Sunday 24 November 2019

Pritchard again - Fiscal Expansion:

Think about the key points - investment vs current spending, inflation, supply-side gains:

Finally the dawn arrives at our long-benighted Treasury. The Chancellor is right to tear up the fiscal rule book and start to plug an infrastructure deficit that has done great damage to the British economy.

Sajid Javid is lifting the public investment target from a long-term average 1.8pc of GDP - and a nadir of 1.4pc in the austerity years - to the OECD level of around 3pc. The most successful countries are even higher.

This should have been done in the recession aftermath when the UK economy had a frightening output gap and ample spare capacity. The bang for the investment buck would have been greater. The multiplier would have been more potent.

Arbitrary fiscal rules and contractionary debt targets - shibboleths with scant grounding in economic science - shaped British economic management for a decade. This persisted even after such assumptions were repudiated by the arch-priests of orthodoxy at the International Monetary Fund.

But better late than never. The Government says we need to spend £600bn on infrastructure over the next ten years to plug the gap and prevent the country being left behind in the global rush towards artificial intelligence and digital technology.

The Chancellor is right to hail “new rules for a new economic era”. The Treasury can borrow until mid-century at real rates of minus 1pc. He is also correct that “there is a growing consensus around the world that the time is right to do it.”

Investment reflation is the new ethos in Davos, at the Bretton Woods institutions, among the banks. As a former managing-director for Deutsche Bank in Singapore, Mr Javid knows this better than his parochial critics.

The risk of a serious inflation backlash - and therefore a sustained surge in borrowing costs - is almost nil within the foreseeable future. Were rates to spike, the shock would cause a global stock market crash and a wave of corporate debt defaults. The process would therefore short-circuit very quickly.

As Lord Mervyn King said at the IMF last month, the world is stuck in a "secular stagnation" trap. There is a chronic surplus of savings over investment. Global demographics are getting worse, not better.

Yes, the frugal Margaret Thatcher once said it is “always cheaper to pay cash” than to borrow but she was living in a world of anti-inflation bond vigilantes. The current pathologies are more like the 1930s but with no end in sight. Frugality becomes your enemy.

In short there is no global market constraint on British borrowing so long as the money is spent competently and with an eye on the long-term economic return - that is to say on projects with an average multiplier above 1.0, a low bar. Fears of a Gilts strike akin to the Greek or Italian debt crises are misguided. Eurozone states do not have their own sovereign lender-of-last resort.

As a precaution, Mr Javid has established a “debt interest rule”. The alarm goes off if interest rates jump and the debt-service ratio rises above 6pc of revenue. It is currently 2pc and trending down.

The Chancellor’s Rule One is a “current budget” limit stipulating that day to day spending must be in balance over three years. Investment is excluded. We are back to Gordon Brown and the Golden Rule. Good.

The IMF says that right now the total cyclically-adjusted UK deficit is 1.3pc of GDP, compared to 2.3pc in Spain, 2.9pc in Japan, 3.4pc in France, and 6.3pc in the US. We are hardly on the cusp of Weimar.

The Treasury’s National Infrastructure and Construction Pipeline says we need to spend £125.4bn over this year and next, half-funded by the private sector. Projects such as the Thames Tideway Tunnel and Hinkley Point C are already underway. Shifting up to the Chancellor’s new targets is not technically easy given the planning times.

“This is going to have to be really well-thought out,” said Carys Roberts from the Institute for Public Policy Research (IPPR). One suspects that it has been rushed for electoral impact. However, there are maintenance bottlenecks across the country with a high and quick rate of economic return. This is the low-hanging fruit.

The IPPR recommends a development bank along the lines of Germany’s KfW that borrows up to 2.5pc of GDP each year with a state guarantee, yet its bond are not deemed public debt - the model for Labour’s national investment bank.

The Chancellor might do well snatch that idea, attribute it to the prudent Germans, and push the UK’s effective investment-to-GDP rate towards 4pc, the benchmark for the world’s best. But today’s pledge is an excellent start. The era of obscurantism is over.

Keeping an eye on key economies:

Germany is not out of the woods - nor is China

Ambrose Evans Pritchard in the Telegraph Nov 14th

Germany has escaped recession but remains mired in industrial slump, leaving the country acutely vulnerable to China’s intractable woes and any further slowdown in global trade.

While Germany’s manufacturing sector has begun to stabilise after two years of contraction, this may not be enough to stop the gloom spreading to services and consumers over coming months.

The economy eked out 0.1pc growth in the third quarter but this was offset by revisions showing a deeper fall in the preceding quarter. In aggregate the German economy contracted over the six months to September.

Chris Beauchamp from IG said the market is paying more attention to the profit shock from Daimler as a gauge of global economic health in any case.

The blue-chip mother of Mercedes - the symbol of stability and Deutschland Inc - announced a €1.3bn retrenchment and a worldwide cull of 1,100 managers, warning that it will take two years to sort out the transition to electric vehicles and shake off the damage of the diesel scandal.

Daimler’s share price has dropped 40pc since early 2015. In a watershed moment, the company was overtaken this week by Tesla, its upstart US rival. Tesla’s $63bn market cap is now slightly larger.

There are tentative signs of recovery in Germany. The "second derivative” watched closely by traders and hedge funds has turned higher. The German Sentix and ZEW confidence indicators have rebounded. The Ifo Institute sees a “light at the end of the tunnel” for manufacturing.

Yet the slightest upset at this delicate stage would smother the green shoots. Much depends on China and Donald Trump’s trade reflexes. More than any other major country, Germany lives off exports. It is highly geared to the ups and downs of the global trade cycle.

The omens are mixed. The Ifo Institute said its global economic climate index for the fourth quarter is still deteriorating, falling from minus 10.1 to minus 18.8 points. The overnight news from China was unrelentingly weak.

Ting Lu from Nomura said retail sales, fixed asset investment, export value, and land sales all deteriorated in October. Growth of industrial output fell to 4.7pc, while production of steel and cement contracted.

He said this will force the People’s Bank to inject liquidity through its lending facility and cut borrowing costs, although incipient inflation makes monetary stimulus more treacherous. Stagflation is creeping in.

The Sino-US trade conflict has compounded the damage from China’s internal woes as it grapples with debt saturation and swathes of excess capacity. This cycle is different from past episodes, mild downturns followed by quick V-shaped rebounds. It has the hallmarks of post-bubble "Japanisation’"

Liu Aihua from China’s statistics bureau issued a candid warning that the country is not yet out of the woods. “Downward pressure on the economy has increased continuously. The risks and challenges we are facing cannot be underestimated,” she said.

China’s troubles pose a structural threat to the German economic model. The German Council of Economic Experts says a permanent 10pc decline in exports to China cuts German GDP by 4.8pc within a four-year period. This level of dependency is staggering.

China is shifting to a strategy of import substitution and partial autarky for reasons of strategic security. It is no longer an insatiable market for German capital goods. It is a rival. The council said China has moved up the technology ladder and is now competing toe-to-toe in the same niches.

Andrew Kenningham from Capital Economics said it is too early to conclude that Germany is back on track after just a flicker of growth. “We think the economy will probably contract slightly next year – so a recession may have been postponed rather than avoided altogether,” he said.

Monday 18 November 2019

Short article on pros and cons of FDI

American investors have feasted on British technology businesses in record numbers, helped by the weak pound and a lack of funding for later-stage companies.

Tech companies received $4.4bn (£3.4bn) from US venture capital funds in the first 10 months of the year, against $4bn for the whole of last year, according to figures released this week. It is the highest investment level on record, says the research provider, PitchBook.

The data is being published as part of Silicon Valley Comes to the UK (SVC2UK), an annual series of events that seeks to build relationships between Britain’s entrepreneurs and America’s biggest technology investors.

The numbers were welcomed as a sign that the UK is producing high-quality tech companies, but will stoke concerns about losing control of our best businesses before they have developed in full.

This year, there have been bumper US -led funding rounds for the challenger bank Monzo, which raised $144m, and OneTrust, a developer of data privacy software that got a $200m investment.

British start-ups have no problem attracting funds in the early stages, but often struggle to find the cash required to scale up their operations. Drawn by the weak pound and a growing number of promising tech businesses, US venture capitalists are filling the funding gap.

“We should be excited that they’re over here, but a little bit nervous as well,” said Sherry Coutu, the serial investor who was an early backer of Lovefilm and LinkedIn and co-founded SVC2UK. “If the cash comes from the US, often that will increase the likelihood of [the company] being redomiciled and floated in a different country.”

She added: “It is a problem for the economy. If a large amount of the cash goes in at a later stage because we don’t follow on in our investing, and you get a tremendous return, then that money doesn’t go into UK pockets and it’s less likely it will get reinvested here.”

Britain is by far the most attractive destination for US venture capital investment in Europe, according to PitchBook. In the past five years, the UK has received $17.8bn from American funds, compared with $10.5bn for Germany in second place and $5bn for France in third.

London has attracted $3.5bn of investment this year, by far the highest amount for a city in Europe. Three of the top 10 cities for American investors — London, Cambridge and Oxford — are in Britain.

“For the UK to punch above its weight in tech globally, we have to attract capital from across the world,” said James Wise at Balderton Capital, a London-based investor that backed Revolut.

“While obviously it would be even better if more UK companies grew to be large and profitable . . . in their own right, foreign investment and acquisitions ultimately still create jobs, provide training and develop software that can have radical benefits to everyone in the UK, irrespective of where those funds originate.”

Saturday 2 November 2019

Regional Economies - important reading

Devolution must be at the heart of levelling up Britain

By Eamonn Ives @EamonnIves

The town hall in Manchester, one of the UK cities which now has a Metro Mayor Photo: Ingolf Pompe / LOOK-foto

The United Kingdom is, in truth, a bit of a misnomer. As CapX has outlined in its excellent Rebalancing Britain series the country remains deeply divided in terms of economic prosperity.

Boris Johnson has committed addressing such disparities – declaring his ambition to ‘level up’ all parts of the nation in his first speech as Prime Minister.

It is in this context that the Centre for Policy Studies this week published a report into economic imbalance in the UK and what to do about it.

We begin with a snapshot of just how unevenly the economy performs across the regions of the UK. Gross Value Added (GVA) statistics are a robust indicator of economic performance, and reliable data has been collected them on a regional per capita basis over the past two decades.

As the graph below makes clear, London stands head and shoulders above other regions on this metric. Moreover, our analysis found that the capital’s GVA per capita grew the fastest over this time frame – while other regions’ increased by 80% on average, London’s did so by 111%.

And while of course we should celebrate the capital’s success, our report is focused on working out how other regions can enjoy that same level of prosperity.

One of the most powerful tools to help struggling areas is devolving political power. While successive governments have taken steps to hand power back to the regions, we believe that process should be extended, both geographically to take in new areas, and in terms of the powers those places have.

As a starting point, all combined authorities – like in the West Midlands or Greater Manchester – should be able to enjoy the powers and responsibilities currently available to the Mayor of London. Devolution in the capital since the creation of the Greater London Authority in 2000 has given City Hall more control in areas such as transport and planning, with huge economic benefits as a result.

It has also created a strong feedback mechanism, in which politicians are more obviously incentivised to facilitate economic success. Lack of skin in the game leads to all sorts of shortcomings in politics, but if a local mayor knows their future career depends on sorting out a congested transport system, they have a lot more reason to get things right.

Beyond that, we believe that the government needs to show more ambition in devolving other competencies which it has largely retained in Whitehall. Fiscal devolution, for instance, is particularly limited – as the chart below shows, the UK is now one of the most centralised countries for tax take in the developed world, with just 5% of tax raised at a local level.

In our report, we are deliberately non-prescriptive about how a more devolved tax system should operate. Indeed, this is precisely the point of devolution – the idea that local authorities are best placed to decide how to run their area. That said, likely candidates for devolution would include property taxes like stamp duty and business rates, as well as granting more powers to local authorities over how council tax is administered.

Understandably, some may worry that greater flexibility in the tax system could trigger a ‘race to the bottom’, leaving local authorities thinly stretched and under-resourced. But these fears are probably misplaced. Indeed, an extensive OECD paper on tax competition which we cite in our report found little evidence – especially in wealthier nations – that this typically occurs when countries permit such fiscal devolution.

Moreover, even if devolution of various taxes did lead to headline rates going down, that would not necessarily be a bad thing. In everyday life, we have premium and budget versions of supermarkets, clothing retailers, and transport options, with people given the choice of spending a little or a lot depending on what they want. Why should the council they choose to live under be any different?

Allowing people this choice would give local governments to get a better idea what ratepayers want from them, and how much they are willing to pay for the privilege.

Important as devolution is, we recognise that it cannot level up Britain alone. To that end, we suggest a suite of other measures, ranging from the creation of a National Infrastructure Fund to the establishment of a new wave of Opportunity Zones – where companies in deprived areas can benefit from more sympathetic fiscal rules and business regulations.

Taken together, we believe our proposals can match the positive rhetoric of the new government in terms of wanting to level up Britain, and help to unleash the dormant prosperity in those areas which need help the most.