economics

On the cost of living crisis

This started last year with the post pandemic wage recovery but what’s driving it today is the increasing imported energy prices, driven by the price of gas and to some extent the cost of food. There are two reasons why gas prices are critical, the first is that we burn it to make electricity and secondly, we use it to heat and cook in some of our homes and workplaces.

The UK privatised its energy distribution services in the late eighties and in doing so the planners had to solve two problems. The new market had to be both profitable and competitive. They broke up the electricity generators and what today are called distributors but are in fact merely billing entities. They created a fake market and slapped a regulator, OFGEM, on top of it. The generator companies make electricity, from fossil fuels, nuclear, and renewables. OFGEM regulates the price onto and off the grid. Today it sets the price based on the highest cost source of supply i.e. Gas. The reason for this was to encourage investment in renewables, which are now capable of delivering to the grid at a considerably lower price.

The companies that are completely unaffected are the extraction companies, those who extract primary energy sources mainly fossil fuels from the ground. The UK quoted companies are BP & Shell, but several more of the UK’s primary energy suppliers are foreign owned. The current purchase price guarantees the extractors a profitable price which can be demonstrated by examining their profitability.

Both the Tories and Labour are planning to cap the consumer price for a limited period; the Tories plan to pay for this by a consumer tax (although they are calling it something else), Labour with a corporation “windfall” tax. The subsidy is needed but the critical reform would be to re-engineer the fake energy market. I would also argue that there should be no public money without a public stake.

Another impact of the privatisation was that gas storage was sold off. Across Europe, the plan has been to buy gas in the summer, store it, and use it in the winter thus reducing the demand during periods of high prices. UK’s storage is now about 4 days; in Europe it is several magnitudes higher.

Privatisation has failed to deliver a resilient national energy plan, and the bulk of the current inflation is caused by the rising cost of imported primary energy.

The other cause is imported food prices, exacerbated by the falling domestic production. Reduced production, caused by a Brexit related labour shortage should lead to increased imports which the Brexit caused falling exchange rate makes it more expensive. This effect is reduced as we are importing less from Europe than we used to, as our European suppliers do not want to ship to the UK due to the increased trade friction costs and the opportunity cost of the transport. Importing substitutes from the US, India or even the antipodes is not cheaper due to the much higher transport costs. The reduced domestic food production also causes competition in the food supply chain which boosts costs.

On top of this, the Bank of England’s response to inflation will be to increase interest rates; this will make mortgages and rents higher which will squeeze family budgets more. Some people will have to walk away from their homes, and renters will face increased poverty as housing competes with food and warmth for a share of the family income.

The final driver for the cost of living crisis is falling real incomes making food and shelter consume a higher proportion of an ordinary family’s budget. The final obvious piece of the cost of living crisis is that there is an effective public sector pay cap. Public sector pay has been held to a 1.5% pay increase at a time of an effective increase in the Consumer Price Index of 10.1%.

James Meadway argues that wage increases are needed, prices should be fixed, and profits squeezed. It’s unlikely that the government will do this; it’s nit going to be pretty. …

A short note on FX & UK Trade

Like many, I am considering the macro drivers of the cost of living crisis and I listened to the AEIP podcast with Gary Stevenson. He has an interesting view and argues that the QE funded furlough scheme was in fact a subsidy to the rich and that the fundamental imbalance in the country is the shift of wealth from poor to rich. It’s a version of the argument that the problem is insufficient demand being caused by the continued pressure on medium and low incomes.

He also argues that the massive QE efforts are an effective devaluation which given the relative stickiness of prices with wages being the slowest to change and everything that wages need to buy increasing will exacerbate the squeeze on spending. He also argues that given the choice between working and starving, people will work. The use of the word devaluation led me to look at the following charts

The pound has been falling against the dollar all year, this makes imports, particularly of Oil, but also of Gas and food more expensive.

Here we see the balance of trade figures, a more traditional cause of devaluations. With the exception of two months, the UK has been in deficit for the last five years. There are those who contest the the balance of trade causes currency price movements and Sterling in particular is impacted by speculative currency flows. The key drivers of speculation are expected rate of return, which for fixed income assets is driven by the bank rate, and animal spirits about which I think it best not to comment. …

Inflation

The Bank of England was made ‘independent’ of the Treasury in 1997, although not really, so that it could take the blame for any decisions to increase interest rates, such as those taken earlier this week (£) when the Bank increased bank rate to fight inflation.

How does that work? Inflation is believed to have one of two causes, one is that there is too much demand, chasing too few goods and consumers bid up prices. The other is that import prices are rising and thus have an impact on the domestic price level. These are known as demand-pull, or cost push. The current inflation would seem to be caused by the increase in the cost of imports especially primary energy products, exacerbated by a fall in the exchange rate.

The monetarist theory is that there is a real world and money view of the economy.

i.e.

Prices x Product = Money Supply x Velocity of Money

PQ = Mv

This equation is derived via definitions and algebra and thus there is no proof of causality. Monetarists say that reducing the money supply will reduce prices. This assumes that in the short term both the velocity of money and the amount of product are static. Recent econometric studies suggest that the velocity is not constant, and there has always been a problem of defining what money supply is as it must include some credit and so is very difficult to constrain. We should note that consumer credit can be increased very rapidly so can no longer be consider static.

There can be no doubt from studying economic history, that increasing interest rates to reduce the money supply causes a recession, unemployment and poverty. It’s also highly likely that unionised workers will demand higher wages to defend their living standards. In a world where business is internationally mobile, business will defend its profits by increasing prices and/or off shoring the work; this is the wage-price spiral where an economy has high inflation, both cost push and demand pull and low growth.

The drivers of growth and/or the floor to a recession are investment, exports or government expenditure, especially benefits. Increasing interest rates makes investment and the national debt more expensive. It makes exports cheaper in their foreign markets but of course the big factor in the export price uplift is Brexit. Higher interest rates increases the income on savings and the expense on business and domestic borrowing. A squeeze on profits will cause capital to go overseas, especially if the exchange rate is high although this may be ameliorate by the increasing yield in bonds. The other cause of the economic malaise is the poor investment rates by both the private and public sector in the UK.

There can be no doubt that increasing interest rates will cause unemployment. This is how it reduces demand.

The other option to monetary policy is product supply, direct investment such as the EU’s Horizon Europe programme or price regulation to cause a profit squeeze, tax the energy companies and banks, build more houses, control profits, transfer income from the wealthy to the poor because the poor spend more of their income and of course rejoining the EU’s single market to reduce both import and export frictional costs.

High interest rates are a choice, a choice of theory and a choice of policy. The inconvenient truth is no-one knows if it works.

ooOOOoo

I conclude with some links to key commentators, professional economists. David Blanchflower, writes in the New Statesman, “The Bank of England is recklessly driving the UK into a deep recession”, he warns of the threat of unemployment, elsewhere on his twitter feed he is highly critical of the Bank and its Governor, Andrew Bailey, He is also quoted in a video clip by C4 on twitter, stating that unemployment hurts people more than inflation, which can be seen to be a declining threat. Anne Petifor exposes the role of the global capital markets in ‘managing’ food and energy costs, Richard Murphy provides a modern monetary critique of the theories. I particularly like his calling out of the role of import prices and speculators,

There is a third reason why the BoE policy will not work. It’s not just the assumption that people have too much to spend that the BoE get wrong. They have actually totally failed to identify the proper cause of this inflation.
The inflation we’re suffering is the result of shortages of oil, gas, fertiliser and food, in the main. Some of these are real (food, in particular). Others are being stoked by speculators who are profiting from them, which is why oil companies are declaring such big profits now
Richard Murphy – On Twitter

The featured image has been taken from Blanchflower’s New Statesman article where he asserts its a BoE MPC authored chart. This I assume can e used under the OGL license. …

Labour’s macro-economics, “Back to the Future”

Starmer made another speech on economics on Monday 25^th July. It is reported in the Guardian.

Starmer has been trying to pitch Labour as the party of fiscal prudence and will say: “With me and with Rachel Reeves [the shadow chancellor], you will always get sound finances; careful spending; strong, secure and fair growth. There will be no magic-money-tree economics with us.”
From the Guardian,

This article looks at growth and debt, Starmer and Reeves flirtation with Osbornomics and Reeves' rejection of nationalisation on the grounds of cost, I note countervailing views from Murray and Long Bailey and note that Reeves places herself in the sad queue of shadow chancellors undermining Labour's election chances by 'telling the truth'. There's more overleaf ...

The Tories, the leadership, tax and Brexit

Phil Burton Cartledge analyses the political platforms and accountabilities of the Tory wanabee leaders and their fetish with reducing tax by which they mean corporation tax. The FT reports on business’s response to the proposal, which is lukewarm. They point out that only businesses that make a profit pay corporation tax and that for a business of any complexity^[1] and with decent accountants, corporation tax is voluntary. The FT article calls for broader support including demand stimulation albeit through tax cuts, but importantly they raise the issue of VAT on energy (but they pay that too) and also investment incentives. VAT at 20% is ridiculous and the Govt. should reduce it; it can now we are out of the EU.

Phil talks about the conflicts in Johnson’s electoral coalition and the victory of the rentier capitalists in gutting any meaningful levelling up programmes, which have been reduced to crude electoral bribes. This is a long-term trend. We used to call it Regional Policy and I looked at New Labour’s failure to put this right; they were driven by unproven meso-economic theories and then polluted the programme with concerns about welfare to work and regional assemblies.

I should add that another cause of the failure of a levelling up programme is the loss of EU funds. While business is arguing for re-joining the R&D fund, Horizon Europe^[2], some local authorities are now lamenting the losses of the European Regional Development Fund & European Social Fund. This was worth about €4bn^[3] p.a. to the UK. The UK Government has never it seems been particularly good at getting EU money for business and people and yet the UK has many of the poorest areas Northern Europe.

It’s another necessary dimension of the ‘closest possible’ relationship. The regional programmes were first launched on the UK’s accession to the EU as a means of reducing the UK’s net contribution to the EU. It seems we’re missing them now.

[1] This does exclude most patron personal services companies so perhaps the policy is designed for them.

[2] Horizon Europe has rules that create an enhanced ‘multiplier’ effect.

[3] This includes UK Gov matching funds.

Image Credit: Ilovetheeu, CC BY-SA 4.0 https://creativecommons.org/licenses/by-sa/4.0, via Wikimedia Commons …

Education and Immigration

The Govt renewed its list of universities which act as gateways to the High Potential Individual Visa route; graduates from approved top universities can apply to enter the UK. The list is published on the Govt web site; there’s been much comment this time round that there are no African Universities on the list but then there are no Latin American Universities nor Asian Universities apart from the pacific rim. The Govt claim to have used two other lists to construct their list; I have examined the QS index, partly because it’s easy to find and partly because I have looked at it before albeit nearly 13 years ago.

What’s startling is the number of PacRim countries now in the top 50, in 2007, there were very few, in 2021, there are many more. This should not be a surprise as the purpose of the QS index was to allow the Chinese state to plan its university programmes to support their investment led growth plans. We should also note that the QS index is/was biased towards English speaking universities.

Top 60 Universities by Region according to QS

There are no Latin American Universities in the Top 50, nor any African. The only Asian universities in this list are on the Pacific Rim, so none from the Indian subcontinent. The top Indian university is the Bombay Institute of Technology (177) and the top African university is the University of Capetown (226). The European figures (15) include 8 from the UK, and two from France, Switzerland and the Netherlands and one from Germany; the last figure surprises me, I would have thought they’d have more, but it could be as a result of the index methodology, although Switzerland has two institutes in the top 50. China has more in the top 60, than the UK and the EU. The HMG list includes the Karolinska Institute of Sweden, which I cannot find on the QS Index, but it claims 7^th. The HMG List includes two US universities not in the top 60, but they claim to have sourced their list from multiple sources.

I would need to think harder about the impact of this route to entry to the country; the focus on the top 60 is clearly discriminatory as is most of the UK’s immigration law. This has even been confirmed by a leaked Home Office report. I predict someone is going to get into a lot of trouble for letting those words stay in the report!

The big and most important conclusion from examining these lists is that China is catching up, it has nine universities in the top 57, of which four are in Hong Kong. We can also note that the EU’s footprint in the top 50 is far lower than it once was as it was overly reliant on the UK’s universities.

Here’s my spreadsheet which contains my versions of the two tables, and several pivot tables and charts. …

The Budget 2021, the highest tax burden in 70 years

I wrote a short piece on the potential need for the EU to acquire direct taxation powers which led to me checking how much the UK government raised from income based taxes vs. VAT. The article reproduced some charts from Parliament but I was surprised to discover how low a share of government revenue it now represented. The article was written after the budget, which had not really made an impact in my consciousness; it just seemed ‘meh’ to me. It is however yet another turning of the screw in a largely successful attempt to make the working classes pay for the crisis in national income and wealth facing this country.

John Crace reviews the speech and budget in this article on the Guardian, A mini budget full of lies from Rishi Sunak, the people’s millionaire , and says,

[He can ] deliver a spring statement – AKA a seismic budget in any other year – that offers nothing to the poorest and most vulnerable members of society while sobbing on their behalf. Who can tell the chamber with a straight face that he is committed to cutting taxes even when the Office of Budget Responsibility is saying that the tax burden is set to go up to 36.3% by 2026: the highest level since the 1940s.
John Crace

I recommend you read Crace’s article in full.

It also reports on the budget, in an article by Philip Inman, their economics editor, Rishi Sunak ‘protecting Treasury from inflation at families’ expense’ | Spring statement 2022

Critics of UK chancellor’s spring statement say it prioritises debt reduction and fails to provide support to lower-income households
Philip Inman

This despite the sub-headline concentrates on the macro-economics, reflecting the argument that since the Govt has borrowed on variable interest rate bonds, as inflation kicks in, they argue they need more money to service the debt. The article concludes by observing that inflation may fall, that soaring energy costs are a drag on prosperity, and that the real reason for increasing tax revenues is to be able to give it back in the run-up to an election.

Despite being under pressure to minimise the effects of the cost of living crisis, driven by Brexit and energy cost inflation and help households across the country who are being forced into poverty, all the budget did was announce a cut on fuel duty, Labour are asking for a VAT cut on energy bills, although instructing Ofgem to implement a price cap would be more effective. He also raised the threshold at which people start to pay National Insurance, which is a means of alleviating the fiscal drag created by freezing the tax free allowance.

From Inman’s article, I also note that Sunak has frozen the income tax free relief for the next four years, together with the IHT limits. The effect of this is that before, people could expect the tax free allowance to rise in accordance with inflation, giving them small amounts of extra disposable income, even if they did not get a pay rise. This has now gone. It will also have the effect of raising the share of income tax paid by the low paid.

He also, in contradiction, to the Tories election promise suspended the pension link with earnings for 2022/23 although he claims to be willing to reintroduce it next year. He has also cut the amount the poorest in our society get by clawing back the uplift paid in 2019-2021.

My segue into this piece was the low proportion of government income attributed to Income Tax vs VAT. The House of Commons Library produced a report called, Tax Statistics: an overview, and my previous article reproduces some charts from it while making the point that treating NI as separate category minimises the impact of employee contributions, which are levied at 12% until one begins to pay higher rate tax and allows Income Tax to be described as more progressive than it is. NIC’s also are paid by employer’s and so clarity on corporate contribution to the exchequer is also reduced.

Chart, line chart

Description automatically generated — from the HoC Library Report : **Open Parliament Licence v3.0.**

VAT is 20%, for the less well paid more than they pay from Income Tax. This needs to be rebalanced.

I finish with Statista’s charting of the Gini Coefficient over time., which measures the level of income inequality in our society,

We have the lowest social security net in Europe, the lowest pensions and amongst the most strongly regulated Unions. Something’s got to give. …

Govt money

I was considering the EU’s NextGenerationEU and the idea that this was the tipping point into a fiscal union. I am not sure because the EU’s tax raising powers are as pre 16th Amendment United States; it cannot tax people or companies. This led me to consider the proportion of Govt. income rasied through income tax and other sources. This is a blog in two part, the first on the EU & the 16th amendment, the second on UK income tax and income equality. I comment on direct taxes and and the 16th by writing the following,

While looking at EU common tax policy, I thought about the need of the US to pass a constitutional amendment to allow federal direct taxation since previously the US required direct taxes to be apportioned to the States. The amendment is the 16th, and was designed to permit Income Tax an overcome a Supreme Court ruling which prohibited it; which came in two years later and has never been repealed. The Constitution Center has a review of the amendment arguing that the 16th only authorises income tax and the court has for instance constrained capital gains taxes. The Atlantic, also comments although the latter is more a history.
Dave Levy

The obvious development of income tax within the US led me to have a look at just how much of the UK Govt’s income is raised through income tax, the most progressive tax we have. The House of Commons Library has described the 2020/21 tax revenue sources, it seems that they’re no longer posting it out to everyone.

from the HoC Library Report : **Open Parliament Licence v3.0.**

The report landing page also has a chart showing the proportion by source over time, and its remarkably consistent. I also note that Income Tax is separated from NI and while some NI is paid by the employer most is paid by the employee. The Govt gets 43% of its income from these two sources and on top of this charges 20% of what one spends. There is also a compulsory private sector pensions levy on workers too, which does not appear in this chart. No wonder the low paid are struggling.

made by Dave Levy, from the HoC Library Report : **Open Parliament Licence v3.0.**

The separation of NI from Income Tax also permits them to claim that “The 10% of income taxpayers with the largest incomes contribute over 60% of income tax receipts”.

If you want to look at income inequality, Statista have the Gini Coefficient over time.

Statista UK Gini Coefficient over time , used under Statista Terms of Use

We need more income tax, less NI & VAT

This article contains Parliamentary information licensed under the Open Parliament Licence v3.0. The featured image is from Images of Money, on flickr, via wikimedia.org and used under the Creative Commons Attribution 2.0 Generic licence. …

The economics hurdle for rejoining!

This was published on the London 4 Europe web site, arguing that the Euro and “Banking Union” are potential political obstacles to rejoining. I just observe that the author has not caught up with the change in macro-economic management, the Stability and Growth Pact has serious credibility problems given the numerous breaches. We can hope that with a new coloured government in Germany the deficit fetishism of the EU will be weakened. Secondly, banking regulation is global and emanates from the G7 and BIS in Basel. The EU has little room for manoeuvre, although of course, should it be in a position to join BIS that would change things. This is an article designed to show how clever the author is and fails in that goal.

I note the article focuses on Sweden, which has agreed to adopt the Euro and not Denmark which has an opt-out. When we get to negotiating re-entry, the size of the UK economy and the sterling zone will be issues which may lead to us being given an opt-out or a Swedish deal, although I was interested to note that Nordea, Sweden’s largest bank has moved to Finland to locate in the Eurozone.

A serious analysis will come later, when both parties need an answer dealing with transaction volume, prudential regulation and fundamentally macro-economic policy. Let’s note that we had an opt-out of the compliance clauses of the SGP, we doubt we’ll be getting that back.

Macro-economics will be a problem if we have a left led Labour Govt., that wanted to pursue a policy of full employment but more importantly will be the need to meet the democracy criterion of the Copenhagen Criteria, where parliamentary sovereignty, the House of Lords and first past the post together may be seen as obstacles. Starmer’s Labour lacks the will to confront the issue of rejoining the EU but would probably welcome the shackles of today’s Stability and Growth pact. Actually, the Stability & Growth Pact is a serious barrier to rejoining for the Left; perhaps the sterling zone will save us from that too. …

Electricity Prices

A twitter correspondent posted a chart on European electricity prices, showing the UK as significantly more expensive. Is this legacy Thatherism, or Brexshite? Bit of both it would seem. There's more below/overleaf ...

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