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29 June 2013

The Bank of England

Tag(s): Politics & Economics
I recently participated in a panel discussion brought together with the Bank of England agency for the South East and East Anglia. Such discussions are held under the Chatham House rule i.e. one can report them but not make attribution. (See my blog The Chatham House Rule 4.6.2011 tag, pedantry) When the Bank of England makes its forecasts it uses fan charts, i.e. these show a range of possible outcomes with a balance of risk described for each. This is a sensible approach but of course the media who do not understand subtleties like these report a specific forecast which invariably proves wrong.  Thus the perception becomes reality.

It is clear that the level of growth is unusually low for an economy coming out of recession and it seems likely that we will not recover lost activity for some years to come. I have talked before in these pages of the flaws in measuring the health of an economy using GDP which measures consumption, not production, i.e. expenditure not productivity. The definition of recession is also deeply flawed. It was originated by a New York journalist over 40 years ago who came up with two successive quarters of negative growth as one of 20 definitions of recession he proposed. For some reason this one stuck even though it could lead to absurdities like the following scenario. Imagine an economy was indexed at 100 at the close of the previous year and grew 10% in the first quarter. It would now be indexing 110. It then grew a further 10% in the second quarter and would now be indexing 121, i.e. 21% growth on the previous year. But in the third quarter after some correction it fell back 1%, it would now be indexing 119.8. and then in the fourth quarter it fell back another 1% and would now be indexing 118.6. Yes, the economy has suffered two consecutive quarters of negative growth and so technically is in recession but in the year as a whole it has grown by 18.6%.

In business I always look at Moving Annual Turnover at the very least to understand the trends in a business. One board I am on looks at figures over three months, six months, one year, two years, five years and ten years. These figures are compared to a benchmark which we are targeted to beat and against our competition. The analysis is not difficult or particularly time consuming. The only reason why it is more difficult at the national level is the quantity of data but for something so important the nation should be willing to collect and analyse such data. But the reason why the Bank conducts these panels is to get some of the colour to go with the data.

There is, it seems, a feeling of greater optimism. The bank has recently given its first upwardly revised forecast since 2007. Evidence of recovery has been more positive in the last quarter. Perhaps the worst is behind us. This might be because of the measures taken in the EU to stabilise the financial crisis although my own view is that we should wait until after the German elections this year before reaching that conclusion. However, businesses do seem more willing to use some of their cash piles and the employment figures are improving.

But there are some factors that may continue to keep a lid on growth. After all the economy has still not got back to its level of 2007 before the financial crisis. Since then net immigration has continued to rise suggesting that GDP per capita has fallen even lower and so all the underlying metrics are worse than generally reported.  In addition there has been the scandal of mis-selling Payment Protection Insurance by the banks. Although this was all done under contract the regulators have forced the banks to repay some £6 billion to consumers and we can imagine that the kind of people who made such claims will not use this windfall to help pay back their debt but will instead buy that new car or go on that extra holiday they fancied. It does seem odd that the car market is so healthy when the overall economy is sluggish and people are complaining of reduced incomes.

We discussed whether we are actually facing a new set of circumstances in which the burden of risk has moved so that the wealth creators are less likely to invest and take on even more risk. Thus there is a general complaint by politicians and others that the banks are not lending. But in fact the banks have no problem lending to large established firms that want to borrow. The problems have emerged with smaller firms where the high cost of regulation makes it expensive to lend to such entities. Similarly the heavy burden of employment law has fallen on the employer. Under the auspices of ‘fairness’ the balance of power has moved from the employer to the employee. There has been a similar move in moving the balance of power from the supplier to the consumer and cumulatively this discourages new entrepreneurship.  

The current debate over corporation tax is perhaps another side of the same coin. The profits of a corporation belong to the owners of a business. If the government seeks to take more of this in tax because it thinks it knows best what to do with the money then this will inhibit enterprise because investors can see from decades of experience that governments don’t know best what to do with the money. Those investors will look for better returns elsewhere and they may find them in more enlightened and developing regimes.

The role of government in depressing expansion of the economy cannot be overstated.  Most government expenditure is counted in GDP and as it has increased exponentially in some parts of the country it drives out enterprise. There are parts of the UK where government expenditure under New Labour exceeded the Soviet Union’s share of its communist economy.

But I also wonder about the role of the internet. The internet is generally seen as progressive and economists will talk about productivity gains made through disintermediation or through the role of the category killers in reducing consumer prices and so giving the consumer more chances and choices to spend her money. The economists will look to the consumer surplus created by the internet but not captured in metrics of economic growth. If for example I save time through finding a piece of information on Wikipedia I should ascribe value to that. But there have always been surpluses created that were not measured. If I bought a book that I liked so much I read it twice noone ever gave that double the original value.

What I see is the literal decimation of the High Street. About 10% of High St shops have closed in recent years. Some of that is because of excessive business rates and upward rent reviews. Much of it is due to purchases moving online. The online penetration of retail is over 15% in the UK, the highest in the world, double the rate of the USA where it all started and three times the rate of the Japanese who are often the earliest adopters of new trends particularly involving electronics. The largest of the online retailers takes the lowest possible buying price, 60% discount in the case of books, and then sells at the lowest price. This must depress the market in two ways, one by lowering the value and two by killing off much of the retail capacity. When Woolworth closed some record buying was lost for good as not everyone wants to buy online.

The panel was asked its views on current business conditions and the outlook for the next six months compared with the same time last year. We were asked if there was any practical impact from global financial market uncertainty. How much spare capacity we had and what is happening to employment in our businesses? Are there shortages of people with particular skills, what is happening to productivity and what is the current level of pay settlements? The Bank wanted to know what is happening to non-labour costs and output prices charged. Have credit conditions for our business and for our clients changed recently and if so, how? Has there been any impact on investment?

While the details of the answers to these inquiries were interesting if anecdotal on occasion nevertheless it was the bigger macro trends that I found of greater interest and the strong feeling that I have had for some time now (See my blog The New Normal 24 March 2012 tag, Politics & Economics) that we need to get to grips with a new paradigm in which growth will be elusive if we keep applying the old formulae and instead we need to be innovative in our business models and in the role of the state.

Copyright David C Pearson 2013 All rights reserved

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