The UK: Statistics and Economy

Some time ago, I was complaining about the increasing opacity/difficulty in obtaining information about the UK economy, for example with the previously wonderful National Statistics now completely hopeless. As such, I have to offer a big word of thanks to Dr. Tim Morgan of Tullett Prebon, who has made an excellent database of statistics available here, and would also recommend the database to those who are likewise frustrated with finding basic data from the official sites. In practical terms, it means less time looking for information, and more time looking at what the data might mean. This is what Dr. Morgan has to say:

Finding key data on UK issues such as inflation, the economy, spending, taxation and debt can all too often prove time-consuming and baffling. The Tullett Prebon UK Economic & Fiscal Database is designed to contribute to the quality of the public debate by providing all participants with ready access to objective and consistent data.

As a celebration of so much easily accessible information, I will today overload on statistics, and use the statistics as a foundation for a review of the UK economy. First of all the government finances, commencing with a breakdown of revenues (billions):

There are a couple of points of note here; the first is that after the drop that took place when the economic crisis became visible, revenue has been steadily increasing with VAT revenue growth particularly pronounced. A commentator recently suggested that the deficit growth was due to a collapse in revenue, but we can see that this only explains a small element of the deficit. With regards to collecting revenues, I propose a more open, efficient and transparent system, and a system that will also reduce costs and distortions in behaviour. For example, I propose the abolition of all corporation tax, and a flat income tax. Since writing the post on reform, I have identified some problems with the proposal, but still hold with the principles (I may update the post if I have some time).

Below, we have spending (£billions):

I don't think any reader of this blog will be unaware of the growing problems of financing pensions and health with an ageing population. I have often spoken about the necessity of priority; that the government needs to make some hard choices between where an ultimately limited amount of resource might go. I have also argued that there are ways of cutting the expenditure of government whilst also maintaining provision of services and safety nets. For example, as one of the more controversial suggestions, I propose that welfare becomes an interest free loan with a finite duration and amount. It is a system that would see the welfare share of spending fall, albeit that it would increase government borrowing in the short term. It is a return to the principle of welfare; that it is a safety net. If you look at the links at the top right of the page, you will find solutions to some other areas of spending. I chose the area chart format as they give a good picture of direction of spending and income, but the overview is better represented through a bar chart (billions, at current values):

It does not look very pretty overall. In fact, it look downright ugly. We then have to ask what this is achieving. How is the UK economy really doing? This is unemployment during massive credit expansion:

In this figure, we can see the impact of the boom, and the appearance of the economic crisis is vivid. When looking at the chart, when looking at the fall in unemployment, it needs to be considered in relation to debt, both government (see above) and private:

It is very apparent that debt growth was masking underlying problems in the UK economy. The second chart perhaps is more scary than it should be. We need to remember that the massive increase in aggregate debt took place during a period of high immigration; the massive expansion of borrowing and the activity that it generated had less impact upon unemployment as it also coincided with high immigration levels. This is from the ONS:

And this reflects in the number in employment:

In these charts, we can see that the rapid credit expansion did dent the unemployment statistics as much as would be expected, as the size of the workforce was also increasing, with significant immigration accompanying the credit boom. The really interesting part is to see what all of these people were actually doing:

Perhaps the most notable point in this, is the increasing size of financial intermediation. Although the figures only go to to 2010, we can see the expansion and subsequent contraction of areas that would be associated with a credit boom; wholesale and retail, real estate. Somewhat surprising is that hotel and restaurants did not see greater expansion. Financial intermediation by contrast, has grown and grown, and (at least as far as these figures go) has not yet started to contract, but I believe that this is now taking place from various news stories (and see below). I took a look at the 2007 SIC codes, to get some sense of what the high expansion in 'all other' means, and examples include legal and accounting, management consultancy, scientific research, R&D, Market Research, rental and leasing of machinery, recruitment consultancy, security services, administrative support services etc. In other words, some of these activities might be associated closely with credit expansion, and other not. Manufacturing is notably flat, as are the primary commodity sectors. Although the chart given above is helpful, it does not give an indication of actual employment, and I dug out some figures from ONS, and created the following (key is given underneath):

A = Agriculture, forestry & fishing, B = Mining and Quarrying, C = Manufacturing, D = Electricity, gas, steam & air conditioning supply, E = Water supply, sewerage etc., F = Construction, G = Wholesale, retail, motor trades, H = Transport and Storage, I = Accommodation and food, J = Information and Communication, K = Financial and Insurance, L = Real Estate, M = Professional and Technical Services, N = Admin and Support Services, O = Public admin, defence and compulsory social security, P = Education, Q = Human Health and social work, R = Arts, entertainment and rec, S = All other services.

The stand outs are the decline in manufacturing employment, Construction, Real Estate, and Retail, albeit that there is something of an uptick in the latter. Also notable is that the numbers working for the state appears to be in decline, but we need to consider this against the increase in 'All other' in the earlier chart of GVA and the increase in Professional Services in this chart; it may be that there is displacement going on here..... Another stand out is the increase in Q, Human Health and Social Work, which now seems to be reversing. A real curiosity is the growth in in D & E, which covers utilities; for E this can be explained by the rejuvenation of infrastructure being undertaken by the water companies (as a guess), but the increase in numbers for electricity is more of a puzzle. As discussed earlier, finance and insurance sees the numbers reducing, which is not apparent in the GVA chart. However, whilst this paints a picture of the post economic crisis, more interesting is to look at what has taken place whilst the world economy restructured in response to the entry of the emerging economies into the system, so I have added December 2000 to the chart, with the label of 'Series 6'. I have placed it next to the 2011 figures to make the changes more apparent.

Manufacturing is startling, even though we have long known this to be the case. For construction, there is still have a way to go before reaching pre-boom numbers, and any reversal of credit growth will mean this sector will shrink even further than pre-boom numbers. If we look at retail now in comparison with unsecured debt now and in 2000 (see earlier chart), the picture is mixed. In contrast to the more recent picture, accommodation and food, however, appears to be an area that may have some contraction if credit growth slows, but there is a question of whether people will forgo retail to continue to enjoy these services, which is a different question, and might mean contraction in retail. In other words, how will disposable income be split between these two sectors if credit expansion stops. Real estate activities still seems to over-large in numbers employed, and still has a way to go down. An offset here is that there are reports of inwards investment into UK real estate, with buyers considering the UK a safe haven. In other words, the sector may yet have 'legs', but my guess is that it is unlikely to last too long.

I have already discussed professional services, and the picture here may be seen as supporting the point about displacement (also see N, Admin support, which may be the same question). However, when looking at export figures, these services appear to have grown, so it is hard to make sense of the figures when aggregated. Education (P) is a real standout for growth in employment. It would be interesting to see how much of this growth is in the tertiary sector, which would reflect the government goals of expanding tertiary education, and also the increase in numbers of overseas students. Whether overseas students will continue to want a UK education is a question that is debatable, as questions are being raised about educational quality (beyond the scope of this post). Finally, we come to another huge standout; health (Q). This stands as an exemplar of the hard choices being confronted by government. In simple terms, each additional person employed in the health system is one less person with potential to be employed in underlying wealth generating activity in the wider economy. And the numbers are going to keep on growing as the population ages. Much more could be said on this subject, but I will leave this open for the moment (at risk of comments that point out that it is not as simple point as I make it). 

 We now come to wages. Below are some key figures for wages and inflation:

I have titled the chart 'getting poorer', as this is the picture it paints. You need to consider this in light of the ongoing massive borrow and spend of government, and the dubious activity of printing money. Also, you need to consider that the indices for inflation are questionable, and that even if accepting the indices in principle, the impact upon individual households is variable. If we really want to understand something about the underlying nature of the economy, the devil is in the detail (sorry for the messy chart, but it is readable). I have gone a bit further back than the chart above, and this is because of the fascinating story of consumer durables.

You will note how there was significant deflation in the price of consumer durables, which we can safely say reflects the entry of countries like China into the world economy. We can see the peaks in energy prices, and the fall in the same prices as the economic crisis bit home. And now, we see inflation in energy once again; however, this time, the inflation may yet be offset as the global economy teeters (in part driven by higher energy prices), in part by the adoption of fracking. On the other sideof the coin, so called 'green energy' are a potential driver in the UK towards higher electricity prices. The chart below gives annual electricity bills, and it is apparent that they are growing rapidly. It deserves a post in its own right, but there are considerable problems looming for UK electricity supply, and the real cost of 'green' energy is now becoming apparent in Germany (e.g. see here and here)

Higher energy prices, it should be remembered, impact more upon those with lower incomes, and the same can be said of food prices. Income spent on energy is not spent elsewhere. The final point of note is that consumer durables have now started to climb in price. If  we look at the $US exchange rate, which is the currency of trade, we can see something of the reason (£GB - $US).

Other factors that may also having an impact are rising wages in places like China, and rising energy prices. However, if China does slow significantly, it is quite possible that there will again be deflation in consumer durables; as orders in Chinese factories decline, there may be a period of significant discounting as businesses seek to at least contribute something to their fixed costs. However, the trajectory of the £GB may offset this, and there is ongoing money printing policies in the major economies to muddle any idea of future exchange rates. Competitive devaluation through printing money means that UK money printing effects may be neutralised by other countries printing money. In summary, inflation is very likely to continue, but the degree of future inflation is a very open question. There are simply too many variables that might impact upon inflation in the UK, with UK government and central bank policy simply additional influences.

With regards to house prices, they continue to fall in price in inflation adjusted terms, even if headline prices are relatively stable:

More interesting is the house price to earnings ratio, given below:

By historical standards, they are still high. I must however mention that house prices are, in part, being supported by the inwards investment, as discussed earlier, in particular in London. Nevertheless, the current ratio suggests current prices are not as stable as they may appear. The Economist also proposes that UK real estate is overvalued compared with rental value (26%) and income (17%), suggesting that real declines will continue at some stage.

My final chart of the day is one I will copy from a previous post, covers the balance of trade, and comes from the (from ONS):

As I stated in a recent post, it is a good indicator of the long term sustainability of the standard of living within an economy and, again, it is not a very positive picture. 

So how can we add up all of these piles of charts? The first point I would like to make is that we can, in part, see that the economic crisis did NOT start in 2008, but started much earlier. It has been so easy for commentators to blame the 'financial crisis', as it evades the fact that there were changes taking place earlier, and that these were simply hidden under the cloak of massive extension of credit. The UK entered the 'financial crisis' already in a state of economic crisis. When looking at relatively benign inflation in the face of credit expansion, the impact of ongoing deflation driven by cheap labour and cost structures in emerging economies was not accounted for. The very real inflation in house prices was ignored; apparently that was un-worrisome inflation. When I first looked at the UK economy in any depth, it quickly became apparent that the boom years were built upon foundations of credit expansion, and I worried for the future and proposed that people were poorer than they thought. We can now see people becoming poorer in the decline in real standards of living, and the now steady decline in the value of most people's primary asset.

People are becoming poorer in spite of government borrow and spend, which is at astoundingly high levels. When consumers were unable to 'grow' the economy through more debt accumulation, the government tried to 'grow' the economy through debt. Spending tomorrow's income now is not a way to grow an economy, as it will see a shrinkage of disposable income in the future. As it is, private debt is now in a very slight decline. However, this slight decline is more than offset by the massive increase in government borrowing; but incomes still continue to fall. This only serves to illustrate the depth of the economic crisis that confronts the UK. Even whilst borrowing and spending more in aggregate, people were becoming poorer, and unemployment was rising. The UK has not even started to address the crisis that sits metaphorically in front of its nose. It does not take much imagination to see what might happen if the UK was to seriously try to balance its budget. Those £billions of debt generate a large amount of employment. What it does not do is generate underlying wealth; that wealth is generated in the primary commodity industries, manufacturing and the export of services. 

These sectors are the ones that are either sitting on plateaus or in decline. Sure, a flood of money into UK real estate might help tide the UK over for a little longer, but that is surely just another repeat of a bubble. There are still such temporary sticking plasters to cover the gaping wound in the UK economy. What these do not do is increase the ability of the UK to export goods and services, which allow the UK to trade in the goods and services necessary to sustain current standards of living. Quite simply, the UK is unable to compete well enough in world markets to sustain the current standard of living. In this post, I looked at government expenditure, and it is apparent that some expenditure is subject to upwards pressure; health care and pensions. These two expenditures look set to rise, even as the UK faces ongoing competitive pressures. In real terms, it means labour being taken from potentially wealth creating industries, and either being redirected into health care, or labour becoming inactive in increasing numbers. The ability to compete with such shifts in the labour force is a challenge the UK must face, in addition to facing the fiercer competition in the world. The UK is not, of course, alone in such challenges, but faces them whilst already struggling to compete. 

I keep on discussing this, but it does not do harm to say it again. The so-called 'austerity' of the current government is not austerity, but a luxury; a luxury that cannot be afforded. It is spending borrowed money to avoid confronting the real underlying standard of living in the UK. It is storing up trouble in the face of the challenges of shifts in the labour force, and a less forgiving world economy. So what is to be done?

The answer is to start to question what can, and cannot be afforded. My benefits reform is an example of how a principle might survive intact, whilst seeing reduction in cost. The aim is simple; to allow what was intended as a safety net to return to its original purpose. Real reform, the kind of reform that is increasingly necessary, requires that the shackles of historic legacies be thrown off. The benefits system did not start out as it is now; it evolved over time into what it has become. The same can be said of swathes of policy that comprises the foundation of government expenditure. If you look at the UK's tax code, it is possible to see that the (sometimes) good intentions of government after government has evolved into a sinkhole to drain away productive activity. Instead, the UK has a massive and fundamentally unproductive industry with the sole purpose of managing tax. Can the UK really afford to have so much productive capacity dedicated to what, in the end, is a process of collecting x amount of government revenue?

It is these really fundamental questions that must be asked, and asked of every area of government; what must the government do, how can it do what it must do differently and better, and where are the priorities for what government should do? These are the questions that are still not being addressed. In the meantime, the UK is becoming poorer. I see no change to this in current policy; but rather see the opposite outcome, which is an acceleration of the decline in the standard of living. After all, where is the policy to really address the poor and declining performance of the UK economy?

Note: I hope this is not too 'clunky'; comments welcomed on this and all points of the post. I have covered a lot of ground in this, so please point out any errors you may see.

Note 2: Shortly after publication - I am not sure I have made the best use of the data given - a bit like a kid in a sweetshop gorging without pause. Thoughts / comments welcomed.

Gordon Brown as Saviour? How Did That Happen?

In my post of yesterday, I suggested that I would not be posting so often. However, there is a disturbing acceptance, even amongst the critics of Gordon Brown, that the bank nationalisation has 'saved' the banking system. I will not rehash my arguments over why the bank nationalisation is a disaster, which can be found in a post here.

Here is an example from the Times columnist Daniel Finkelstein:

'Gordon Brown is enjoying himself so much at the moment that it is sometimes hard to recall whether the aim of the exercise is for him to save the banks or vice versa. But to have to spend billions of pounds of taxpayers money to save the entire British banking system from collapse is an odd sort of triumph,'

Daniel Finkelstein is quite rightly critical of the record of Gordon Brown but, as can be seen in the above quote, but is accepting that the UK banking system has been 'saved'. There are two basic problems with this assertion. The first is that it is very, very early days yet, so one must ask on what evidence the system has been 'saved'. The second is to ask at what cost? By this I mean, at what cost to the viability of the wider economy. That second question may be answered in the near future by government default on the debt it has accumulated, and by the costs imposed upon business and consumers to pay for this bailout. It is borrowed money that has 'saved' the system, and that means it must be paid for, and that means the UK economy has new structural costs. These additional costs will, of course, be buried amongst a host of other costs, such that their effects will be hard to strip out and isolate. However, the difficulty of isolating them will not mean that they are not there.

The really dismal part of the news is that Gordon Brown apparently has gained 'political capital' and is now proposing leadership of an exercise to rewrite the rules of the international trading system. This is like asking the captain of the Titanic to rewrite the rules of seamanship on the basis that he arranged the evacuation of the ship efficiently. However, in this case, we still do not know whether Gordon Brown has even saved the 'passengers'. As just one example, there is news that unemployment is soaring in the UK (exactly as I predicted), and rose at the fastest rate for 17 years in the three months to August.

The idea that Gordon Brown has gained 'political capital' is very worrying, and further increases my doubts about leadership through this crisis. I have consistently been worried about the leadership in the Western world, but this is very worrying indeed. I can only hope that the leaders of other countries start to see through vacuity of Gordon Brown's thinking. In the meantime, with Gordon Brown ascendant, what hope for the UK economy?

A very short post but I am very disturbed by this sudden lift in the reputation of Gordon Brown. It does not bode well at all for the future, but suggests that the reality of the economic situation will continue to be ignored in favour of the magic wand solution of debt led recovery. As I have said so many times, this is just postponing the disaster, and postponing at a price.

Note for Ishmael (comment below): I am afraid that I did not receive your last comment, so I am unable to reply to it. It seems that some comments are not getting through to me (though most are). I am not sure why this is the case. I have had one other commentator mention that their post did not appear. All I can do is apologise. I chose Blogger on the basis that it was a well known service, and has a good reputation. It seems that, despite this, it has some glitches. Please accept my apologies for inconvenience as, at the end of the day, I chose this service, and therefore my poor choice is responsible for causing this inconvenience. Unfortunately at this stage, it is a little late to change services, so I am in the unhappy position of having to accept these gltiches will occur. I can only apologise for this again.

Note 2: Another commentator has posted on the New World Order conspiracy theory as follows:

'Do some more research on NWO,
This conspiracy theory had been planned since before 911, 2001. One World Bank , One world currency standard.
The only way this could happen was through a melt down or collapse of the market, not just our but a world market.
There are only a few that can plan such a thing, but those are the ones pulling all the strings. (Men in Black)
Don't be foolish. I knew this was going to happen years ago.
Remember we only get what is spoon fed by the media.

Here take a number SS or CC and be a part of a system, if not good luck in surviving in Babylon.'

Who are the conspirators, how are they operating, what have they actually done, and why is this conspiracy theory more convincing than the reasons I have detailed throughout this blog?

Once again, I would ask anyone who believes in the conspiracy to offer some evidence from a reputable source. I followed a link given to me and found that it led to a video of a white supremacist showing an 'Amero' coin. This was hardly convincing. I am genuinely open to being persuaded on this, but would appreciate any references that the conspiracy theorists might be able to offer to convince me. Until such a time, I can only assume that there is no conspiracy. In my original post on the subject, I presented an argument as to why a conspiracy is unlikely. Having followed up the subject, I have yet to have my mind changed.

Note 3:

LordSidcup (see comment below) makes a perfectly fair point in saying that Gordon Brown is not alone in making the errors that have led to this crisis. The reason for my worry that he is in the ascendent is that he represents a good example of the delusions that have been at the heart of the cause of the crisis. Were it George Bush, Bill Clinton, or any other of the world leaders, who failed in their analysis, I would make the same comments, were they striding high on the world stage. My selection of Gordon Brown is without any partisan basis, but is based upon his record in running the economy, and on the basisthat he seems to be taking a lead in the management of the crisis.

Yes, others made the same errors. This does not mean that Gordon Brown did not have the opportunity of making a correct analysis of the economic situation all those years ago. In this sense it is not personal, and my point is that it is indicative of the problems of the leadership in the Western world. The same leaders who made the wrong analysis, are now the same leaders analysing the results of their first failed analysis, and proposing solutions to the problems they helped to create. It is hardly encouraging.

However, a perfectly fair comment. I should have been clearer in why I selected Gordon Brown as the basis for my critique. It is because he is in the ascendent. My worry is that there should be economists and politicians who are striding the world stage who are offering the media and public a more realistic evaluation of the situation. In short, the ascendency of Gordon Brown is symbolic of the continuation of the dream that more debt is an answer, and yet more poor analysis of the situation.

I write this blog in the probably vain hope that the blog, and views of other commentators who share more realistic views, will eventually have some influence. It is the hope that politicians/ the media / the public will finally look at the underlying reasons for this crisis square in the face, and look to remedies that will help reconstruct the economy in the medium and long term. Gordon Brown's ascendency is the symbolic antithesis of such hopes.

Note 4: I have just made a (very quick) survey of the new editions online. It seems that any hope that there is any boost in confidence from the bailouts is diminishing fast, as economic reality bites (as I proposed in a previous post). I also proposed that markets might go through ups and downs, but perhaps the sheer scale of the bad economic news will lead to a negative tracjectory only? Meanwhile there is more news of high borrowing countries crumpling under the weight of their own loans, and more calls on the IMF. Nervousness about the UK and US will no doubt be mounting in foreign creditors, even as I am writing. I proposed that a crisis in government insolvency was about 3 months away, but am now thinking that, just possibly, it may be sooner. As for the EU, I think Hubris comes to mind, when reading the following quote:

'The monetary blitz was welcomed in Brussels, where EU leaders were meeting yet again, just days after agreeing to the most comprehensive bank bail-out in history. "We are not at the end of the crisis, we are still living in dangerous times," said Jean-Claude Juncker, Luxembourg premier and Eurogroup chair.

He issued a stark reminder that life is going be very different for the banking elite as governments move to restore the lost discipline of the Bretton Woods financial order and attempt to "civilise" capitalism, the code word for clamping down on the City – dubbed "the Casino" in Europe.

"Let everyone remember after this crisis, who solved it. Politicians did, not bankers," he said. Mr Juncker added that this episode would have a profound effect on the euro debate in Britain.'

Yet again, apparently, the crisis is being solved. Perhaps some of these politicians should read the news?

I will try to write a proper review of the situation soon, as ever more problems are emerging, and the situation appears to be moving in an even worse direction than my own already very pessimistic predictions. I will try to round up all of the news, into a more integrated picture, and see where it will leave the world economy, and the economies in the UK and US, and to a lesser extent Europe.

The Banking Crisis is as Much a Symptom as a Cause

It seems that my post on reform regulation will have to wait a little longer, so I apologise to regular readers who may have been waiting for the post. It seems that the news of the moment is worth further comment.

A good starting point is to refer you to some commentary in the Telegraph newspaper:

'In a year's time, consumers may look back on the past 48 hours as a bit like the first few minutes after the Titanic struck the iceberg, when high-spirited passengers played snowballs unaware of the danger they were in. '

It seems that people are finally waking up to the reality of the dire situation that we are in. The current banking crisis has arrived a little sooner than I expected (about one or two months earlier than I thought), and is actually just the start of the carnage. In a related story The Times today reports that unemployment has now reached a 9 year high, and with the highest increase since 1992. Once again, it is very much as predicted. The return home of Central Europen workers has acted as a dampener, but it could only slow the growth in unemployment so long. There is also a growing recognition that house prices have a long way to fall yet.

Following the Northern Rock fiasco, the first of the second tranche of UK banking problems is HBOS, with the government scrabbling around for a rescue package. I have not looked at individual banks closely, so I will not give a long list of those at risk. However, a good way of looking at the question of which bank is at risk is simply to ask which banks have seen massive growth in profits and expansion over the last ten years. Banks such as Royal Bank of Scotland come to mind, but I emphasise that I have not looked closely at individual institutions.

As if the fiasco were not bad enough, there are calls for the prevention of short selling of stocks (see here for a good description of what this means). This makes me think of the analogy of a person saying that they want to ban the use of thermometers for patients with a fever. It reveals the ignorance of those in power. The short selling is just an indirect indication of the underlying problems.

As for the whole idea of bailing out the financial system, I have suggested that government bailouts are not the solution. I am now ever more confident in that view. The reality is that the governments are just taking on liabilities from a stricken sector, and will then have to use the remaining healthy sectors of the economy to pay back the debt that they accept. Taking on such liabilities will also add to the coming crisis of government finances, as governments find that confidence in their ability to repay debt wanes, or collapses. They are, in other words, spreading the 'sickness' into other parts of the economy. Furthermore, where will governments stop, and how much can they bail out? The following makes the point:

'Fears that America's central bank – the Federal Reserve – may have over-stretched itself in agreeing to bail out AIG were underlined after the US Treasury announced plans to raise $40bn to allow the Fed to "better manage their balance sheet."'

Incidentally, the Economist reported a long time ago about the potential risks in insuring credit, but I am afraid that I do not have a reference for this (despite a quick search of the Economist site). We can expect more problems to emerge amongst the insurer and reinsurance companies.

The bail outs, I'm afraid, amount to a philosophy of 'something must be done', whether the something makes any sense or not.

In amongst the emerging realisation that the crisis is not going away, and the realisation that it will get much worse, there is no sign yet that anyone has yet realised that the banking crisis is not the problem. The mainstream economists, governments, and bankers still do not understand what is happening. The foolishness of the credit bubble has just been a mechanism of delay in the rebalancing of the world economy, putting off the inevitable restructuring of the world economy. There is no doubt that the credit bubble will have made what was always going to be a painful adjustment much worse. But it is not the cause of the problem.

For those who are new to the blog, I would suggest that you take a look at the recommended reading at the top left of the blog for an explanation of why the world economy needs to rebalance. The reasons are pretty straightforward, and blindingly obvious once you read them. The shocking thing is that none of the 'experts' seem to have grasped the nature of the problem.

The purpose of this post is, as much as anything else, to re-empahise that the banking crisis is not the real crisis. It is as much a symptom as a cause. It has taken such a long time to wake up to the fact that the economies of the OECD have been built upon foundations of sand, it makes me wonder how long it will take for everyone to wake up to what is the real cause of the problems. No doubt, for a long time yet, the symptoms will be confused for the cause.

Without understanding what the root cause of the problems might be, the solutions provided to solve the crisis will continue to be misguided. The UK, and other Western economies, can not afford to continue to try to navigate whilst blind.

What of New Zealand?

I had a comment from someone asking the prospects for the New Zealand economy. My apologies for the belated reply, and that I do not have time to find the original comment.

The answer is that, like the rest of the 'rich world' New Zealand will suffer in the current crisis, but there will be some countries that will feel the pain more than others. I do not know the New Zealand economy that well, (due to the size of the economy, it is not well reported on) but will hazard an opinion nevertheless (so treat what I suggest with caution). As a second apology I am rather pushed for time, so can only go on memory rather than checking facts and figures (so I reemphasise treating my comment with caution).

New Zealand has strengths and weaknesses. The first weakness is that, as the world globalises, scale of businesses will increasingly matter. New Zealand is just too small an economy, and lacks the large companies that will increasingly be dominant in the world economy. Another problem is that the New Zealand economy has a large tourism sector, and that this will be hurt by the current financial turmoil. However, this can be ameliorated by finding ways to appeal to new markets, such as China and India. The question is whether New Zealand can find an appeal that will resonate with these markets, and that is a question of marketing. At the moment New Zealand is very good at promoting itself as a 'clean green' location. The trouble is that the environmentalism that New Zealand loves may hobble other sectors of the economy, in particular agriculture and forestry.

As for the rest of the OECD, New Zealand has had a housing and credit bubble, but the size of the bubble is not as large as, for example, the UK. I have not looked in a long while, but I believe that the government debt is very high. and overall external debt, allowing for population and size of economy, is at a similar level to a country such as Germany (based upon a quick back of a cigarette packet estimation - please do not take this too seriously).

On the positive side of the balance, New Zealand has a large commodity sector, and this is a good thing in the world economy now, and in the future. Whilst commodities will have a bumpy ride, as the world economy swings wildly, the demand for commodities is, on balance, going to increase. Of particular note is the New Zealand agricultural sector, which has more potential than is currently realised. In particular, New Zealand has potential to develop a stronger food industry, and move up the value chain. If New Zealand is to realise this potential, they need to start to switch their added value food products to products that will service the Asian market. This will need a shift in the thinking of the people who run the large New Zealand food companies. The current milk scandal in China will not help matters much, but hopefully that is just a blip.

Overall, I think that New Zealand has the potential to fare relatively well, but I would like to reemphasise again that I speak from a position of relative ignorance.

Note for Lemming (a regular commentator on the blog):

Anatole Kaletsky still seems to have retained his job as a columnist, despite getting it all so wrong. He is still opining with complete confidence, and still seems to think he knows the answers. I wonder whether he reflects on his previous errors and suffers doubt? See his latest article here.

Note For Tin Hat:

Tin Hat, thanks for your question which I have edited and added below:

What are your views on how bad will it get. Lots are suggesting another Great Depression, that bad? Is there anything that can be done to protect your savings. On the basis of your assessment government bonds do not even sound appealing and gold buried in your back garden seems extreme! Your thoughts would be appreciated

Right now, I am afraid that I would be a very foolish person I were to be giving firm advice on where to invest. The trouble is that, in the short term there is no place of safety. The reason for this is that world economy is going to become more and more chaotic in the coming year. Much will depend on the actions of governments and politicians, and they are individuals who carry all of the faults of people anywhere. How will they react? So far, not very well. However, as the situation worsens, and the demands for action multiply, they will likely act upon their economies in increasingly irrational ways.

The other problem, at least in my mind, is what the instability will do to China. I have discussed this in another post, and the problem is that, if China's economy is pulled down enough by the turmoil, it is quite possible that the country will see civil unrest. The real question is whether China can sustain itself through the current turmoil, and I confess that I do not know the answer to that question. It is too opaque an economy to have any certainty. However, if the current crisis tips China into recession, then the world really will be in for a period of chaos, including civil unrest in China and the possibility of war as well.

As a general point I would suggest commodities, as they are likely in the medium term to gain in price, but holding commodities is not easy. I do not know enough about futures to know the maximum length of contracts, but suspect that they would not meet your needs, and would any case be too complex for most people. However, as the world economy absorbs the current blows, it will shrink back, lowering commodity demand in the short to medium term. I do not know what your time scales are.

As for putting gold in the garden, that seems as good a bet as any (just don't tell your neighbours). But seriously, as mindless as it is, gold does do well in periods of turmoil. The danger with gold is the very fact that it is a safe haven, and that means sentiment is the real driver of value. However, in the current climate, I can not see sentiment turning positive (on aggregate at least) for some time yet. However, I have to reiterate that, in the current situation, there really is no safe investment (there never has been, but I speak in relative terms). It seems that your instinct appears to be in accord with mine. Maybe you need to get out and buy that shovel (or spade if you are from Yorkshire).

Reforming the Benefits System

In many of my posts I have proposed some radical solutions to some of the structural problems of the UK. You may want to see my posts on education and healthcare. In many ways the following article may appear to be radical, but is only really radical because we have become so used to the current system. However, it is perhaps the most controversial of solutions proposed so far.

The first thing to establish is that the current system is unsustainable in the future that is currently unfolding. The UK can simply not support the 'luxury' of a system that lets people stay idle on benefits. This is to sidestep the debate over 'what kind of society we want to be', because we will simply be unable to afford the current system.

What is the scale of the current problem? I am not going to go into figures here, as the figures for unemployment and how they are calculated is highly contested. All I will say is that it is far, far higher than the headline figure. What I will do, however, is step away from economics (although it is about economic drivers) and enter some muddy and dangerous political waters.

Before starting, a principle has to be established. If you provide economic incentives, and these incentives are perverse, you will get perverse outcomes. The current system provides just such an incentive with perverse outcomes. The problem in question is that of children. Having children in large numbers is currently a way of ensuring that the state gives support. The simple fact is that, if a person has responsibility for children, then they will gain the full financial support of the state, always with a justification that children must not ever suffer. This is a powerful moral argument, and very difficult to deal with. It is a moral force.

As difficult as it may be, the issue must be dealt with. Under the present system there is a perverse incentive to have children as a way of guaranteeing state support. This creates the incentive to have children in order to guarantee security. It is a curious parallel with 'less developed' countries, where having children are also seen as offering security - though with the vital difference that in less developed countries the security is taken from the potential for the future labour of their children. The problem in the UK is that the support that is provided for children of unemployed people is a drain on the state, and therefore a drain on every productive individual and business. The system is one in which children are being born into poverty, and adults are being encouraged into this situation. The more support the state offers for the sake of the children, the more children there will be born into poverty. At some stage the cycle has to be broken leading to the impossible moral dilemma of having to accept that some children must suffer so that others do not. Is there a path through this dilemma?

One thing to consider is that, in order to generate the wealth to support such a system of benefits, the country must be very productive and efficient. However, in order to be productive and efficient, the country must have a sustainable competitive advantage, and that a part of that advantage is an efficient state, and productive workers. Both of these are negated (in part) by a system in which, year on year, the numbers of people claiming benefits slowly increases. Even if the current challenges to the economic success of the 'Rich World' had never taken place, at some point a system of ever more state support 'for the sake of the children' would become unsustainable. In the current situation of intense global competition, the illogic of the system is being exposed more quickly. This does not address the morality of the situation, but does address the fundamental reality. If the current system continues, it will hit a brick wall as there will simply be less money available to support such a system.

At this stage it would be easy to characterise this point of view as heartless. How can anyone propose anything that will see children suffering from poverty? However, this is to ignore the reality that sufficient wealth absolutely must be generated in an economy to sustain such a system, and yet this system is in part a reason why the economy will fail in that task. In sunnier economic times, it was just about possible (just) to have a compromise in which all this was possible, that the economy as a whole could support the unproductive part of the economy. However, times are no longer sunny, and it will therefore be unsustainable.

Here is the real dilemma. If the benefits system continued without the reform of the principle of protecting children, then it would be impossible to create any system where any childless individuals might be subject to bad circumstances without further encouraging people to have children to ensure their own security. Children would simply become an even more important passport to the benefits system. One way or another the principle of benefits to protect children can not survive. If anyone can resolve this dilemma, I would be very interested to hear their thoughts (assuming that you agree with the view that the UK must reform, based upon the idea that we have entered an intensely competitive world).

I will now move on from this subject, and as a reader you have to either accept the economic rationale behind what I have said, or condemn me as a heartless monster (I will at some later stage offer another such situation where I might be so characterised, but for the moment this is the extent of my 'monstrousness'). Also, if you read on, you will see that it is unlikely that many children would ever suffer in the system I propose, though inevitably some would.

Having said this, I believe that overall less children would be born into poverty in the first place under my proposals. With no incentives for living on benefits, less children would be brought up in the benefits system. Furthermore, the system proposed (and this may surprise you) offers more generous benefits in some respects.

Having started with such a controversial point, I will start off the argument for reform with a quote from my essay 'A Funny View of Wealth' as it covers one of the central problems in the current benefit system.

'As mentioned before, all things in the UK are not equal due to the minimum wage, but also because the UK employer needs to compete for labour with the UK benefits system (which is an indirect minimum wage that applies to anyone entitled to social welfare benefits). This system allows an individual to remain economically inactive, or to choose an option of accepting a low paid job for very little real remuneration despite a major increase in the expenditure of their labour. In such cases the value of the labour expended is far below the minimum wage as it needs to be calculated as the weekly pay minus the benefits, to give an actual wage for the work done. The rational person in this situation might reasonably ask whether the loss of their free time to work is worthwhile for what will often be little financial incentive as, in this situation, the UK worker is often working for extremely low wages.'

This situation becomes even more extreme where there is a family involved. Under such circumstance there is the possibility that overall the individual will be working for very little additional income relative to the benefits.

Even more perverse are the benefits provided to those who are in work, benefits to supplement their income. In this situation the government is subsidising the labour of low paying employers. Without raising the wage to a living wage, many people would not be able to support a family and therefore would not take the job (under the current system). This raises the question as to why the government is in the business of offering subsidies for low wages? Whilst a teenager working as a waiter may not need a subsidy, there are many who are subsidised in their employment by the government. How can this make sense? In practical terms, employers who are paying living wages are also indirectly paying the wages of workers of companies that do not pay enough to create a proper incentive for work.

It is all very twisted and convoluted, but I hope that you grasp the basic principle - that perverse incentives are acting upon the market.

So how can this odd system be reformed? No one wants to see people begging on the streets, or children 'going without'. However, in order to retain the levels of employment that avoid this, the economy as a whole needs to be productive and efficient, and that means that the state needs to leave more money in the hands of business and individuals. This is the opposite of the welfare state as we know it.

As for my post on education, there needs to be an element of compromise. A situation in which a person is thrown out of work can not lead them into immediate destitution. It could be argued that they should save for a 'rainy day', a libertarian argument. However, history shows us that those at the bottom of the system often struggle to save enough for such an eventuality. However much people might argue for self reliance, it will always have limits. Those who are poorly educated, and with only a small amount of disposable income will never make such choices. Even in countries with no benefits system, people still do not save if they are at the lower end of income.

The compromise proposed here is that each individual should be given a personal allowance for unemployment. From the moment that a person reaches working age, and has worked for one year, they get an allowance for their entire lifetime, an unemployment account. This allowance is there for them to draw down at any time in which they become unemployed and would be calculated at the annual earnings of the average wage according to predetermined age bands. The allowance would be based upon 365 days of unemployment total, and each day of unemployment would give the individual up to 1/365 of the annual average wage. If they chose to take a portion of that wage, then they would only be debited a proportional amount from their unemployment account.

However, once an individual returned to employment, they would then recommence 'recharging' their unemployment account at a rate of 10% of their salary, paid each month into their unemployment account until they reached the full 365 days level. For the astute, it will already be apparent that what in effect is happening is that the government is offering a subsidised and unsecured loan.

In addition to the loan, another element of the unemployment system would be a process in which the person who becomes unemployed would also be immediately have returned their last three months income taxation. This would be paid in three lump sums over the three months following being made unemployed, and would still be counted as having been paid, despite being returned, if they gain employment in the tax year. This is to aid with the additional expenses of job hunting, and to offer a minor breathing space for higher earners with potentially higher outgoings (notwithstanding that higher earners should be in a position to save, some recognition of their higher net contribution seems fair).

One of the obvious problems with such a system is that some people might use such a loan to have a long holiday, or otherwise misuse the system. In order for a person to be given the unemployment allowance, they would need a letter from their employer that stated clearly that the person was made unemployed, with the employer liable for repayment of the money in the event that they lied in saying they made the person unemployed.

What happens if a person deliberately gets fired so that they can take advantage of the system?

Employers will be given an opportunity to identify cases where they believe an individual deliberately sought to be fired. Such cases would be investigated, and if it was believed that the individual deliberately acted in a way to lose their job, then the benefits would be withheld. It would probably not take many cases before the risks in such an approach became apparent, with the effect of making this kind of behaviour unlikely.

So what happens to those who exceed their allowance of one year of benefits?

Quite simply, they will need to fall back on charity, friends and family. In the traditional usage of the word, they will be destitute.

What about a young person who is having trouble finding their first job?

I have already outlined the education system in my previous post. If a person is unable to find a job then they will have the option of continuing education, provided they can be funded for this. If they can not either find an educational opportunity or work, they will be destitute and reliant on charity, friends and family.

Why include those who earn enough to save?

I start from a principle that everyone who is part of the system should be subject to equal treatment. As more wealthy people will be providing a larger proportion of the subsidy that the loan represents, they should at least be able to benefit from the same system.

Isn't this very harsh?

I am not sure that it is. It still provides a safety net, but also encourages individuals not to claim benefits unless absolutely necessary. Whilst an individual is unemployed, they will be well looked after. However, the cost of such care will be minimised.

The advantages in such a system is that it returns to the original principles of welfare systems, that it offers a safety net, and a good safety net. Being unemployed will not lead to impoverishment unless it is over a very long period of time. Even in a situation of deep recession, a person could extend their benefits over a longer period through not drawing down their full allowance. In fact they will have an incentive to only draw down the minimum, as it will have to be repaid.

Furthermore, with the time limitation, and the requirement to recharge the account, there is always a strong incentive to get back to work as soon as possible. Only the truly feckless would lose out in such a system and hard working people would have a safety net that would not only protect them, but would also protect them well. It would also provide a strong incentive for those that can afford to save for 'rainy days' to do so.

Lastly, it would be a much cheaper system, as the money would nearly always (one way or another) be paid back, with the only cost being the interest for financing the system. In an extreme example, it might even be possible to charge interest on the unemployment benefits paid out, though I am not proposing that here. Unemployment is a miserable enough experience without loading the cost with interest (possibly a rare sentimental point of view).

As with all my solutions, I welcome challenging questions, as such questions might highlight weaknesses I have not seen.

Note: Regular readers will have noted that I have still not continued my discussion on government spending and the Comprehensive Spending Review. I do have a partially finished version in draft, but thought is was time to address another positive solution. I will (eventually) get back to the review.

Note 2 Added 19 August:

I have not mentioned sickness benefit in the above post, and this is a major omission for which I apologise. There are widespread reports of doctors being 'sympathetic' to unemployed people and putting them on sickness benefits. As such, these benefits would only be granted when a person has seen a doctor appointed by the benefits system. They would also be required to attend the doctor at regular intervals, dependent on their condition, to confirm that they are still too sick to work.

For some conditions, there would be a maximum period of time for them to be allowed to claim, such as depression or injuries such that a person can not undertake manual work. Whilst there are some conditions that genuinely preclude work (which should be treated sympathetically) there are many types of work that can be undertaken by people who have less serious conditions, such as back trouble, where the person can retrain and find new work.

For those that are in a position where their sickness is short term, the benefits should be identical to the unemployment benefits system. For those who have sickness that is likely to be long term (greater than three years), the level of payment will need to be lower. Whilst this may appear as a 'punishment' for illness, it is actually just a recognition of the likelihood that the money provided will be unlikely to be paid back. As such, the cost to the state will be much higher and, in real terms, the benefit received will be higher (as they will not just be benefiting from an interest free loan, but will be benefiting from real cash sums). In addition, in some cases, there may be a need for grants for equipment which will be a further cost for supporting the long term sick.

As for the amount of payments it is difficult to give a formula here, as it depends on what level of payment would be needed to provide an acceptable life in different economic circumstances, and the family situation of the individual (in this case, having children should matter). As a ballpark, up to 2/3 of the national average wage would probably be reasonable. In order to afford such costs, the eligibility for sickness benefits would have to be rigorous, but that is the point of having independent assessment and clear delineation of what sickness genuinely precludes working. In a system that only awards the benefits from those genuinely precluded from work, the level of benefit can be higher than at present and still cost less overall.

Note 3 Added 19 August:

Inevitably, one of the problems with the system outlined will be the transition. One year on from implementation there would be a rash of horror stories in which families fell into destitution. There is no real solution to this. It is one of the reasons why genuine reform is so difficult. There are many people living on benefits who probably simply would not believe that the state would abandon them to their own devices. For such people, there is no solution except destitution to make them realise that they do need to contribute, and not just take. As a result there will be some heartbreaking stories one year on, and this would lead to campaigns, headlines, and a media circus. As with many reforms, it would require courageous politicians to implement the reforms. That is a matter beyond the scope of this post.

UK Unemployment

I have long been predicting an accelerating increase in the levels of unemployment, going back to November of last year, and more recently said this:

However, also expect the rate of rise in unemployment to increase more quickly in the coming months (original post here)

In my original essay (November) I pointed out that it was likely that the position on unemployment would be ameliorated by Central European workers returning home, but that this would not be enough to stop the rise in unemployment, a point reiterated in my later post.

Today the newspapers are announcing that 'UK Unemployment Jumps Most in 16 Years'. This headline, under normal circumstances would be a cause for worry. However, bearing in mind that the predicted return of the Central Europeans is taking place, the extremity of the situation is even worse than the headline appears. As ever, the statistics on the Central Europeans are lacking but anecdote suggests that they are returning home in large number - a trend likely to be accelerated by the fall in the £GB, as their wages will be worth relatively less.

What this means in real terms is that unemployment is going up, but levels of employment are going down faster. This is indicative of the dire straits into which the UK economy has plunged. However, the consequences are going to be far deeper than imagined. One of the main sources of revenue for the government is the tax receipts from income taxation (I include National Insurance as Income Tax, as that is what it really is), at just under half of all revenue. We can do some back of cigarette calculations as follows:

Let's say that the total tax take (all taxes) on an average worker being laid off, or returning home to central Europe, is a conservative average of £8000 per annum. If we take a conservative guess at 200,000 Central Europeans having returned home in the last six months or so, that gives us a figure of lost revenue for the government of £1,600,000,000 per annum. These job losses will not show up as unemployment, but in a drop in employment. Furthermore, as the economy turns down, the number returning home will certainly be increasing. We should also consider that many of these workers are young, single and healthy, such that their net contribution to the economy was extremely high. As such their relative net contribution was likely raising the average net contribution per worker on average, such that their departure will bring down the average net contribution. As such the impact of their departure will be greater than for example, the magical disappearance of an average UK worker will be.

To this, we need to add the increase in unemployment among UK workers, which do show up in the unemployment figures. As these workers will be claiming benefits their impact will be even greater than the return home of Central Europeans (If you read the above carefully, you will see that I am not contradicting myself). Not only do they stop contributing to government revenue, but they also become an additional cost for the government. In the case of July alone, the figures show an additional 20,000 workers becoming unemployed, and the figures suggest that the rate of rise is increasing fast, with July's figures exceeding forecasts.

In short, the situation for the governments finances are dire. I have not even mentioned the falling tax take from VAT, Corporation Tax and so forth. Basically, every type of revenue is plummeting.

What I have also not mentioned is another impact of the Central Europeans return home. Many of the workers will have saved a significant amount of money, as that was why they were working here in the first place (money to return home with). As such, each of those central European workers will be returning home with a significant lump of cash, and we might guess that the average savings per Central European worker at £3000-5000 per annum. If we were to guess at the average length of stay in the UK as two years, that would give a lump sum of money withdrawn from the UK economy of about £8000. This is the equivaent to the import of a small car. This is a big lump of money to be withdrawn from the UK economy, and will have even greater impact than might initially be thought, due to the multiplier effect. The multiplier effect means that the loss of this cash to the UK economy means that this represents a considerable loss of economic activity in the economy as a whole. This loss of activity will also translate into a further loss of revenue for the government.

The rise in unemployment and the drop in employment are just starting to accelerate significantly. I actually suspect that there will be a substantial number of people who are actually unemployed but not yet claiming benefits yet. I can imagine (and it is no more than that) that there will be large numbers of people who will be living on redundancy money and/or credit for a couple of months in the hope that 'something will turn up'. I can also imagine these people appearing on the unemployment roll in the next month or two. For this reason the rate of unemployment increase will lag the drop in employment by a 2-3 months. As such, the unemployment figures of today may not fully reveal the drop in employment of UK workers. Again, there is a high likelihood that the the situation is even more dire than the headline numbers suggest.

I do not think I am alone in realising the severity of the situation. I note that the Bank of England is increasingly gloomy, and is starting to accept that the economy is in real trouble. However, even with their newly discovered pessimism, they are still not recognising how bad things will get. The UK economy is sinking like a stone.

I keep on mentioning it, but the rise in unemployment is going to start the second credit crisis. If we look at the headline figures of 20,000 increase in unemployment in July, you can see the harbinger of this crisis. Defaults on mortgages have been steadily rising over the last six months, and that rise lags unemployment rises. If we think of those 20,000 people, many will have mortgages and significant personal credit exposure, and will start falling behind in payments in a very short while. With the majority of UK households heavily indebted, each rise in unemployment will see mounting losses for the banks. With no ability to recover their money through repossession of housing (as the value of the house will increasingly be worth less than the debt), each default will represent a huge loss. These losses will now be starting to hit the banks hard and, even as I write, there are probably panicked meetings being held in all of the major retail lending institutions.

As I keep on saying, the situation is getting to get much worse yet.....