Oct 23 2012
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UK Economics

One Nation, or One Big Charade? By Mark Coles

Ed Miliband’s unveiling of Labour’s “One Nation” brand to take into the next election reveals several things about our only real source of official political opposition given the current Conservative-Lib Dem alliance. What does it mean in practise, and will it tessellate with the economy as we recover from years of sluggish performance, and more importantly, will voters buy it?

For the purposes of this argument, we will assume that all the ideas put forward would be included in a manifesto/parliamentary debate and overlook the trend to drop inconvenient pledges once the election is safely in the bag.

The vernacular implies giving people more control over their own lives, making a fairer society, with greater link between effort and reward whilst still protecting the key institutions that Labour cherish. This aims to gel together the old Labour principles and the centre ground which many voters now lie (no doubt along with numerous disillusioned Labour voters), and unite great swathes of the electorate delivering change and unite the notouriously divided Labour Party. The Telegraph reported one source saying it would be “hard to bring everyone together” and he could end up creating “insipid Leftism”, which would appeal to very few.

On the economic front, the new thinking may challenge the Old Labour orthodoxy, but at the moment very little detail has been released. One cannot help but think there is not going to be a huge amount of difference from the course taken by the Brown administration or the Coalition. Cuts will still have to be made, only the speed, depth and location of them is being argued. We are not in a position to borrow to invest to kick-start a sluggish economy, or adapt a standard Keynesian approach and any doctrine that advocated this would find it a hard sell to the masses and a sitting duck for any opposition criticism.

This brings us to the final and most important question politicians ask themselves, will voters buy it? Borrowing the “One Nation” moniker may seem like a sneaky move to steal a Tory faction that existed from Disraeli to Thatcher, but to ordinary people this will not easily resonate with what is going on in their daily lives. What is needed is more detail, and as more detail is rolled out, is when there is chance for more criticism and cynicism. What’s more, Miliband and Balls will have to find a pretty good explanation as to how they can protect more public services, and still deliver the cuts we need to bring us back into financial line.

It seem therefore, that the idea seems sound, the actual detail a little patchy, but as with so many things in politics and life: Only time will tell.

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Oct 15 2012
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UK Economics

Rebalancing the UK economy: more important than cutting the deficit? By Matthew Campsie

The UK’s Balance of trade deficit is now at its largest since modern records began. It is now clear that the unprecedented economic stability between 1993 and 2007 masked growing imbalances in the economy. Many have stressed the need to ‘rebalance’ our flagging economy but so far the size and the nature of the problem has not been sufficiently acknowledged.

The first, and main problem is that the economy is over reliant on financial services for growth. This is largely due to the massive decline in the industrial decline that Britain has suffered over the past thirty years. This is not exactly a new problem, but one that needs to be arrested in order to reverse Britain’s  reliance on consumption and financial services to drive growth.

The UK’s previous industrial strategy exacerbated this problem as it focused purely on the financial sector. Chris Benjamin, formerly of the department of Trade and Industry, suggested that as a result of this the UK ‘lacks the sinews, networks and public perception of a genuine industrial society.’ The fact that UK goods are often of poor quality and design and poorly marketed (and, a few well recognised cases aside, sold into declining markets) is largely down to low investment levels and the UK productivity gap.

Indeed, The Economist dubbed UK productivity ‘the missing guest at Gordon’s party’, and even though the productivity gap has closed in the last two decades, the UK is still behind the rest of the G7 nations by an average of 8%. In the long run growth results almost entirely from productivity growth, so there needs to be a particular focus in improving productivity in manufacturing.

The historically low share of investment in UK GDP has long been recognised as a problem. Although  this is an area which has improved a little in recent years, Since 1980 the UK has ranked either 6th or 7th of the G7 advanced economies by this measure. Investment’s share of the economy in 2009 was at its lowest in 40 years and much lower than that of France, Germany and the US. This is a particular shame as it has caused Britain’s failure to harness the potential of new ideas and technologies. It has a high quality science and engineering base, yet the low R&D spending levels means that this potential is wasted. Britain’s education system also fails to produce the the type of worker needed to allow a successful manufacturing base to flourish. Nearly a quarter of the population lacks basic literary skills, more than double that of Germany, while a third of 25-34 year olds have few or no formal qualifications beyond compulsory education. Too many people leave education early and relatively few get an apprenticeship or skilled craft qualification, according to the OECD.

The  reliance on financial services becomes harder to defend when their lack of support for British industry is taken into account. There are no links between industry and finance in the same way that there is in Germany, for example. To counteract this the government are setting up a new bank which when fully operational aims to provide up to £10bn of new and additional business lending. They have that suggested that this is a direct attempt to ‘address long-standing structural gaps in the supply of finance, as identified in Tim Breedon’s report on non-bank finance.’ This is very much a step in the right direction.

Given Britain’s obvious comparative advantage in financial services it would be foolish to oversee a decline, but the economy should be less reliant on one industry for growth. Indeed, the Bank of England’s Andrew Haldane has argued that much of the growth in financial services productivity that boosted GDP in the run-up to the crisis was a ‘mirage’ rather than a ‘miracle’ driven by excessive risk-taking. This analysis suggests that an unreformed financial sector of a comparable size to that we saw before the crash would pose an inherent risk to the UK economy, regardless of how much value it created in the short-term. Ultimately, the UK economy needs to restructure before it can achieve sustainable, steady growth. Indeed , this is an issue the present government wanted to address, as in February 2010 the then Shadow Chancellor George Osborne suggested that: “We will increase saving, business investment and exports as a share of GDP.” However, the output of financial services rose by 2.4% in the two years to June 2012, while over the same period GDP as a whole only rose by 0.4%, suggesting the share of the economy accounted for by financial services is rising rather than falling.

Furthermore, it could be argued that restructuring the economy away from financial service dependence may be a more important task than reordering public finances, as it is the only way back to sustainable growth, and higher national debt may not have such a horrific outcome – the loss of a triple A credit rating has not affected the US or France in any great way. Furthermore, austerity might lead to higher national debt, by damaging growth and confidence, leading to the automatic stabilisers kicking in, leading to more austerity, which sparks a vicious circle. In fact, the OBR argued in July 2011 that the overdependence on finance and property related revenues was “one of the primary drivers of the severe deterioration in the UK public finances in recent years, exposing the risks to sustainability of reliance on revenue from these sectors.” So rebalancing the economy may also help deal with tackling the levels of public debt.

In summary, a combination of reasons has led to the decline of the UK’s manufacturing industry and the resulting over reliance on financial services for growth has led to serious problems. The way forward seems to be fraught with difficulty, and although several measures have been put into place to counteract this, more needs to be done.

Oct 04 2012
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Global Economics

Sunny side up. By Ayush Varma

fter scrolling through the numerous articles on this forum, I feel dejected, struggling to see the light of day. My colleagues and I have painted a world immersed in a ceaseless recession, only made worse by the austere economic policies of the deceitful and incompetent politician. While that is a rather accurate picture, it is not a complete one. If we look outside the confined sphere that is the west, we may be surprised to learn that there are a few who flout the trend and are thriving during these adverse times. There has been much hysteria over the BRIC countries, and the oil opulent Middle East; however, none of these are the topic of this article. Rather, it’s a country more renowned for its beaches, babes, and beer, than for its economy- Australia.

The Australian Economy in numbers…

  • The United Kingdom has a GDP estimated to be $2.43 trillion; remarkably, the Australian Economy is only half it’s size- standing at $1.37 trillion. See girls, size doesn’t matter…
  • Whilst we are struggling to escape the hole in which we find ourselves, Australia has enjoyed a healthy period of GDP growth. The latest figure is 0.6%.
  • It has been awarded a unanimous triple A rating, higher than those of both China & India. Although, how telling is a triple A rating anyway? If the rating system was actually competent and effective, we might have never ever even been in such a predicament.
  • Australia’s unemployment rate is 5.1%, on the higher side because of increasing unemployment in the rural parts. However, the figures are merely a molehill when put aside the UK’s 8.1% and Spain & Greece’s 24%.
  • Unsurprisingly, it has an extremely high HDI rank of 0.92. The sun-soaked golden beaches of Queensland, or the gloomy streets of Middlesbrough? I know what I’d prefer.

Since the beginning of the global financial crisis, the Australian economy has had an almost impeccable growth record. Apart from two blemishes, it has grown at a healthy GDP rate each quarter. However, unlike the UK boom years post withdrawal from the ERM, Australian growth has been export-led rather than debt-fuelled.

The Australians host an impressive export portfolio of diamonds, iron, and coal. Thanks to the demand from China, the economy has increased the value of its exports in the last 4 years. This has reflected well on their current account, which is at a surplus of $18 billion. In comparison the UK has a deficit of £20 billion, which is largely down to a certain “Iron Lady” whose pursuit of “Reaganomics” weakened our once potent primary and secondary sectors.

Surpluses on the current account of balance of payments have translated into reasonable fiscal surpluses. This is especially remarkable when considering that Australia is under Labour stewardship, who are known to be more fiscally reckless than responsible. The competence of the government has also resulted in effective monetary policy, with base rates being slashed to 3.5%. This has helped to curb demand-pull inflation, thereby maintaining inflation within the ideal 1% to 3% range. In addition to this, the government has been able to amicably sustain pressure on banks to pass on the base rate, which has had positive multiplier effects.

An area where the economy has not enjoyed as much success is with employment. An urban-rural inequality exists; in rural states, such as Tasmania, the unemployment rate is as abnormally high as 6.9%. These figures are high for a country that is subject to such large amounts of foreign direct investment, and is in its honeymoon phase. However, this can be easily addressed through careful government investment in rural locations.

Barring any unforeseen external shocks, Australia’s future remains fairly secure. Economically, Gillard and her government have embarked on a fiscally responsible program, which has left Australia running small fiscal deficits. It has also contributed to them having a sustainable public debt of only 30% of GDP. Also, having other booming economies as their major import and export partners brings with it a sense of well-being, which they wouldn’t have had if they had relied solely on Europe or America. All in all, the Australian model is sustainable and has been successful, a model which can be easily applied to the UK, and I believe should be used as a blueprint for future Chancellors & Governments.

Aug 30 2012
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Global Economics

China’s Slowing: The Problems with Having Such a Large Export Sector. By Mark Coles

Even the most unobservant of international scholars will have noticed the drastic advances China has made in the past 40 years due to its factor endowment and reforms such as the Great Leap Forward instigated and other programmes introduced by various administrations since. We are swamped nowadays with “Made in China” stickers, which have long been associated with low cost, cheap consumer goods. However, there have been problems in the past few years.

China’s astronomic rise up the GDP leagues was fuelled by huge amounts of exports to the West in low tech, consumer goods, fabrics and anything that could be cheaply outsourced to lower a corporation’s cost base. We also saw mass migration from the villages and countryside to the towns and cities, with whole towns now dedicated to the manufacture of one item and the population swell to around 1.35 billion (World Bank figures). Chinese economists therefore calculated that to keep everyone happy and the economy ticking along nicely, it would have to expand by 8% per year. This was all very well, and in keeping with 8 being lucky in China, but earlier this year The Economist reported Hu Jintao predicting only a 7.5% expansion this year. Chinese predictions have always been frowned upon for their accuracy, but for Mr Hu to predict this was unprecedented. Of course, a tough export market was blamed, but it still raised eyebrows.

China’s big western markets have all been grabbling with sovereign debt problems (Not on the scale of the PIIG countries admittedly) and trying to deflate personal debt levels, that were used to finance the purchases of many of China’s products. Emerging markets are still affected by the same problem, but to less an extent, but again have seen the belt tightening of those at the top of the food chain affect their revenues, meaning they are importing less. The reduction in the size of an export market needs to be taken in context with the breakdown of China’s GDP. Advanced nations consumption (UK) accounts for around 60% of GDP, with Investment, Government spending and exports making up the rest. Chinese exports alone made up 40% (World Bank) in 2007 and have fallen since then and consumption accounted for 35%. By relying so much on exports and investment, the most volatile components of GDP, China may face problems.

The remedy it seems then is to work to create a more affluent domestic market, to consume rather than just produce to help rebalance. Until the Chinese start consuming en- masse then this issue will remain. A middle class has emerged in China, but it often strong links to the ruling Chinese Communist Party (entrepreneurs have even been offered membership to a “Communist” organisation), and the rule of law regarding property ownership is less than transparent, and an inefficient banking sector hamper progress. The way to “affluenticise” is to move away from cheap consumer goods and to produce hi tech products with higher margins and a workforce that is educated to make them, making capital less footloose, and infrastructure to be developed.

The Chinese have tried to be different to the Western models of development. The disgraced politician Bo Xilal had developed the “Chongqing Model” during his governorship with the private sector giving profits to the public sector to develop amenities and infrastructure, rather than relax laws to incentivise industry like often happens here. This seemed to work but the next problem as reported has been a shrinking population. America’s is on the rise, and China is in danger of creating an upside-down bottleneck with fewer workers than pensioners, creating more social division and strife.

For years the unofficial secret to success and population appeasement has been the scant regard paid to human rights. “Keep quiet, we’re all making loads of money and doing well” was the reply citizens got in their request for rights. This won’t be the case now if the economy is expanding slower than what is needed. With a new round of leaders and Politburo appointments due in early 2013 there may be some changes, but it is this factor that may create a bigger headache for the Communist Party than the 0.5% drop.

China is still doing well by anyone’s maths in such tough times but some of the aforementioned problems may come home to roost if there is not a sustained reduction in the dependence on China’s export sector.

Aug 29 2012
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European Economics

Earthquakes & Euros. By Ayush Varma

The Mayans envisaged unprecedented geographic calamity-violent earthquakes, cataclysmic eruptions, and crushing tsunamis-which would inevitably spell the end of mankind. Fortunately, apart from a so-called ‘drought’, British weather remains as miserable as ever. Perhaps, the manifestation of this ‘apocalypse’ is far subtler? It could be, that on the ill-fated, 21st December 2012, rather than the whole world coming to an abrupt and agonizing end; the curtain falls on the Eurozone. Let’s face it; the latter is the more probable outcome. On a positive note, if a Euro-collapse, is on the cards, we can take steps to avert Armageddon.

Back in May, the cynic inside of me, was desperately hoping SYRIZA would win the Greek legislative election; in doing so, making the important decision that Euro leaders have for so long shied away from. A Greek exit should have taken place when, Papandreou, first came begging for a bailout. At worst a couple of banks, primarily French, would have defaulted; but it would have saved the Eurozone billions that it has since invested; and most importantly, salvaged some of the lost confidence in the Euro. I still believe it isn’t too late.

I do acknowledge that a return to the Drachma would bring immeasurable hardship upon the common man. But, we have to look at the bigger picture. A Greek exit, in comparison, would bare more trivial consequences than a Euro collapse, on the global economy. It is also worth noting unlike Spain or Italy, who are in similar predicaments; Greece isn’t a vital cog in the wheel of the Eurozone. It only contributes to 2.65% to the total GDP of the Eurozone, and neither are there significant trade benefits to warrant their stay. Their exit would help to restore confidence, allow the Eurozone leaders to concentrate their energies and money on Italy and Spain, and will provide a solid platform for recovery.

A ‘Grexit’ ought to be the first phase of recovery; the next stage is the most crucial and perhaps, the most uncertain, in terms of outcome. There are three main alternatives- Eurobonds, austerity, and a European Monetary Fund. At first, Eurobonds are a very inciting prospect. Rather than investors loaning to individual countries, Eurobonds involves them loaning to the Eurozone as a single entity. It’s seemingly a ‘win-win’ situation- investors are more willing to invest, whilst the debt-ridden countries of the Eurozone are provided with vital funds required. My main worry is that inevitably a free-rider problem will arise, which would result in the big fish burdening most of the liability, that could have an adverse affect and jeopardize their individual recoveries and therefore, is not a viable route.

As it’s a ‘sovereign debt-crisis’ austerity, inescapably, austerity has to be one of the remedies in the mix. To all of those vying for Keynesian policies, it’s simply ludicrous-it’s a debt crisis; the idea of borrowing to spend is fundamentally a wrong one! Though, through a mixture of foreign direct investment, and, government spending, governments in the Eurozone have to invest in their primary and secondary sectors. One of the things this crisis has highlighted is the over-reliance on the tertiary sector, and the large current account imbalances of some nations. These measures will help to address these shortcomings.

Personally, the most appealing solution thrown into the basket is the proposal of a European Stability Mechanism. I can hear a few groans, and moans-it’s just means more austerity doesn’t it?

The main proposals are…

  • Keeping government deficits below 3% of GDP
  • The maximum structural deficit a country can operate is 0.5%

The proposals will be legally binding; in addition, the agency will monitor governments, and charge those who exceed targets.

I feel it’s promoting fiscal discipline, rather than austerity-and I think we rather learn our lessons now, and avoid a reoccurrence. Though, my only gripes are that it’s going to be incredibly difficult to enforce and monitor, and that the initial blueprints are quite limited-many other problems are left unaddressed.

Over the course of the recovery period, it’s imminent other countries too will falter. Depending on their relative size, and importance in the Eurozone, each country will have to be dealt with individually. God forbid, a country finds itself in a position similar to Greece, again after weighing its economic significance; defaults and exits have to be considered. I do fear, Greece’s exit might come a bit too late, but, in the future, the leaders have to be more decisive on such salient issues.

Lastly, I think the Convergence Criteria of the Maastricht Treaty, ought to be redrawn. It has clearly failed, as its prime purpose, was to avoid such a situation!

I hope the 2012 prophecy doesn’t transpire, just like the other thousands of doomsday prophecies that have come before. I guess we’ll just have to wait to see what our fate will be on December 21st. There are one of three possible outcomes; a large wave sweeping us away; or an economic earthquake that will shatter the Eurozone into pieces; and lastly, another ‘non-white’ Christmas in recession.

Aug 04 2012
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Global Economics

China’s GDP, Next in Line for a Scandal. By Andreea Anghel

The scandal culture raised inside the world of finance, having pillaged Barclays and HSBC, is now preparing to sink its teeth into China. Enough with the banks and private sector – this time, the front seat is saved for the world’s second biggest economy. In an interview at CNBC, Lehman Brothers vice-president, Lawrence McDonald, expressed his suspicions that China‘s 8% GDP in the first quarter simply doesn’t add up. He called it the new Libor, pointing out that a fraudulent figure like that is worth a lot more attention. Analysts at Barclays joined in to fuel these suppositions with an investigation of their own and reached a similar conclusion.

It is known for a fact that Chinese public figures lack transparency. There is little information available to consider when calculating its GDP. Economists usually guide themselves after China’s electricity production levels because they are more accurate and they often correlate with its GDP. Only now, the GDP has grown in contrast to a decline in electricity production. In addition, while Western countries take about three months to calculate their GDP, China publishes these numbers almost immediately – a point which further questions their precision.

Associating this case with the Libor scandal gives way to scepticism in more than one direction. First of all, both the Libor and the GDP are welfare indicators. So faking either of them implies some serious cover-ups. It’s as if nobody wants to admit the cold hard truth anymore, choosing instead to simulate the state of affairs. That’s exactly the kind of attitude that led to the 2007/8 financial crisis, resulting in an overall loss of confidence among financial actors.

But before we set out to ring the alarm, let’s look at who’s talking. McDonald represents Lehman Brothers, which, back in 2008 was caught red handed sitting on top of a throng of toxic assets. The analysts at Barclays themselves are undergoing recovery from the recent Libor episode. With these people suddenly setting the focus on China, we can easily assume that a grand diversion is on its way. Media attention has never been flattering for finance, so why not send it all the way to the other side of the world? Lehman and Barclays will surely agree on this one. What’s more, the assumptions coming from McDonald fall in line impeccably with Mitt Romney’s point of view, that China is a ‘currency manipulator’. Declarations like these encourage bad publicity for China, especially when a presidential candidate blames it for American jobs being at stake. In this case, we might as well turn to the often precise opinions of Nouriel Roubini. Having predicted the financial crisis as early as 2006, he also mentioned, back in January 2012, that “China is in a recession regardless of what the highly massaged official numbers claim”.

ANZ research shows a more moderate approach on the entire Chinese GDP issue. They discovered that correlating the GDP with energy production figures is misleading because, lately, China has invested a lot in energy efficiency. Previous periods of divergence have also occurred in 2008 and 2009. Furthermore, GDP growth may not depend on China’s heavy industry anymore. Studies reveal that its light industry and service sector are experiencing considerable development and, consequently, may represent more reliable indicators for outsiders to consider.

The present interpretations are forwarding premature conclusions. Beijing could be providing flawed data; the US may be bluffing. Either way, it will take a lot more than a few reports and a TV appearance to undermine a major actor in the world economy.

Aug 02 2012
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UK Economics

Why Looking Solely At Figures Maybe A False Economy. By Mark Coles

News today that unemployment figures fell should come as no big shock to anyone,given that even with poor weather seasonal employment will of picked up, creating new posts in tourism and leisure industries. This still leaves questions about the UK’s structural issues with a skills set that only loosely fits our national order book and capabilities. Yet with this on-the-surface positive figures reveal that we still borrowed more than in May/June 2011, even after a budget full of tax rises.

It is these tax rises that form the main crux of this article. We have seen since the birth of the coalition, the abolition of the 50p tax rate and the lowering of corporation tax to one of the lowest in the advanced group of economies, with a broad aim to increase the overall yield from the net increase in commercial activity. These were widely noted in the press,along with more specific planned increases on caravans and pasties. Both of these have since been scrapped but the logic in their conception was flawed.

A good tax is one that is feasible, cheap to collect, easy to assess, changes incentive structures for the better or creates a more equitable society. It was the corporation and income tax that accommodate the last requirement,but the two aforementioned taxes fall foul of at least two criterion. A pasty tax was never introduced because it was to difficult to decide upon what ‘ambient room temperature’ was on a non seasonal basis (summer and winter) and clearly inequitable when a cheap simple morsal goes up in price and affects the whole competitively of an industry. The caravan tax was similar. Proposed on the grounds that it would be more equitable to home owners,the consequences were clearly overlooked. Problems would present themselves in classification caravans, by size, usage etc. Secondly and most startlingly would be its effect on the tourist industry. To raise the tax incidence would be disastrous.

Whole areas of the UK would suffer as tourism is relied on as an annual cash cow,and one of the few growth sectors (domestic tourism) in light of a weak Eurozone would have throttled. The seasonal jobs that probably account for the fall in unemployment would dry up and a secondary affect would be felt by local businesses and council’s as both direct and direct tax takings fall. Holidays like anything else are a product and an area that the UK can still be competitive (to itself) in would be pricing its own market out of game. The sunk costs of caravan ownership are significant and to raise these further for little fiscal game would seem absurd.

Why then were these taxes suggested? No doubt the answer lies in Treasury methods. Presented with a piece paper outlining possible areas to raise taxation, these two would seem the obvious sort of things to amend,but it is the detail behind these areas that explain exactly why the have not been tinkered with before. It seems then that too raise taxes based solely on how they look on a spreadsheet makes neither economic or political sense. The political fallout and loss of credibility and level of incompetence have totaled far more than the taxes would of raised. Fiscal decisions need to be made looking at the factors behind them rather than the amounts they appear to raise. It is that way we will achieve more of the tax criteria set out and that way we are more likely to return order to public finances than plough ahead and raise taxes where we see fit.

Jul 21 2012
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Global Economics

The Inefficient Hand of Keynesian Economics. By Andreea Anghel

Once upon a time, the capitalist fairy-tale of free markets shined in contrast to the centralized economies of the USSR. It was a shake of hands between Regan and Thatcher that released F.A. Hayek’s once obscure theories into the real world. Ever since then, market competition and state intervention altered themselves to match the true capitalist ideal.  Subsequently, the Western community buried Keynesian economics under a prevailing sense of resentment towards socialism and its extreme practitioners in the East. Who needs a state-owned safety web when there is no downside to economic progress? The religion of the upward slope will have provided people with hope to last for a century.

Enter the financial crisis of 2007/8. A dozen of bubbles and bursts later, the big real-estate bubble had splashed America and Europe with the panic of a decade. General distrust became the subject title of society’s problems, as the free markets’ ’natural’ functioning entered a state of paralysis . The globalized economy had irresponsibly amputated its ‘invisible hand’ – assuming that this force ever existed in the first place. Of course, there are scholars such as Cambridge professor, Ha-Joon Chang, who would happily explain the free market myth in terms of unnoticed acts of state legislation. To people like him, the immediate follow-up to the financial crisis simply resembles states’ decision to get a tighter grip on their misbehaving financial sectors. To everyone else, the sudden bail out funds and state take-overs looked like we had entered a regrettable stage of recession.

However, from one point of view, it seemed as if Keynesianism had bounced back: weakened by the existing national budget deficits, though still applicable. To eliminate any confusion, the doctrine entails is that, in times of economic prosperity, governments should step back and allow public sector development to reach its full potential. During this period, the nation states are expected to run budget surpluses which would, in turn, enable them to support and resuscitate their economies when necessary.

Unfortunately, before the crisis, growing national economies, like that of the US, were also accompanied by a reckless trend of unsolved budget deficits. This meant that states were not capable nor were they preparing to handle a serious intervention. Nevertheless, when governments rushed to resuscitate the system with injections of capital, for a while, it seemed like the right – Keynesian – thing to do. But add those rescue funds on top of deficits and, five years later, we now have the states themselves in need of saving. Paul Krugman and Richard Layard would disagree that the previously existing budget deficits contributed to the crisis’ aftermath. But even so, the plan backfired on more than one level.

According to the Keynesian model, when economies experience a shortage of demand, as they did, the aiding capital should target the development of infrastructure. And indeed, the economic infrastructure received enough care and attention. However, its costly maintenance came to the detriment of the system as a whole. Throwing money at the problem thus proved to be a backward reflex, partly because it lacked holistic considerations.

In the end, it turns out that our carefully crafted theory did not perform well under pressure. Maybe it wouldn’t have stood the test of time in the first place. After all, how could a 20th century model guarantee a universal solution, especially at the rate at which finance is now reinventing itself and the global economy with it?

Jul 19 2012
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Global Economics, UK Economics

Tapping the energy solution. By Charles Bentley

Whilst shale gas extraction known as hydraulic fracturing (or fracing) has existed for around 60 years, only recently has its press and popularity exploded. As awareness grows over its utility, with larger oil and gas companies looking to get a piece of the market, and the controversy over its environmental effects develops, Shale Gas will become more and more important, both as a resource and as a topic of environmental debate.

Its utility is threefold. The first, being that it may hold an important solution to concerns over energy supply at least in the medium term. Malthusians often contend, and recent reports from the Resource 2012 Conference seem to confirm the view, that with ‘overpopulation’ we will reach a point of catastrophe in terms of resources. This clearly underestimates human potential and innovation in working to solve these issues, according to “Simons” Axiom as the world’s population has grown, living standards and life expectancy have risen due to innovation. As oil and natural gas become expensive, the IEA stating that oil has reached the ‘critical level’ of accounting for 5% of world GDP in 2011, searching for and employing the use of unexploited resources becomes a profitable enterprise, in this case, shale gas. Supplies vary between nations, but Poland, with perhaps the largest supplies in Europe, is anticipated to have sufficient natural gas to fulfil its energy requirements for 300 years. In Britain, reports keep improving as further investigations take place, estimates for the North West, where Cuadrilla began (but have since ceased) fracing, now claim it holds 200 trillion cubic feet of shale gas, and this is without recognising the supposedly larger reserves in the North East. Looking to the effects of these developments, it is hard not to be optimistic. The US is the best (and only) real example of a country that has made use of this technology for a substantial period of time. Over the past 60 years its operations have expanded to a point where fracing accounts for 21% of its natural gas consumption, with a 48% year on year increase, by 2035 production is expected to triple. This expansion has been reflected in the price of natural gas, with a 25% drop in price since 2008, returning to its lowest level in 10 years, whilst oil at the same time has increased 175%. This has led to savings in electricity prices for consumers, and considering the political capital that lies in reducing energy costs for the public, it would be a wise decision and a PR gain for the coalition to make use of this resource sooner rather than later. Granted that the savings are unlikely to be of the same scale as in the US, especially in the short term, with shale gas extraction a relatively primitive industry in Europe, there is still a possibility of reducing energy costs. A further boost would come in the form of job creation, in the US 600,000 people are employed in Shale Gas extraction in some form, and this number is set to expand by another 270,000 by 2015, reducing unemployment and providing an opportunity for people to develop a useful and employable skillset, again a likely PR gain for the government. Importantly, the discovery has aided manufacturing in the US, with companies, such as Dow Chemicals, choosing to base themselves at home, rather than in China, as reduced energy costs make up for higher labour costs. Whilst this seems to be more of a pleasant unintended consequence rather than a set out aim, with the British manufacturing sector on its knees, a leg up would not be amiss.

There is also significant potential for political gain in terms of energy security to all nations who have reserves, but most prominently, to European countries who are all (except Norway) net importers of energy. Russia’s situation is becoming increasingly complicated; a hostile investment climate stifling the development of new gas fields, the energy-based courting of Asian nations by Russia diverting their attention from supplying Europe and memories of the disputes with the Ukraine in the latter half of the last decade creating shortages throughout the continent have led European leaders to look elsewhere. Considering the additional threat from Iran to block the Strait of Hormuz, choking off the world from Qatari LNG, which accounts for 25% of the world’s supplies, as well as the oil reserves from the region, a viable alternative is looking increasingly necessary to ensure energy security. Poland, France, Britain, Ukraine and Bulgaria all have significant supplies, and the relative stability of these nations can give security to them and to the rest of the continent. Indeed, Eni, the Italian energy giant has looked this way, recently signing an agreement with Ukrainian producers to produce shale gas in the Lviv Region of the Ukraine to reduce dependence on Russian and Middle Eastern supplies.

Clearly there is an issue with externalities resulting from fracing, and the well-publicised concerns over environmental damage, particularly with regards to earthquakes and contamination of the water supply, must be addressed. Earthquakes have, undeniably, been the result of fracing operations. In the UK Blackpool has seen a series of minor tremors causing Cuadrilla to halt extraction for a period and, in the most severe case, Ohio has had a 5.6 richter scale earthquake. These occurrences, however, must be taken in context; an earthquake above 3.0 like Ohio is very unlikely, especially for a country or region that doesn’t lie near a fault. A variety of precautions can and are taken with regards to earthquakes, such as using existing geological stresses which reduces the chance of seismic activity, installing seismic monitoring and closing the site temporarily when incidents do occur. Earthquakes are both a minor and a manageable risk of fracing.

The second risk, of contamination of the water supply has been exaggerated, whilst the polemic Gasland, made much of flaming faucets caused by methane leaking into the groundwater (which is less to do with fracing per se and more to do with the presence of natural gas in the area), polluted water supplies are a minor risk, especially if precautions are taken. Bearing in mind the depth at which extraction takes place and the casings that are used, the chances of pollution are slim. Concerns over the chemicals that are used in the process are also misguided, with these diluted in a 1:200 ratio, rendering them harmless. A report by Willis, a Global Insurance Broker, maintains that if sufficient precautions are taken and best practice applied, the risks are similar to any other industrial process and have been blown out of proportion. Whilst accidents may happen and penalties will apply, serious concern is not warranted.  Indeed, the EPA in a 04’ study concluded that fracing operations have been taking place for 60 years without any serious concern.

In addition, the massive potential for reducing carbon emissions through the use of fracing, with natural gas power stations producing up to 70% lower greenhouse gas emissions than coal-fired stations, there is an environmental benefit to fracing. According to the Economist, in the last decade, the importance of coal in America’s energy mix has reduced by a 1/3rd whilst the use of natural gas has increased by 8%, leading to a fall in carbon-dioxide emissions by 450m tonnes, more than any other country in the last 5 years. Whilst, perhaps only a bridge to renewable energy, it is still an improvement, and with China possessing large reserves of shale, and coal accounting for 70% of their energy mix in 2010, there is substantial progress that can be made now. Shale Gas can be the bridge to zero carbon energy generation.

Strong environmentalists may find this view abhorrent for a number of reasons. Firstly, the presence of vast quantities of natural gas, which was previously undiscovered weakens their argument substantially. For environmentalists, the best motivator is fear, and fear of catastrophe with running out of energy resources has been an effective means by which to convince some members of the public that government investment in renewable energy is a necessity. A valid and major concern of Environmentalists over the rise of Shale Gas is the probability that public and private investment in renewable and zero carbon energy sources will decline. Making renewable technology viable is a worthy goal, and whilst all barriers to entry should be removed to encourage them to compete, government spending and subsidies are not appropriate, especially during a recession. In using taxes to pay for a business that wouldn’t survive without subsidies and keeping energy costs artificially high, the public suffers in terms of taxes and electricity bills. To add to this, it would be wrong to let the goal of developing zero carbon technology stand in the way of making improvements in the emission levels from moving from coal to shale.

In a time where political opinion over this matter is divided, from the extremes of France and Bulgaria where it is banned to the US where it has proceeded relatively freely, concerns for environment have been important in shaping attitudes towards this practice. Whilst valid, these externalities can be mitigated, to not take advantage of this valuable resource and the improvement it brings with regards to moving towards a reduced carbon energy mix, would be a mistake we would live to regret.

Jul 08 2012
1 Comment
UK Economics

The Wider Impacts of LIBOR. By Mark Coles

With the Westminster summer recess and Olympics around the corner and “silly season” kicking off, I was worried that no news worthy of writing about would surface, but luckily the Barclays LIBOR rigging scandal came to light to save my bacon.

Barclays so far has been the only bank to take the rap and subsequent fines, but this does not show the extent to which the scandal is limited. Anyone familiar with the LIBOR process will know that it is set by averages, with the top and bottom quartiles excluded and the middle 50% of submissions averaged out. To affect the rate by an amount worth taking the risk for (Barclays defence is that their rates were higher than everyone else’s, which cast doubt over their creditworthiness), market participants would have needed to work in some sort of tandem to create a lower average. This would make the frenzy of criticism Barclays has come in for seem a little unfair, given that they probably weren’t the only ones involved. This industry wide practise as I am sure it will be exposed as will place bankers below used car dealers on the public affection scale, and do little to reassure the public the message sunk in when it was abundantly clear that the system needed to change. The emails offering bottles of Bollinger in return for keeping the ruse a secret and being let in on it, smacks of materialism, aloofness and arrogance.

Depending on figures you believe this may have cost the ‘real’ economy up to £10bn, which washed through the system in terms of mortgage rates for homes and business at levels which may not have been their market rate. With businesses struggling and household incomes squeezed, this will make many angry. This anger will be further stoked when those responsible remain in jobs, are sacked and rehired elsewhere, or leave with “golden handshakes” running into millions of pounds.  This gross distortion of remuneration to effort and behaviour shows how out of touch those at the top have become.

Fast forward a couple of days and emails appear of correspondence between the Bank of England and Barclays, with dialogue that was allegedly misinterpreted as a cue to lower submissions from the Deputy Governor, Paul Tucker. One will never know the true meaning of these messages if there even was one, but it is at this point that the ugly face of party politics rears its head. Questions need to be answered whether any political pressure was exerted by the Labour Government at the time as  “it did not always need to be the case that [Barclays] appeared as high as [Barclays] has recently.”. This has provided an opportune moment for the Conservatives to portray Labour as untrustworthy on the economy and simultaneously shift the heat of scrutiny from the poor economic figures to this debacle.  Ed Balls, now Shadow Chancellor would be instantly discredited and probably forced to resign, casting considerable doubt in the minds of voters with pens hovering over Labour, questioning Balls’ ethics and Ed Miliband’s integrity.

This is a scandal unlikely to go away and will be cited by traditionalists as an erosion of ethics, and the inquiry set up to investigate it will produce its findings in due course and no doubt implicate a wider circle of people as it digs ever deeper. More heads will roll before the scandal blows over. A personal view is that the greatest thing that will come from this will be an ever declining trust in professions, institutions and authority. We have had an MP’s scandal that rocked Parliament, a phone hacking scandal which has implicated the media and No.10 and both the LIBOR debacle and huge bailouts in the face of irresponsibility that have rocked the banking sector.  To ask more people to participate in the political process and engage in the Big Society seems bare faced cheek when so many at the top are on the “fiddle”. It is issues like these that are remembered, not the good work and good customer service that many at the bottom of institutions provide and take the flack for. This should be realised by the wider public and shift the emphasis onto those who are ultimately culpable rather than those it is easiest to blame.

 

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