Gerry Lyons: How the Bank of England has failed to control inflation. And what should be done to reform it.

3 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.

This week sees the Bank of England celebrate 25 years of independence. Quite rightly, the current rise in inflation has raised questions about whether it is time to reassess its remit and governance.

There has been a rise in inflation across western economies. That this is more than a UK issue should not divert attention from where the problem lies.

If you are driving a car and approach a red light and decide to not only ignore the signal to stop but put your foot down on the accelerator, you are driving dangerously. That some other cars may do the same does not change that fact. It is not safety in numbers, but is more likely to cause greater carnage. Last year, in monetary policy terms, central banks went through the red light – with their feet down on the accelerator. The Bank of England was near the front.

At that time, it was clear that our economy was recovering and inflationary pressures building. The supply-side shock triggered by the pandemic was already evident. The correct policy would have been to tighten policy, not add fuel to the fire by increasing Quantitative Easing to a mammoth £895 billion.

The question I posed then was: which ‘p’ was this inflation? Would it pass-through, persist or become permanent. The Bank strongly believed it would pass through quickly. It was evident it would persist. It was unlikely to be permanent because of intense global competition but, even if inflation persists, once it then eases it may settle at a higher level than before, say nearer three per cent to four per cent than one per cent to two per cent.

The danger, as was clear at the time, was that even if the initial cause of inflation is a supply-side shock, action needed to be taken to prevent cost-push inflation by which firms raise prices to pass on higher costs, or second-round effects allowing prices and inflation expectations to creep higher. Effective communication as well as clear actions were called for. We got neither.

What are the lessons and implications?

Consider the 1970s. It may be hard to believe, but Britain began the 1970s as the low inflation country of Europe. Monday 15th February 1971 was Decimalisation Day, when we moved from 240 pennies in the pound to 100 new pence.

Ahead of that day, I remember paying my bus fare with pennies that had been minted not just in the early part of the twentieth century but some in the nineteenth century too, with Queen Victoria’s head on them. That such old coins were still legal tender was testimony to how well Britain had kept inflation under control.

Apart from the First World War, when annual inflation averaged 15.3 per cent in the UK, only the 1970s saw high inflation, averaging an annual 12.5 per cent during that decade. There is no reason why, with the right policies we cannot return to being a low inflation economy.

The 1970s showed that inflation is deadly. That’s why the complacency with which the Bank treated it last year was wrong. It is felt by everyone, with the poor and those on fixed incomes like pensioners suffering the most.

Another lesson is that the measures necessary to control inflation are deeply uncomfortable, often requiring sharply higher rates, with damaging economic consequences. Nowadays, with borrowing higher, the economy is not only vulnerable to higher rates, but can be impacted sooner as policy tightens.

UK policy rates are currently only 0.75 per cent, while annual consumer price inflation in March was seven per cent, ten times higher than its rate of 0.7 per cent a year ago. And it will head higher.

Harold Wilson, Edward Heath and Jim Callaghan all lost elections because of their inability to control inflation. A central feature of the two general election campaigns in 1974, and even of that of 1979, was the use of a shopping basket to show how the Government had failed. Don’t be in any doubt as to who pays the price for a failure to control inflation.

Given this background, and how important monetary policy is in everyday life, one might think Westminster would pay more attention to the Bank of England – to how it is governed and keeping inflation under control. It is now as the cost-of-living crisis bites and the economy slows sharply.

The weekend saw much coverage of the 25th anniversary of the Blair landslide in 1997. An early decision – on 6th May 1997 – was to award operational independence to the Bank of England.

Although a surprise – having not been mentioned in the campaign – independence had been a topic of discussion for some time among economists. Indeed, I remember a well-attended Society of Business Economists debate early in 1997 where David Currie gave the case for central bank independence and I argued against. There were pros and cons. It would embed low inflation expectations, but there was a need for transparency and democratic accountability.

Even the Bank’s own Quarterly Bulletin in 1995 had carried an article by a leading economist, Robert Barro, showing that it was not independence but often an external factor that was the driving force behind inflation. Indeed, China’s entry into the World Trade Organisation in 2001 contributed to intense competition – helping to drive inflation down globally and in the UK for much of this century.

Inflation has averaged two per cent over the last quarter century. While welcome, this should not divert attention from how the economy has suffered the consequences of three major policy mistakes from the Bank.

First, monetary policy has fed rampant asset price inflation, in financial markets and property. Alongside low property supply, this has fed intergenerational inequality.

Second, a cheap money policy through low interest rates and Quantitative Easing has fed financial instability as markets do not price properly for risk.

Third, the Bank’s recent policies have fed inflation.

Attention usually focuses on the Monetary Policy Committee and interest rates. Thus, the Bank’s other policy committees on prudential regulation and financial policy are too often freed from scrutiny – as is the interaction between these policies. The economy, after all, is significantly affected by the prudential controls placed upon on banks, and peoples’ ability to borrow has been impacted by micro-prudential regulations.

While the Bank, in recent years, has played a welcome role in how finance can help achieve the green agenda, there are other important areas that the Bank should confront. Not least among these is the low level of commercial lending to small firms. It should also be more of a cheerleader for the Square Mile.

Now, it is time to ask whether the Bank’s inflation targeting regime has run its course. I favour a new remit based on a target for nominal GDP. An anti-inflationary monetary policy remains critical, but change is well overdue.

In this much-needed review of the Bank there needs to be a reassessment of its governance, transparency and accountability.

The Bank’ governance is overseen by the Court, but this is rarely held to account, and would appear to pay only lip-service to diversity, not least in thought. Groupthink can be a problem with policymakers. In my view, one might ask if the Bank’s historic underrepresentation of those from working class backgrounds in senior positions hinders how it sees its policies affecting those on low incomes. Its communications too have caused problems. Yet, effective communication is critical – not only to the public and financial markets, but to global audiences too.

David Green: Now is the time to break the United Kingdom’s commercial dependence in China

25 Mar

David Green is CEO of Civitas.

The age of unfettered globalisation is now over. It is now widely accepted that buying whatever we want at the lowest price available anywhere in the world now comes second to national security. Above all, nations that fight wars of conquest against weaker neighbours are not worthy trading partners.

But is this change of direction just a temporary response to Vladimir Putin’s unforgivable aggression, or are permanent changes in the world order implied?

The great champions of free trade in the Nineteenth Century, such as Richard Cobden, used to argue that trade led to peace. The First World War shattered that illusion. But what we can call the naïve theory of free trade came back in the 1980s and 1990s, symbolised by Thomas Friedman’s famous claim that ‘No two countries that both had McDonald’s had fought a war against each other’.

He reasoned that the prosperity that resulted from free trade created a middle class that had too much to lose from war. The wars in the Balkans soon contradicted his hypothesis.

It turns out there is a causal connection between trade and peace, but champions of the naïve theory got it the wrong way round. Trade does not necessarily make peace more likely, but a commitment to peace does make free trade more likely. The underlying imperative is that nations that want peaceful existence are more likely to seek mutually beneficial trading arrangements.

It has been well recognised at least since the time of Adam Smith that trade can be looked at in two ways. It can be a method of gaining advantage at the expense of others, usually called mercantilism, or it can be a means by which both parties benefit from transactions.

Russia has been storing up its gains from trade in order to expand its empire. The question we now need to confront is the motivation of China.

Is it wise to allow Beijing to become even more powerful through trade so long as it is an authoritarian dictatorship with openly declared ambitions to expand its territory, with Taiwan the next target? Moreover, its Belt and Road initiative is not a device for spreading prosperity in less-developed parts of the world, but rather a way of creating conditions of dependency that can be used to exert political pressure when the need arises.

Our reliance on Chinese imported manufactures is now so great that every foreign policy decision has to take into account the preferences of the Chinese Communist Party (CCP). All Chinese companies are under the influence of the CCP, whether they are nominally private or not; a Chinese company controls about 25 per cent of North Sea oil, and others own suppliers of gas, water and electricity.

A study in 2020 estimated our ‘strategic dependency’ on China. Such dependency arose when a nation was a net importer of a product and imported more than 50 per cent from China when China controlled more than 30 per cent of the global output. The conditions were met for 57 categories of goods and services.

Moreover, Chinese economic power is partly a result of Western investment. A 2017 study by Professor Michael Enright of the University of Hong Kong looked at the contribution of foreign direct investment,  ‘foreign invested enterprises’, and foreign affiliates, and estimated that it accounted for about one-third of China’s GDP and over one-quarter of China’s employment in the years up to 2014.

We should reconsider all our trading relationships and ask whether we are empowering a potential aggressor, or putting ourselves in a position that allows us to be strong-armed. The case for free trade remains strong – but only with peace-loving peoples.

What should we do? First, we should stop investing in China. Second, we should end our reliance on China for so many goods. We should aim to have at least one home producer so that we can’t be pressurised. Third, we should exploit all our own resources, notably oil and gas.

Fourth, we should trade with countries committed to peace and who have renounced wars of conquest. This rules out China until it gives up all claims to Taiwan. And fifth, we should press for China to be expelled from the World Trade Organisation while it remains a state-dominated economy.

America 1) Bim Afolami: Yes, the United States is withdrawing from its role abroad. So we need to reinvigorate our alliances.

23 Aug

Bim Afolami is MP for Hitchin & Harpenden.

Does “The West” mean anything any longer? Over the past week, we have watched the 20 year old US-led invasion of Afghanistan come to an inglorious end, with the final exit of US military forces in a way that was visually reminiscent of the American exit from Vietnam in 1975.

This has not just been an American story. Four hundred and fifty-seven British troops lost their lives there, as did over 600 soldiers from other allied countries. As a result of this shared investment in trying to save Afghanistan from the Taliban, the departure from Afghanistan has been met with much hand wringing and emotion in the UK and much of Europe, with much criticism of Joe Biden for both the fact and manner of withdrawal.

At the time of the invasion of Afghanistan in 2001, we knew what “The West” was. Broadly speaking, it was a collection of like-minded, democratic countries – a long term partnership between the US and Western Europe which had eventually won the Cold War.

NATO was its core infrastructure, largely funded and buttressed by the America, supplemented by the European Union and different bilateral partnerships. The US acted as a superpower and often acted selfishly in its own interests (lest we fool ourselves otherwise), but it retained a sense that the unity, purpose, and values of the West meant something, and that it was America’s responsibility to lead it. Isolationism was still a dirty word.

Henry Kissinger wrote: “torn between nostalgia for a pristine past and yearning for a perfect future, American thought has oscillated between isolationism and commitment”. Isolationism has always been a recurring force in US foreign policy. In his famous Farewell Address, George Washington warned against what he called “entanglements” and against permanent foreign alliances, and regarded Europe as having “a set of primary interests which to us have none or a very remote relationship. Our detached and distant situation invited and enables us to pursue a different course”.

America was extremely reluctant to enter both world wars, and were late in doing so. After 1945, the Cold War saw a renewed American commitment to engagement on a global scale, but after the fall of the USSR and the resultant ideological “End of History” of the early 1990s, the oscillation that Kissinger talked about remained through the controversies of Bosnia, Afghanistan and then Iraq.

Anyone watching President Biden’s speech last week would have noticed that the Trump “America First” stance is alive and well. If this stance is the new normal for the US, at least for the foreseeable future, what does this mean for Britain? It appears to me that there are three potential strategic futures for the UK.

One option is for us to shrug our shoulders and accept the current situation as the new reality. The West’s period of dominance cannot last for ever. China is on the rise, the US is in decline, and therefore we – as part of the old “West” – will decline along with it. We should focus on our domestic problems, and be highly pragmatic with our international relationships to keep us out of entanglements as much as possible, ignoring much of the value-driven approach that we have championed over the past generation.

The second option is for us to try and reinvigorate our existing alliances and institutions, and somehow find new strength, unity and purpose to tackle the pressing challenges we face. Unless faced with a changed approach from Washington, this will mean a significant investment in military and diplomatic power from European powers.

To achieve this would require much better relations with them, and improving our defence and foreign policy cooperation. Do they really want to partner with us fully with Brexit, still an open wound for them? Is Europe really willing to improve its NATO contributions, and explain to its electorates that there is the need for less butter and a more guns?

The third option is perhaps the most radical: a fusion between these two. We need to breathe fresh life into the phrase “Global Britain” and rethink our foreign policy not in the world we would like, but in the world we actually live in. America is no longer likely to act as the “leader of the free world”, in the short to medium term. The Chinese are increasingly willing to flex their muscles in foreign affairs (only hours after the Taliban overran Kabul, a Chinese foreign ministry spokeswoman said Beijing was ready for “friendly cooperation with Afghanistan”), and India is not far behind.

Yet in the UK our values matter to us, and our partnerships with the US and Europe are not just historical: they are based on fundamentals of our culture and shared understandings in the modern day.

I believe that the UK can help play a truly global role by seeking a more independent route in foreign affairs, by leveraging our strong relationships all over the world and our soft power. We should act as a global convenor – a trusted and safe network hub in which all the major powers wish to operate, and bring our positive influence to bear in this way.

This could be in areas as diverse as international finance (e.g. rules on international tax), diplomacy (e.g. reforming the UN and WTO), humanitarian assistance (i.e: ensuring more vaccines are sent to the developing world and tackling climate change). Not to act as a bridge between the US and EU, but to continually act as several bridges between many more powers – the US, EU, China and the Commonwealth.

Thereby, we could play a central role in reshaping the global institutional framework of tomorrow – one in which China, India, and many in the developing world feel that their status is more fairly represented. A retreat from a unipolar world into a multipolar world does not necessarily mean chaos if we have the institutions to manage that new reality.

Whatever one’s view of the right path forward, it is my strong belief that in Britain we need to shift gears. We need to accept that American power is waning, and they are no longer interested in using its blood and treasure in faraway countries of which they know little. We can either just accept this reality and continue pretending that the West’s dysfunctional institutions and military weakness doesn’t matter, or we can reinvigorate our alliances, reshape the international system, and work much more closely with the new ascending powers to try and adapt to the new multipolar reality.

Shanker Singham: The Dimbleby food plan would wreck Britain’s trade policy

18 Jul

Shanker Singham is CEO of Competere. He is a former adviser to Liam Fox when he was Secretary of State for International Trade, and to the Office of the United States Trade Representative.

There have been a couple of important independent reports published recently on the subject of trade and agriculture.

In March of this year, the report of the Trade and Agriculture Commission (“TAC”), an independent commission staffed by a secretariat from the Government (primarily the Department of International Trade), was presented formally to the Secretary of State for International Trade.

Yesterday, another independent report (Part Two of the National Food Strategy (“NFS2”) was published. This report was commissioned by the Government, but was an independent review whose lead author is Henry Dimbleby, the co-founder of Leon restaurants.

I was privileged to serve as a Commissioner on the TAC. NFS2 covers many areas, but touches on trade policy aspects of food and agricultural trade, and it is here that its recommendations overlap with those of the TAC, whose primary focus was to study the interaction between trade and agricultural policy issues.

NFS2 correctly draws attention to the unanimous proposal from the TAC regarding the interaction between the UK commitment to trade liberalisation in the form of a zero tariff and zero quota policy, and its recommended approach to deliberate deviations from agreed core standards in areas like labour and the environment.

The TAC report regarded such deliberate deviations from agreed standards in the FTA as potential anti-competitive market distortions, for which a mechanism to impose a tariff could be legitimately crafted.

It is certainly true that gaining such a consensus was a significant achievement from the TAC, and in particular its chair, Tim Smith. However, it does a disservice to that delicately poised consensus to mischaracterise the TAC recommendations in the way NFS2 does.

The TAC report was very clear in its recommendation that, in exchange for a commitment to zero tariffs and zero quotas, the UK would propose a mechanism whereby, whatever core standards were agreed in FTAs, any deliberate deviation from them for trade gain would constitute an anti-competitive market distortion (ACMD). Provided the aggrieved party could show this and its effect on competition, as well as causation and damage, it could request a corrective tariff to offset the artificial cost reduction gained by the deviation from agreed standards.

However, and crucially, those standards have to be agreed. The TAC was careful to ensure that any policy proposed by it would comply with both the letter and spirit of WTO rules on sanitary and phytosanitary issues (SPS rules), as well as the WTO rules on Technical Barriers to Trade (TBT rules). These require a commitment to sound science and non-discrimination and constrain unilateral action.

It was absolutely clear from the TAC report that the UK could not unilaterally assert these standards, but that any tariffication mechanism would come into play only when there was a proven deviation from agreed international standards, or from those expressly agreed in the FTA

It was also axiomatic that this tariffication would be an ex-post event only if all the elements could be proved. I knew that even this proposal would raise eyebrows in capitals around the world. I backed it because I could see the justification for it, and that it was rooted in a normative framework that recognises the interaction between competition and trade policy.

I believed then and do now that many countries could be brought round to this way of thinking, and would not simply assume that this was a protectionist gambit by the National Farmers Union. Proof of this is that we are seeing variants of it emerge in the UK-EU Rebalancing Mechanism, and in US proposals in the WTO.

In addition to completely mischaracterising the actual recommendations of the TAC, NFS2 goes on to publish a table comparing the food standards of the UK’s key trading partners and geo-strategic allies.  It assumes without any analysis that rules that are more restrictive and burdensome automatically mean that standards are higher. It does this even if practices that have been found to violate the WTO.

NFS2 mischaracterises and simplifies the TAC recommendation to the point of absurdity. It will be rightly regarded with deep hostility by capitals around the world. It is to be hoped that the careful consensus obtained in the TAC, and understood by our trading partners, will not be shattered as a result.

It is certain that when our trading partners read NFS2, they will regard it as the type of wild assertion of protectionism that they have come to expect from the EU’s agricultural trade policy. They will also note with horror that NFS2 goes far beyond what even the EU has dared to suggest. Far from being the free trade superman of Boris Johnson’s Greenwich speech, this policy would turn the UK into an international trade pariah state, even worse than the mini-version of the EU that many of our key trade partners such as the US, Australia, New Zealand and Singapore fear, and even more of an outlier.

If these recommendations were to be applied to our imports from the EU, we would immediately be in litigation with them, and they would rightly invoke the rebalancing mechanism to slap tariffs on UK exports. As for the rest of the world, let us not forget that the EU’s sanitary and phytosanitary rules have unified both the developed and developing world against it in the WTO. If implemented, thee proposals would compound the pain inflicted on the global poor in developing countries at a time when the UK has also just announced a cut in its aid budget. This is not trade or development terrain that the UK wants to occupy.

Our trading partners are rightly concerned about which side of the table the UK will eventually land on. Our agricultural trade policy will be a strong indicator of where that will be. If we are even more of an outlier than the EU in these areas, we will be dismissed into irrelevance.

The NFS2 recommendations in trade policy will drive a coach and horses through the UK’s external trade policy, any improvements it could make in terms of domestic reforms in the agricultural sector, and render the seminal Johnson Greenwich speech on free trade into “sound and fury signifying nothing”.

Trade policy matters, and policy recommendations must be carefully calibrated if they are to have any chance of success. NFS2’s trade policy recommendations do a material disservice to the hard won gains and consensus developed in the TAC. They should be comprehensively rejected.

Stephen Booth: While UK-EU talks gather momentum, Britain should continue to diversify its trading relationships.

25 Jun

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

There are signs that the UK-EU negotiations on the future relationship may be gathering some momentum.

Last week’s stock take meeting between the Prime Minister and Ursula von der Leyen and Charles Michel, the European Commission and European Council Presidents, respectively, confirmed there will be no UK request to extend the transition period beyond December 31 this year.

Both sides agreed to inject fresh impetus into the negotiating process, with talks set to intensify in July, August and September. This marks the make-or-break period to reach a trade agreement and new arrangements in other areas such as cooperation on policing and security.

In my previous column, I argued that the nature of the impasse – essentially whether the EU is prepared to cut a deal under which the UK would be free to leave Brussels’ regulatory orbit – means that it is incumbent upon the EU to move on the key sticking points.

These are fishing and the demand for ongoing UK alignment with EU law on the “level playing field”, particularly with regard to state aid. Important UK-EU differences remain but there are encouraging signs that this is now happening.

Following her meeting with Boris Johnson, von der Leyen signalled in a speech to the European Parliament that the EU was prepared to compromise without, of course, putting into question “our principles and the integrity of our Union”.

In her speech, von der Leyen made no mention of the EU’s initial demand to maintain EU boats’ access to UK waters on the basis of the status quo. “No one questions the UK’s sovereignty on its own waters,” she said. “We ask for predictability and guarantees for our fishermen and women, who have been sailing in those waters for decades.”

Neither did von der Leyen mention the demand for ongoing alignment with EU law on state aid or a role for the Court of Justice (ECJ) in overseeing the level playing field. “It should be a shared interest for the EU and the UK to never slide backwards, and always advance together towards higher standards,” she said.

Notably, she limited her remarks on the role of the ECJ to the part it should play “where it matters” in the area of police and judicial cooperation, rather than in the wider trade deal. If the UK wishes to retain access to EU crime and policing databases, these are underpinned by EU law and there is no escaping that the Court has the role of interpreting how law applies on the EU side.

Though, as the UK has pointed out, the EU has consistently agreed treaties with non-EU countries on policing and judicial matters without requiring the ECJ to settle disputes between the two parties. Equally, the Government has said it will not agree to the extraordinary EU demand for treaty provisions that would oblige the UK to maintain its existing implementation of the European Convention of Human Rights in domestic law.

Meanwhile, there is speculation that a compromise on the level playing field is being explored, under which Britain would assert the right to deviate from the EU rules that it will inherit after the transition period expires. And, in return, the EU would have the ability to apply tariffs on British exports if regulatory divergence amounts to unfair competition.

Neither side has formally adopted the idea yet, but there are reasons to suggest it might have legs. The UK would regain regulatory independence (and the consequences), while the EU would retain the ability to control access to its market in instances where it perceived the UK was lowering standards.

Brussels would need to give up on its desire to export its regulatory model to the UK indefinitely by treaty and the UK would need to compromise on its current position that any commitments on subsides, labour and environmental rights should be exempt from dispute resolution.

It is also an idea hiding in plain sight. The EU’s draft UK trade agreement text already proposes so-called “temporary remedies” and “interim measures” in the event of non-compliance with treaty commitments.

Such a model would not be without difficulties. The UK and EU would still need to agree on the relevant benchmark for identifying a breach of level playing field commitments. The UK could insist that evidence should be required to show that the effects of divergence are harmful to open and fair competition. The EU could continue to insist that the letter of EU law is the benchmark.

Equally, the prospect of the EU using tariffs or market restrictions as a political tool to secure leverage over the UK in other areas of the agreement cannot be discounted. This has been a feature of the EU-Swiss relationship in recent years. However, this needs to be weighed against the prospect of UK-EU trade facing the full panoply of tariffs on day one, if talks break down completely and trade reverts to World Trade Organisation terms.

Critics have noted that rather than providing for managed divergence, such a mechanism would create perpetual conflict. But, ultimately, while it would be nice to avoid it, the likely reality is that the UK and the EU will face disputes in the future, just as they have in the past. This is a feature, rather than a bug, of an independent UK. Some disputes may be easily resolvable through treaty dispute mechanisms, others will require political resolution.

One way for the UK to insure itself in the event of such disputes is to diversify its trading relationships outside of the EU. And negotiations with the UK’s priority non-EU markets, the US, Australia, New Zealand and Japan, are also intensifying over the coming months.

This week, Hiroshi Matsuura, Japan’s chief trade negotiator, called for a UK-Japan deal to be secured in just six weeks to be ready for ratification in the Japanese parliament. The challenge is to replace the existing EU-Japan agreement, which is due to expire at the end of the Brexit transition period, and Japan is insisting on a bespoke UK deal rather than a simple rollover of the existing EU agreement.

This may mean that the deal is less ambitious than the UK would like on agricultural tariffs but Japan and the UK could go further than the EU was prepared to in areas of mutual interest such as services and digital.

Unlike the Japanese deal, the talks with the US, Australia and New Zealand are about fresh deals and the talks are expected to run into next year. UK accession to the Comprehensive and Progressive Agreement for Trans-Pacific Partnership is next on the agenda. India would be another potential candidate for the future.

With this week marking the fourth anniversary of the EU referendum, the contours of the UK’s international trade policy are beginning to take shape.