proportion of GDP goes on wages. Trade union power is almost entirely in the public sector – there are few private sector strikes.

The public sector is much slower-moving and less responsive to economic shifts than the private sector. So when Covid hit us, public sector employees were more likely to keep their jobs and pay – also, partly, because more of their jobs deliver essential services. Public sector workers have more protection of jobs and pay in a recession.

But when inflation is rising fast then lagging, public sector pay puts them at a disadvantage. Public sector pay loses out when inflation is high. So at the moment total private sector compensation including bonuses is rising by eight per cent. Basic pay in the private sector is rising by five per cent. In the public sector that is closer to three per cent. So the sector of the economy with higher rates of unionisation also has lower increases in pay. Strikes are the result.

Ironically, inflation may reduce real pay in the public sector whilst also in the short term boosting public revenues. More people are pulled into higher rates of tax. Public budgets set in cash terms lose some of their value.

Overall, pay is rising less than inflation. This is not some inflationary spiral. It looks as if the adjustment to our being poorer is partly happening through pay rates. The disappointment of expectations which inflation brings is particularly felt amongst workers. They are unhappy, but they are not getting an explanation of what is going on around them which is honest about the economic pain and recognises who is bearing it.

The Government has indeed belatedly tried to protect people, especially those on the lowest incomes from rising energy prices. But it still needs to pull all this together in an account needs to show the scale of the adjustment we are going through and that whilst the sacrifices will be widespread there will also be some protection for the groups worst affected.

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Stephen Booth: Brexit is a process, not an event. So it’s far too early to judge whether it’s working.

16 Jun

Stephen Booth is Head of the Britain in the World Project at Policy Exchange.

Next week will see another Brexit anniversary as we reach six years since the 2016 referendum. Meanwhile, the UK-EU Trade and Cooperation Agreement (TCA), which marked the beginning of the UK’s new relationship with the EU has been in place for nearly 18 months. No doubt we will be debating the merits and consequences of Brexit for many years to come, but what can be said at this point?

Much of the Brexit debate has focused on trade and the economy, and the deteriorating economic situation has prompted some commentators to lay the blame squarely at the door of Brexit. However, it is almost impossible to disentangle any Brexit effect from the much larger economic shock resulting from the pandemic, and now the war in Ukraine, which have taken a heavy toll on the global economy.

Due to the volatility caused by these global events, it is difficult to make short-term comparisons across economies. However, according to OECD figures, the UK economy exceeded its pre-pandemic (Quarter Four, 2019) level of GDP for the first time in the first quarter of 2022, by 0.7 per cent. I

By contrast, German and Italian GDP was still below pre-pandemic levels (by 1.0 per cent and 0.4 per cent respectively) in the first quarter of 2022. And while UK inflation is at the high end compared to other economies, the Netherlands and Poland are both experiencing higher levels, illustrating that the UK is not a particular European outlier.

Given the degree of change to the UK’s trading arrangements, it would be a surprise if Brexit had no impact. At the time of the Spring Statement, the Office for Budgetary Responsibility noted that UK trade had not recovered as quickly as other advanced economies and that the trade intensity of the UK economy had fallen as a result. However, looking beyond the headline figures presents a complicated picture, not easily explained by Brexit alone.

The biggest contributors to the UK’s decrease in trade intensity are from a decline in imports of goods and services from the EU, even though the barriers to trade have overwhelmingly been erected on the EU side of the border (the UK has delayed imposing checks on EU goods entering the UK).

Equally, UK exports of goods to the EU have recovered more strongly than UK exports to non-EU countries. The reorientation of supply chains may have played a role in this. However, much of the global demand for goods was generated by US consumers, and the UK is not a major exporter of the products (computers and electrical equipment) that the US imported over this period.

Finally, the UK’s export mix is more dominated by services than its competitors. The pandemic has had far-reaching consequences for trade in services and, paradoxically, again it is imports rather than exports of services to the EU that have seen the biggest falls since the pandemic. This evidence would suggest that greater barriers to exporting to the EU seem to be playing only a limited role in the UK’s disappointing post-pandemic trade performance. This shouldn’t be cause for celebration, but it is important to diagnose the problem properly.

On the question of immigration, which dominated political debate prior to the referendum, it is notable that the UK has remained open to global talent and skills. The tight labour market is primarily to do with older UK workers exiting the market rather than the loss of EU workers, the vast majority of which have been replaced from outside the EU under the UK’s liberalised visa system.

Net migration to the UK was estimated by the Office of National Statistics to be 239,000 in the year ending June 2021 and work-related immigration to the UK has recovered strongly in the wake of the pandemic. There were 277,069 work-related visas granted in the year ending March 2022 (including dependants). This was a 129 per cent increase on the year ending March 2021 and is 50 per cent higher than in the year ending March 2020.

It is also clear that despite continuing high numbers of arrivals, public attitudes on immigration have softened significantly now that the UK is able to devise its own policy without the strictures of EU freedom of movement. According to Ipsos-Mori, the proportion of people wanting to see immigration reduced has fallen from around 65 per cent in 2015 to 42 per cent in 2022. The share saying immigration levels should stay the same or be increased has risen to 50 per cent from around 30 per cent. Those dissatisfied with the Government’s handling of immigration are largely concerned with illegal Channel crossings.

Meanwhile, there was a fear that Brexit would consign the UK to geopolitical irrelevance on the global stage. However, the UK entered into the new AUKUS security partnership with the US and Australia and it has played a leading role in the international effort to support Ukraine.

The crisis with Russia has not united the EU behind a common foreign policy to the exclusion of Britain. As I noted in a previous column, Emmanuel Macron’s drive for EU “strategic autonomy” on foreign and security policy has been severely undermined, probably fatally, by the fact that many in Northern and Eastern Europe have concluded that the US and the UK are more reliable partners in this field than France and Germany.

This is not to suggest that Brexit has been plain sailing or that the UK does not face significant difficulties. Clearly, the row between London and Brussels over the Northern Ireland Protocol has the potential to escalate and fundamentally destabilise the UK-EU relationship yet again. The domestic economic and political challenges of increasing productivity, improving economic performance across the entire country, and reforming public services pre-date Brexit.

Some Brexiteers are impatient for greater divergence from the EU. Some Remainers will continue to see Brexit as the root of every problem. However, Brexit is a process rather than an event and the experience of the past six years should demonstrate that the UK’s decision to leave the EU does not in of and itself mean it is on the road to success or failure.

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Gerard Lyons: Ministers have an opportunity to cut taxes, drive supply side reform – and help reduce the cost of living

17 May

Dr Gerard Lyons is a senior fellow at Policy Exchange. He was Chief Economic Adviser to Boris Johnson during his second term as Mayor of London.

“My Government’s priority is to grow and strengthen the economy and help ease the cost of living for families.” These opening two lines of the Queen’s Speech provided a powerful message.

Further action is needed to address the cost of living crisis. Also, those affected are not just families, but the vast bulk of households that are being squeezed. If the Government doesn’t appreciate this, then it may have its work cut out.

To its credit, the Government has already announced a host of targeted measures. These include a £150 refund on council tax for those in bands A to D. While welcome, the gains are partially offset by a rise in the average Council Tax in band D of £67.

The main help by far, though, was announced by the Chancellor in the Spring Statement – an increase in the threshold at which the higher rate of national insurance is to be paid. This has now been aligned with the starting threshold for income tax, around £242 per week. There is also the expectation that the Government will act again, as energy bills are expected to rise again this autumn, when the new price cap kicks-in.

Indeed, the cost of living crisis looks set to get worse, before it gets better. UK inflation is set to peak soon, probably above 10 per cent, and will then stay elevated for some time. While inflation is set to decelerate next year, it seems unlikely to return to its two per cent target anytime soon.

It also vital to appreciate that we are very quickly moving away from the main problem being inflation to it being a lack of economic growth. There thus needs to be a reiteration of a clear, executable vision and strategy to grow and strengthen the economy. But first, the cost of living crisis merits further attention.

High fuel and food prices are already exacerbating problems for lower income households, who spend a higher proportion of their income on these areas. At the same time, a large part of peoples’ disposable incomes fund their housing costs. Furthermore, as the retail price index heads higher, rail fares will rise, and changes earlier this year added to the cost of repaying student loans.

While some have savings they can dip into, many don’t. Thus, overall, discretionary spending will be squeezed with widespread negative consequences for retailers and many firms. In turn, there will be upward pressure on costs, prices and wages.

Even the labour market, where unemployment is low, could see change since a sharp economic slowdown is likely, including the possibility of a technical recession with two successive negative quarters of economic growth.

The challenge is that, surely, the Government can’t go on spending taxpayers’ money at every sign of trouble? That is right – but downside economic risks mean intervention is needed, not only to ease the burden but also through low taxes to revitalise growth. The situation also highlights the need to restore both fiscal and monetary stability, once the economy allows, allowing scope to cope with future shocks.

The economic and political shock-absorber is a looser fiscal policy over the next year. Although the budget deficit is higher than one would like, the good news is that it is falling sharply: from £317.8 billion in 2020/21 to £151.8 billion in 2021/22, and is expected by the Office for Budget Responsibility to decline further to £127.8 billion in 2022/23. Moreover, higher inflation is already bolstering tax receipts.

So what should be done? Relaxing fiscal policy and targeted support should not add to inflation since demand is already slowing. Targeted help is needed for those on low incomes, but also there is a need to help the squeezed middle.

Other countries have enacted policies to shield people from rising energy prices, including reduced taxes on energy or VAT; retail price regulation; wholesale price regulation; transfers to vulnerable groups; mandating firms’ behaviour; windfall profits tax; business support; or other measures (such as cutting the green levy in Germany).

While other countries, too, are tightening monetary policy, the UK is unusual in that it is squeezing fiscal policy. Benefits, for instance, were not raised in line with higher inflation in the Spring Statement, when perhaps they should have been. Crucially, the tax take is at an all-time high. The latter needs to be reversed. It includes too many people being dragged into higher tax brackets, and this can only be addressed by raising tax allowances and the levels at which people enter higher tax bands.

Quickly executable targeted measures could include a further increase in the Council Tax rebate. Another would be to use Universal Credit to direct more money to those in most need, while preserving work incentives. A mid-year rerating of benefits to raise them in line with higher inflation may take longer to implement but is another option

Temporary removal of some of the permanent components of fuel duties should be considered although, like many of these measures, further cuts in taxes on energy are not cheap. The temporary five pence cut in fuel duty is set to cost £2.4 billion this fiscal year. Suspending VAT on domestic energy while gas prices remain high has been suggested by some MPs.

Another possible but unlikely option is a temporary suspension of the environmental levy paid on energy bills. It would not, in my view, compromise the Government’s commitment to the green agenda, and could free up about £340 per household per year. The importance of addressing climate change is critical; it is peoples’ ability to pay that is the issue.

There is a clear case for bringing forward the one pence cut in income tax that has been pencilled in for before the next election. The Treasury calculates that this will costs £5.4 billion in its first year, but it would address an important issue in that income tax collection is now heavily concentrated, with roughly four in ten adults only paying it. A broader tax base with low tax rates makes more sense, but that may be a future aim.

There is also a search for non-fiscal measures that can help businesses and households. Measures that both ease the burden on firms and employers, while bolstering their confidence about the future, should figure prominently.

The most obvious is to implement supply-side measures from the Taskforce on Innovation and Growth Report. Although some may take time to feed through, they should bolster business confidence and encourage investment.

Also, measures to turbo-charge the housing market are welcome. Planning reform, while necessary, appears to have taken a back burner. A year ago, in a research paper for Policy Exchange, I outlined measures on the demand side that could help Generation Rent become Generation Buy, including allowing those who cannot afford deposits to use their history of regular rent payment to enter the housing market.

If the economic climate deteriorates, banks should be encouraged to exercise forbearance on loans if firms encounter difficulty. The Bank of England should also re-examine prudential requirements to ensure that these are not having a negative impact on growth.

This proactive policy response to address immediate challenges is complimentary to other areas of policy. It should not threaten the inflation outlook. Crucially, it is consistent with the existing fiscal strategy of reducing the ratio of debt to GDP from its present level of 96.2 per cent and the aim to achieve a significant improvement in the public finances. Strengthening the economy is the aim, easing the cost of living crisis is the immediate focus.

Ranj Alaadin: The Ukraine crisis. Brexit Britain is proving itself an international force. Here’s what we should do next.

21 Feb

Ranj Alaaldin is the Director of Crisis Response Council, a UK and US based international affairs organisation, and a Non-Resident Fellow at the Brookings Institution.

British foreign policy is in the midst of a honeymoon period. Post-Brexit Britain is defining itself on the international stage, thanks to its support for Ukraine’s sovereignty and the resettlement in the UK of tens of thousands of Hongkongers fleeing China’s repressive rule.

Irrespective now of whether a Russian invasion of Ukraine materialises, Britain’s valiant effort to push back against Russia’s aggression has exemplified resolve, conviction and moral authority, allowing the British flag to emerge as a beacon of freedom and democracy in a matter of just months.

When the Integrated Review was published last year, its critics rejected it as a pipe dream, premised on the notion that Britain could not be a “soft power superpower” outside of the European Union, but our approach to Ukraine has highlighted an ability to balance our soft power tools with our hard power capabilities: the dispatching of weapons to Ukraine and the mobilisation of our allies might just de-escalate tensions, and one could argue that our muscular approach has forced Europe to get its act together, potentially paving the way for the Russians to contemplate a diplomatic resolution that may have previously been unfathomable.

The same critics of the report who predicted Brexit would lead to a Britain less relevant in global affairs are also currently disparaging the Government for spearheading the global pushback against Russia. Opponents of Brexit warned that the withdrawal from the EU would diminish the country’s capacity to shape the contours of international affairs, but the logic of that argument meant that less Europe would mean more responsibility.

The Government has, therefore, rightly adopted a proactive and assertive foreign policy that allows Britain to be both global power and global broker to work closely with like-minded nations to address common threats.

Our approach to Ukraine should continue to set the tone for British foreign policy moving forward, namely by deploying the country’s reputational assets and global reach to address ongoing and future threats, and to mobilise our allies into action in increasingly complex and multi-layered challenges to international security. The shape and nature of long-standing and evolving security threats, which at times inter-connect, requires a re-calibration of how we combat them.

Firstly, coercive diplomacy, like that which we have undertaken with the Russians, constitutes a strategy designed to make an enemy stop or undo an action, either with or without resorting to military action. What is essential is ensuring the threat of force is credible enough to compel adversaries to comply with the coercing party’s demands.

The Government, along with its allies, has demonstrated a resolution and willingness to escalate the dispute militarily, thereby producing escalatory steps that can be either advanced or reversed depending on how the target country, Russia, responds. This differs from the conventional use of force in situations where diplomacy may be on the margins or discarded altogether and where the use of force is designed to be decisive and at times overwhelming to achieve military objectives.

In this instance, Britain’s approach has set the bar and paved the way for the likes of the Americans to step-up and assume more responsibility for a collective response to Moscow, while increasing the pressure and inducing action on the part of the Europeans, including the French and the Germans.

Second, the Ukraine crisis notwithstanding, inter-state wars are rare but proxy wars, civil-wars and hybrid warfare are on the increase, which requires re-calibrating policies to account for the reality of warfare today. Conflicts come and go but the resulting calm is often deceptive: of the countries that have suffered a civil war since 1945, more than half experienced a relapse into violent conflict – in some cases more than once – after peace had been established. These are the conflicts that inflict long-term damage to the fabric of societies and produce refugee crises that have far-reaching cross-border implications.

Re-calibrating policies to account for the reality of conflict and warfare today could not be more urgent: a paper by Stanford University concludes that droughts, floods, natural disasters and other climatic shifts have influenced between three per cent and 20 per cent of armed conflicts over the last century. One in four intrastate conflicts will result from changing climate, according to the paper.

Hybrid warfare will continue to test the rules based international order: such countries as Russia, China, Iran and North Korea will deploy and become increasingly effective at harnessing cyber and information operations to undermine the West’s interests and values. This year will see at least ten elections of note across the globe – arenas where malign state and non-state actors will look to subvert and manipulate electoral outcomes, undermine democracy and circumvent the true will of indigenous populations.

Britain should lead the push for an international framework that establishes the guiding principles for combating cyberwarfare. Its purpose would be to enable investment in cybersecurity and cyber resiliency, and to establish a framework that is similar to the 2006 commitment from NATO countries to commit a minimum of two per cent of their GDP to defence spending. Cybersecurity is underfunded, but our private and public sectors are increasingly exposed to sophisticated attacks designed to wreak havoc on our lives and national infrastructure.

Finally, to prevent and address conflicts that produce the breeding grounds for terrorists and their state sponsors, that enable the ascension of malign state and non-state actors, and that produce humanitarian and refugee crises, the government should establish a conflict-mediation unit within Downing Street, a team of dedicated experts whose sole mandate would be to empower the ability of Number 10 to navigate the tricky waters of conflict mediation. This could provide a valuable adjuvant to the work of the Foreign Office, which more often than not is ill-equipped to undertake agile and creative mediation and negotiation strategies that constitute tradecraft in their own right.

Such a unit would continue to build on the momentum that has been generated from the Ukraine crisis, a legacy builder that empowers Number 10 with sense of direction and purpose, and that allows Global Britain to stay true to its convictions and ideals as it moves to establish the country’s post-Brexit identity on the global stage.

Tony Danker: Now is the moment for the Government to go for growth

3 Feb

Tony Danker is Director-General of the Confederation of British Industry

For business leaders, the past few weeks have felt like peak politics. But this week has marked a shift back to economics. And it is most welcome.

Yesterday saw the publication of the long-awaited Levelling Up White Paper, with its transformational aspirations. Today there are energy price announcements and an interest rate decision. Economics is coming to the fore once more.

For me, the biggest takeaway from yesterday’s PMQs is that the debate about long term growth has now reached primetime. Here at the CBI, we’ve been banging this drum for a while now. We partnered with the Campaign for Economic Growth at Conservative Party conference back in the Autumn because we wanted the government to focus more on business investment to drive the economy. And today I was joined by the brilliant Robert Colvile from the Centre for Policy Studies at a joint CBI-CPS event to answer the question: are we actually serious about growth?

The UK currently has the fastest growing economy in the G7, but it doesn’t tell the whole story. V-shaped recoveries around black swan events are no time for credit or blame. The downward nosedive is not an accurate judgement of economic performance; and nor is the climb.

The truth of the matter, as set out in black and white by the OBR, is that we’re looking at post-recovery growth of just 1.3-1.7 per cent. For a country that has demonstrated it can do growth at around 2.5 per cent, this is not ambitious enough.

And let’s be honest, without higher, sustainable growth the ambitious, levelling-up goals set out yesterday, from improvements to public services and much more besides, will be all the harder to achieve unless we can get growth going again.

Let’s look a little closer at the bind we’re in – and importantly – how we can escape being caught in a trap.

Lumping more onto the UK’s tax burden – already at the highest sustained level seen in peacetime – cannot be the answer. The evidence is clear that raising taxes stifles growth, and cutting them drives it.

We’re not talking growth at any cost and by any means. And we’ve not lost sight of the need for fiscal responsibility. We’re talking sustainable, long-term growth stemming from greater investment, innovation and productivity.

Just as companies can’t afford not to invest in growth, nor can countries. It’s not just about money – it’s about ambition and imagination too.

And there’s never been a better time to go for growth, because right now we’re at a unique moment: when once-in-a-lifetime events have coalesced to create a burning platform for change.

One of those is Brexit. I am a big believer in the opportunity of post-Brexit Britain. I think it gives us the platform we need to push the UK’s huge economic potential and the freedom to make big bets. It can awake us from the flatlining productivity that took hold after the financial crisis.

Another is the pandemic, which has driven huge acceleration in tech and digital adoption.

And finally, we have the opportunity that flows from our world-leading position on decarbonisation. There is a wall of investment to fund decarbonisation – backed by firms with over $130 trillion in assets. British businesses are begging Conservative politicians to see the enormous economic prizes available go to those who move fast.

All this means this is our moment.

So how do we seize it? By harnessing the creativity and initiative which birthed the Super Deduction, new skills bootcamps and offshore wind investment – measures which spurned orthodoxy in public policy and showcased the boldness and vision we need.

The first step should be a permanent Investment Deduction, succeeding the Super Deduction and mitigating the looming Corporation Tax rise. It would act as a long-term incentive to invest and grow enterprise, with businesses acting across many fronts in service of the nation.

Achieving the Prime Minister’s vision of the UK as a science superpower requires nurturing a workforce fit for the future. So, how about building on the Apprenticeship Levy with a new Skills Challenge Fund to invest in the high-value skills businesses really need.

We also need to get serious now about generating more of the skills we need at home – so we’re less reliant on immigration. Nadhim Zahawi is onto something with his new Unit for Future Skills, examining where skills gaps exist. Let’s supercharge that and build an independent Council for Future Skills. It could optimise training towards future economic demand and recommend visas to overcome shortages in home-grown talent, setting the Shortage Occupation List.

On energy, ending uncertainty on hydrogen and schemes like carbon capture and storage will enable the UK to lead in global green markets.

Meanwhile, let’s build on Monday’s Benefits of Brexit paper by establishing a new Office for Future Regulation to allow a post-Brexit UK to become the smartest and most future-focused regulator in the world, with a clear remit to target competitiveness, investment and innovation.

The focus of this new body should be the big bets for our economy. Set free to be agile, now we are no longer bound by EU-wide consultation and compromise. Proportionate, so that it strikes a better balance between investment and consumer protection. And more dynamic, allowing regulators to act quickly and decisively, as we saw with the vaccine, when the MHRA saw the UK lead worldwide.

This is not all on Government. Business has a key role, and the CBI will be promoting serious growth to firms across the country. We will ask them to increase business investment. In net zero. In innovation and digital transformation. In exports. In skills. In workforce health and wellbeing. And we will gather them in clusters around the country to deliver levelling up the only way it can be done – by the private sector through better skills, jobs and wages.

Business leaders – of all sizes and sectors – will respond because they are serious about growth.

So let’s get serious, together. Let’s unite, creating sustainable growth – the only real answer to our cost-of-living crisis, rising energy prices and high inflation. Growth that propels the UK beyond recovery to a new era of prosperity.

After a disappointing decade for UK investment and productivity, this is our second chance. Let history show that, this time, we seized the moment.

 

Theresa Villiers: Regulatory reform – and what the Government must now do to win that Brexit Bonus

31 Jan

Theresa Villiers is a former Environment Secretary, and is MP for Chipping Barnet.

Two years on from leaving the EU, it is time the Government made the most of our new-found freedoms and reshaped our approach to regulation, so that we can drive growth, economic investment and competition into every corner of the UK.

The public put their faith in the Conservatives, not only to ‘get Brexit done’ but also to improve their lives and their communities. It is completely understandable that for much of the past two years, the devastating effects of Covid have dominated Government activities and consumed bandwidth that would normally be devoted to different areas of policy and reform.

However, now that we appear to be over the worst of Omicron, and hopefully returning to something approaching normality, we must refocus back on the core issue of driving growth and investment and improving living standards across the country.

If we are to deliver the long-term economic growth that benefits all communities (and opens the way for tax cuts), we must recognise that unleashing productive investment from the financial services sector is crucial. The UK is home to some of the most innovative companies and thoughtful investors in the world. It is up to the Government to create the optimal conditions to allow our business leaders and entrepreneurs to reach their potential. That is a key means to increase prosperity and opportunity, and to raise living standards for all.

However, aspects of our regulatory system can act as a barrier to this potential wave of investment. The complexity of regulations – many of which originated from the EU – and their gold-plating by regulators, means that long term investment can end up being directed more towards very large companies that don’t need the funds than to, for example, urban regeneration in our cities.

A perfect example is Solvency II. This is an EU law designed to provide a one-size-fits-all framework for all EU insurers to bring consistency to the way they hold capital to protect policyholder benefits. The rules, which are extremely risk-averse, continue to force UK-based insurers to hold too much capital back, preventing that funding from flowing into a range of much needed projects that could deliver real change in our communities.

For example, new research by Pension Insurance Corporation describes how £20 billion of additional investment over the next decade through reform of Solvency II could be channelled into the building of new social and affordable homes, improving existing social housing stock, as well as on renewable energy projects and urban regeneration.

This could enable the Government to claim a major Brexit bonus, demonstrating to people how the UK, as a sovereign nation, can re-write an unnecessarily complex and risk-averse EU law to the benefit of communities from Barnet to Bolsover.

Solvency II is just one of many EU laws copied on to the UK statute book after Brexit which we need to assess to see whether they are still fit for purpose. But with Lord Frost’s departure from government, we need urgent clarity on who has responsibility for this vital task. With EU relations now wrapped back into the Foreign Office, no Minister appears to have the lead responsibility for post-Brexit regulatory reform since Lord Frost’s resignation.

Past experience shows that drives to remove unnecessary regulatory red tape soon run into the sand if they are not driven with determination at the most senior level in Government. As things stand, we are in great danger of missing one of the most important opportunities Brexit has given us.

In the first instance, a Secretary of State should be made responsible for the Brexit Opportunities Unit which currently resides in the Cabinet Office and is tasked with identifying our economic and political opportunities post Brexit.

Secondly, and as I and colleagues on the Taskforce on Innovation, Growth and Regulatory Reform recommended to Government in our recent report, UK regulators should have stronger duties to promote innovation, investment and competition – as well as consumer protection – pushing them to play a much more active role in supporting growth. The Prudential Regulatory Authority (PRA), which oversees insurance companies, for example, should take a more evenly balanced approach to reforming Solvency II to ensure that there is increased investment in productive assets.

Thirdly, we need to ensure MPs are properly resourced both to scrutinise regulators and hold them to account. Strengthening the select committee system to ensure more effective use of economic impact assessments and metrics will help parliamentarians ensure that regulators really are replacing the EU model with a new, more innovative and proportionate UK regulatory framework.

This would mean that our country really can start to bank that Brexit bonus. At the moment, we face the ironic situation that EU may actually overtake us on Solvency II reform if regulators continue to drag their feet, potentially making us less competitive. As we emerge from the pandemic, long-term investment in our communities across our whole United Kingdom should be at the top of our priority list, and Solvency II reform can give a big boost to our efforts to deliver this. The opportunities are there for us to seize, but we must act now.

Gerard Lyons: How to tackle the cost of living crisis

11 Jan

Dr Gerard Lyons is a senior fellow at Policy Exchange. He was Chief Economic Adviser to Boris Johnson during his second term as Mayor of London.

Crisis? What crisis? The good news is that the economic rebound continues, and the jobs market has returned to broad health. We may also be over the worst of the pandemic, although possible new variants mean that learning to live with Covid and avoiding further restrictions may be a key priority this year.

Yet it is not this recovery but two other economic matters that look set to dominate policy this year: the immediate cost of living crisis and, less talked about, where growth will settle post-pandemic. Views on the latter may influence how policy responds to the former.

While the consensus expects growth around 4.5 per cent this year, after seven per cent last, there is still much pessimism about the future trend rate of growth.

It decelerated following the 2008 global financial crisis. If future growth is low, more of the budget deficit is structural, not cyclical, and needs to be addressed through fiscal restraint – a squeeze on spending or higher taxes. That thinking, which seems to dominate at the Treasury, will be resistant to reversing planned tax hikes for this spring.

Moreover, the economic consensus is that Brexit will exacerbate this challenge. However, despite this common refrain, tax rises are not inevitable. It is not leaving the EU but what you choose to do after you have left that helps determine future growth. In this respect, the Government still needs to articulate a market-friendly pro-growth economic strategy.

It also has bearings for now. There is no easy way to stop a cost-of-living crisis, but the first thing you should do is not implement policies that will make it worse.

The present crisis has multiple components. Inflation that is set to peak at over seven per cent in the spring. Higher energy prices though global in origin, are exacerbated here by decades of poor energy policies, including price caps that are now being lifted.

Furthermore, there have been two separate decisions taken to raise taxes this spring: higher national insurance, and a stealth tax in the form of a freeze on income tax allowances. And then there is a postponement of the triple lock on pensions, which means that they will rise by less than the increase in inflation this year.

Often at times of economic shocks, the search is for a timely, targeted and temporary response – that is, one that addresses the immediate problem but does not change longer-term policy.

Currently, policy is looking at how to support those most in need, which raises questions of how it can be funded.

Temporary financial help as offered during the pandemic would be one approach. It could be paid for by a windfall tax on energy firms. Such a measure would not be ideal, but it has been tried before, for example on North Sea oil producers and banks.

The argument against a windfall tax is the message that it sends. Firms across all sectors may need to factor in that high future profits could be seen as a cash cow by future governments, and this might deter planned investment in the UK by attaching a risk premium to it. Corporate tax rates have already risen, adding to the anti-business perception.

Another option is to cut the five per cent VAT on fuel. The saving, while small, will help those on low incomes. That measure alone, however, would not be enough in itself. And the Prime Minister seems to have ruled the move out as a blunt measure that disproportionately benefits higher earners.

It also appears that the planned tax increases will not be reversed – particularly as the hike in national insurance was effectively presented as a hypothecated tax for health and social care. Reversing this would reopen questions about how to fund the latter.

However, reversing the tax increases makes more economic sense. Not just because it would alleviate the cost-of-living challenge, but because the fiscal numbers, while poor, are improving and mean that such tightening is a choice, not a necessity.

These decisions are not easy. There is no right or wrong answer.  They are about judgement calls – to address the immediate challenge as well as to position for the future.

A current economic debate is about how much fiscal space governments have, despite public debt levels being at an all-time high globally. The debate is less concerned with providing a case for rampant state spending, and more with avoiding being pushed into tightening fiscal policy unnecessarily.

A high level of debt adds to problems, but if the rate of interest is less than the rate of economic growth it creates fiscal space, and improves the chances of debt sustainability. Debt to GDP can be reduced steadily, provided growth is solid and inflation does not let rip. The latter forces rates and yields up, hampering growth.

However, the Bank of England has been asleep at the wheel over the last year. The risk is that the inflation genie is already out of the bottle, as inflation expectations rise and firms increase prices.

In all likelihood, inflation will peak in the second quarter – since some of the initial supply shocks are now over and imported inflation may have peaked already – and, after staying elevated for a short while, will decelerate.

But chances cannot be taken and inflationary risks will force the Bank to raise policy rates this year, and reverse its printing of money by implementing Quantitative Tightening (QT).

We witnessed a short-lived cost-of-living crisis in the wake of 2008, when a weaker pound triggered a temporary rise in inflation. But the last such major crisis was in the mid-1970s.

There is a need not to be taken in too much with current comparisons being made with that decade, since the economy and environment are so different.

While there are not many economic lessons to heed from that period, one springs to mind. In a battle against a rising cost of living, it is vital to have the public on side. Not only so that they can understand the tough policy context, but also in the case of inflation to avoid what are called second-round effects – or put more bluntly, a wage-price spiral.

In June 1975, the annual rate of inflation hit 26 per cent. The then Prime Minister, Harold Wilson, decided that every household needed to receive by post a pamphlet about his policy to fight inflation. I still have a copy.

Entitled Attack on inflation: A Policy for Survival – a Guide to the Government’s programme, its 16 pages made clear why inflation needed to be brought under control. One telling message, in bold capitals was: “the battle (against inflation) cannot be won in one year…but the battle could be lost in one year.”

In the event, the Labour Government lost the battle. Policy focused on a wages and income policy, culminating in the “winter of discontent” in 1978-79. The annual rate of inflation did not fall back into single digits until 1982, after Mrs Thatcher was in power, and also following a deep recession.

I am not advocating such a booklet now, but rather stressing the importance of ensuring that people understand the context of what is happening, especially when here is so much uncertainty and the pain may be severe but short-lived.

The best that can be done is to control the controllables. Provide assistance, ease the pain, reverse the tax hikes, explain why – and focus on a pro-growth strategy.

Garvan Walshe: The time for fine-tuning Brexit is over. The Government needs to focus on making the most of their own deal.

6 Jan

Garvan Walshe is a former national and international security policy adviser to the Conservative Party.

It’s a year since the entry into force of the “Trade and Cooperation Agreement” between the UK and the EU, in which the Government chose one of the most decisive forms of Brexit, with Great Britain leaving the Single Market and Customs Union.  And the UK declining to participate as associates in Europol, the Erasmus programme, and the European Defence Agency.

The Government took the view that the terms offered weren’t good enough to satisfy the grievances of those who votedLleave in 2016, and nor, indeed are the terms of the deal it itself negotiated: that’s why it is trying to revise the Northern Ireland Protocol.

But it is now five and a half years since the referendum vote, and even Leave voters are tiring of this approach, with only 48 per cent endorsing the government’s handling. Its time would be better spent making the most of the situation they have crated, instead oftrying to fine-tune the Brexit deal further. Two areas are in particular need of attention.

First, Brexit entails a restructuring of the British economy: the Government needs to focus on maximising economic advantage, rather than seeking to address the grievances that led to Brexit.

And second, now that the UK has left the EU, it needs to exploit its diplomatic relationship with a still reasonably friendly bloc to its maximum, rather than re-fighting the Brexit negotiations.

Economically, new barriers to trade in goods and services have been erected, and the net loss is projected to amount to four per cent of GDP each year in the long run.

Making good this annual loss requires dramatic improvements to productivity. Long term economic growth depends on equipping people with the skills for tomorrow’s economy. This cannot be achieved by policies to improve the conditions for people who lack those skills and are unlikely to acquire them, or be in parts of the country where they could take advantage of them even if they did. Rather, levelling up will only be affordable if productivity can be enhanced elsewhere.

As Richard Baldwin argues in The Great Convergence, modern industrial goods are manufactured in three main geographically concentrated clusters: south-east Asia, North America, and continental Europe. Leaving the EU’s Customs Union is a decision to uncouple the UK from pan-European supply chains.

Leaving the EU has also made it harder to access customers there, limiting Britain’s access to the high-earning part of the European value chain. This leaves two possibilities for profit, increasing access to other parts of the world, and taking new steps in design and invention.

Trade deals alone cannot make up the loss of leaving the EU, because trade is inversely proportional to distance, and the rest of the world is far further away than Europe, but ways of reducing other aspects of what trade economists call “trade resistance” can.

Having cut itself out of the only manufacturing cluster within reach, the UK has to rely on its dominant service sectors. Differences in regulations impede service sector trade, and this is hard to reduce without the sort of enforceable agreements to harmonise them that this Government considers an infringement of sovereignty.

This leaves travel costs and cultural difference. Travel to Europe apart, costs are largely a matter of airport infrastructure and, in the medium term, decarbonising air travel. Reducing cultural difference means persuading more British people to learn languages and about other cultures.

Another aspect of services is people. If more aviation and languages boost service sales abroad, effective immigration policy can boost their creation at home, with the proceeds (because immigration is in virtually any circumstance economically beneficial) being used to build up domestic human capital too.

As David Willets has argued, we should build more universities in places that lack them, so that more young people can participate in the international service economy. All this will better equip the UK economy to thrive outside the EU’s trade structures.

When it comes to relations with the EU itself, the Government should start with an accurate understanding of the organisation it left. The EU is not merely an association of member states, but has acquired some of the powers and apprutenances of a state. That is why British voters wanted to leave, after all.

Yet the Hovernment persists in focusing on bilateral realtionships at the expense of that with the Commission. Even when it does not descend into the absurdity of Lord Frost refusing to call the EU by its name, this fails to recognise the reality of the Commission’s power in trade and economic policy, let alone the fact that the countries still in the EU have decided to pool their powers in Brussels.

So rather than wishing the Commission away, the government needs to seek out a real, mutually beneficial, relationship with it, in areas like research, and security and defence policy, even if closer trade policy is currently off the agenda.

Anti-Brexit opinion, which is concentrated among the young, has consolidated, rather than faded with time. Though it will take some time to work through, the weight of that opinion will eventually be felt, and take Britain back towards a closer relationship with the EU. If the Government wants its Brexit legacy to stand, it had better start thinking how to make it work.