Extension material Y13 - Danger Ahead:

The video mentioned in this post can be found on this website; it may not be around for long.

Seven Reasons To Listen To Carl Icahn’s Danger Ahead

Posted date: October 04, 2015

By Worth W. Wray, Chief Economist, Evergreen GaveKal - EVA on Carl Icahn

EVA Summary:

This week’s Guest EVA features a video from the legendary activist investor, Carl Icahn, who is starting to make a lot of noise about frothy valuations, fuzzy accounting, and the corrosive consequences of zero interest rate policy.

In the video, the billionaire corporate raider approaches the United States like a firm turnaround, employing the same thought process he typically applies to troubled businesses with ineffective management.

While Mr. Icahn isn’t saying anything radically new, his warning deserves your attention. Investors who can weather the next downturn will find themselves well-positioned to capitalize on historic long-term opportunities.

This week’s Guest EVA features a rare video message from an indisputable Wall Street Legend. [While my colleagues and I know online video may not be the ideal medium for some EVA readers, let me say that you don’t want to miss this video. It’s getting a ton of attention in the press and for good reason. If you are adamant that you don’t “do” video, my text should give you a decent overview.

Still, there’s no question that Carl Icahn’s decades-long track record ranks him right up there with elite investors like Benjamin Graham, George Soros, and Warren Buffett. Time Magazine even called him the “Master of the Universe” and “the most important investor in America.”

The man clearly understands financial markets, Corporate America, and the tax/regulatory environment coming out of Washington… which is why his latest warning deserves your attention.

In the 15 minute video, Icahn basically treats the United States like a corporate turnaround, employing the same thought process he typically applies to troubled companies with ineffective management. First, he sets his sights on a country that is still not living up to its potential and where he’s already acquired a large, albeit a non-controlling stake ($22 billion across more than 10 industries). Then he lays out several steps for unlocking the economy’s productive potential and makes an aggressive push for the CEO (in this case, President) he believes should lead the charge (Donald Trump). And finally, with this video, Icahn is doing his best to sell shareholders on the overall vision (in this case, American voters).

Rather than getting bogged down by Carl Icahn’s politics – or what he stands to gain from the tax/regulatory changes he is advocating – I’d encourage you to focus on the very real reasons he sees “danger ahead” for US financial markets.

Here are some of the highlights from Carl Icahn…

(1)The United States needs meaningful tax & regulatory reform, which is unlikely without a strong President who can “move Congress” and “wake [this country] up.” At a time when the US electorate has become more polarized than at any other time in decades, it will take a special leader to win an election dominated by extremes and then unify the nation.

(2)The United States is “shooting itself in the foot” by double-taxing foreign profits, discouraging US-based multinationals from repatriating roughly $2.2 trillion, and driving some firms to leave the country altogether. We’re talking about overseas profits after foreign taxes have been paid – roughly equivalent to half of the Federal Reserve’s balance sheet. This massive sum could have a material impact on productivity and employment in the United States in the event that tax-free repatriation is allowed in exchange for investing a portion of those funds in people, plant, and equipment.

(3)Reported earnings in publicly-traded securities are highly suspect despite the broad adoption of GAAP accounting standards. In practice, headline earnings often do not account for stock compensation; they don’t amortize intangible assets, and they largely ignore restructuring and/or takeover costs. Thus, most investors are overestimating earnings, valuations, and debt sustainability at both the individual security and broad market levels.

(4)Financial engineering benefits companies’ income statements at the expense of their balance sheets. Low interest rates have enabled firms to engage in financial engineering through share buybacks and M&A. These practices – which both hit record highs in 2015 – boost earnings and stock prices temporarily, but leave firms with little buffer in the event of special situations, adverse economic conditions, or an abrupt increase in the cost of capital. The irony, of course, is that Icahn has forced these kinds of financial engineering activities – especially stock buybacks – on a number of firms in recent years.

(5)Ultra-low interest rates are fueling asset bubbles & threatening to trigger another financial crisis. With interest rates so low, savers are being forced to take more risk in asset classes like equities and high yield bonds. And the longer rates stay at zero, the greater the misallocation it feeds within Corporate America. Icahn says the Federal Reserve should raise interest rates immediately before the asset bubbles forming across the US financial markets give way to another 2008-style crash. [Our view at Evergreen GaveKal is that these bubbles have already formed and some are currently in the process of bursting.] While we have all heard this argument a thousand times in recent years, it has never been more compelling than it is today.

(6)Low-rated bonds are almost certain to collapse. While he believes an equity market crash is likely, Icahn says the risk of a crisis in high yield is a “no brainer” which he handicaps as a “98%” probability. It’s also worth noting that Mr. Icahn is heavily short junk bonds in anticipation of that event. He may be talking his book, but we agree the risk of wicked spread widening, and even defaults, in junkier ratings is higher than most investors realize. As Icahn outlines in the video, the retail rush away from high yield ETFs and mutual funds – which investors have piled into in recent years – could lead to the same kind of forced liquidation that we saw in 2008. [It’s worth noting that Evergreen believes “high-grade, high-yield” credits remain attractive, though we have been trimming some of those issues due to “collateral damage concerns.”]

(7)Liquidity is an illusion. If interest rates begin to rise or economic conditions begin to deteriorate – especially in the credit markets – investors may find themselves in a situation where the markets cease to function. That means that investors may find themselves in a position where they cannot sell at any price. That’s when the low interest rate party bus goes off a cliff… and when large cash positions will become invaluable.

Carl Icahn

Wild stuff, isn’t it?

Before you dismiss this message as rambling from a perma-bear selling fear, note that Carl Icahn is actually one hell of a risk-taker.A quick look back at the Forbes billionaires list reveals that Icahn’s personal net worth fell from $14 billion in 2008 to $9 billion in 2009 and then surged to $22 billion by 2015. He made a fortune by sticking to his discipline during the financial crisis and then capitalizing on the recovery in asset prices.

Quantitative Easing....

I have a hunch it will be in the exam, directly or indirectly (Unit 4). Bradley has prompted some deeper thinking on QE, so I have been collating key points for you, which we will cover in revision sessions today or next week. This will be in the form of a Q&A session to test your knowledge, but (by pure chance) the following sharp analysis appeared in my inbox, courtesy or emergingmarkets.org; it is so good I will give you a printed copy as well - if nothing else, take the core concept of supply and demand and be ready to use it in the exam - evaluation &/or conclusion:

FINAL WORD: Can cows fly – or have central bankers forgotten their Economics 101?

13/05/2015 |

By Krzysztof Rybinski

People, irrespective of their nationality, education or religion will agree on some issues, but at the same time fight over others. For example we all agree that a cow cannot fly. But people disagree whether executives in large banks should receive multi-million dollar bonuses. Some argue that such bonus schemes align interests of bank clients and other stakeholders with those of senior management, which is essential as banks play systemically important roles in many countries and globally. Others would say that those I will call “banksters” spend their time inventing products that force bank clients to take large risks and suffer large losses.


But this article will not be about cows, nor will it tackle the bonus schemes at financial institutions. It will be about the basic economic principles that we all agree with and that are taught on the Economics 101 course. Banksters have successfully convinced people that these laws have stopped working, that now we have new economic laws.


Let us take a look at the basic law of economics that has been questioned by banksters, and also by central bankers and politicians who support them. When we have many goods and services, and suddenly the volume of one good or service rises significantly relative to others, then the price of this good or service will decline relative to other prices. Central banks in many developed economies have transferred huge amounts of money (dollars, euros, pounds, yen) to accounts that banksters keep at the central bank. Banksters borrow money from the central bank at a zero interest rate, buy government bonds using this credit and resell them to the central bank at a handsome profit. Not only do banksters have access to huge amounts of free credit, they also make guaranteed risk-free profits.


But what happens with these trillions of dollars, euros, pounds and yen that were printed as a result of this process? If the quantity of one good suddenly goes up, the price of this good should go down. So when more money is printed, its value should go down. Decline of the value of money can be seen on the goods and services market or on the financial markets. In the case of goods and services markets, a decline of the value of money means higher inflation. But we do not observe this. On the contrary, inflation is close to zero and in some countries we even have deflation, i.e. falling prices. But it is a result of the banksters’ behaviour. They do not want to share money they got from the central banks with the wider public, so no new credit is extended to businesses or Main Street. Banksters keep these trillions for themselves to speculate on financial markets. So the value of money in relation to other financial assets does go down, as predicted by Economics 101. Prices of equities, government and corporate bonds, real estate and other financial assets go up. Economics 101 works well.


So where is the problem of the flying cow? The value of money goes down relative to the value of other financial assets, as the amount of money relative to other assets gets bigger. But we do not see inflation in the goods and services markets. So banksters say that we can print even more money, and there will be no inflation. Cows can fly, against the basic law of physics.


There are two possibilities. First, central bankers will refresh their Economic 101 course and will stop printing money, gradually raising interest rates to reduce the amount of money flowing round. But we know what will happen to financial markets: the value of financial assets relative to the value of money will go down, and banksters will lose money.


The second possibility is that central banks will continue to print money. But then inflation will rise much faster and on a much bigger scale than can be anticipated today. We all remember what high inflation does to the middle classes, and what is the effect of destruction of the middle class. When it happened in Germany, a few years later Hitler rose to power and Nazi Germany killed 6 million Jews and 14 million of other nationalities. Denying the basics of Economics 101 course can have dramatic consequences.


There is no easy exit from this situation. Either markets will crash first, or we will have high inflation first and markets will crash later. When huge amounts of money are printed, we should be prepared to face the consequences.


It will not happen tomorrow. In the meantime banksters will continue their propaganda and will release new promotional materials showing more flying cows, while economists paid by banksters will develop new theories about flying cows. But smart people will know that basic laws of physics and basic laws of economics cannot be abolished.


Krzysztof Rybinski is rector of New Economic University at Almaty, Kazakhstan, and former deputy governor of the National Bank of Poland

Bank of England report current position):

Released May 13th 2015 anything in italics is my comment


EMPLOYMENT:


There were 31.10 million people in work, 202,000 more than for October to December 2014 and 564,000 more than for a year earlier.

The proportion of people aged from 16 to 64 in work (the employment rate) was 73.5%, the highest since comparable records began in 1971.

Employment increased by 0.7% on the previous quarter.


[Total hours worked per week were 998.6 million for January to March 2015. This was: • 2.4 million (0.2%) more than for October to December 2014 • 20.2 million (2.1%) more than for a year earlier • 84.2 million (9.2%) more than 5 years previously.]

Comparing January to March 2015 with a year earlier, pay for employees in Great Britain increased by 1.9% including bonuses and by 2.2% excluding bonuses.


INFLATION:


The Consumer Prices Index (CPI) was unchanged in the year to March 2015, that is, a 12-month rate of 0.0%, the same rate as in the year to February 2015.


OUTPUT:


Output is now 4.0% above the level at the start of the economic downturn in Q1 2008. [NB output per capita is DOWN...]


Four-quarter hourly productivity growth remained weak


The MPC’s best collective judgement is that productivity growth will pick up gradually over the forecast.


The services sector as has grown by 8.5% over this period.


CURRENCY:


In effective terms, sterling is around 2% higher than in February and 16% higher than its trough in March 2013.


[For those of you interested, if we use the old rule of thumb for this area which the Bank of England has apparently forgotten the rise in the value of the Pound since March 2013 is equivalent to a 3.5% increase in Bank Rate making its equivalent value 4% now as opposed to 0.5%.]


CONCLUSION ON THE PATH OF INTEREST RATES:


under the assumptions that: Bank Rate rises gradually to 1.4% by 2018 Q2, in line with the  path implied by market interest rates;


i.e., ceteris paribus, rates MAY hit 1.4% by June 2018...

AS/A2 UK Economy 2015 update and more:

tutor2u: A recording of last night's UK Economy in 2015 - Exam Revision Webinar is now available to view on the tutor2u Economics Channel here: UK Economy in 2015 - Exam Revision Webinar To support the topics covered during the webinar, you might also want to make use of this new series of Macro study notes: AS Macro Study Notes In the run-up to the AS Macro exam on Tuesday, don't forget to follow Geoff on Twitter and also the main tutor2u Economics account.

Some key context for different macro concepts:

Innovation, R&D and growth (in the future):


Rolls Royce developing hybrid technology for trains




Nice, up to date analysis of Germany's trade surplus:


Germany's trade surplus is a bigger problem than Greece




China & growth (or not); it eased again today, but this looks at recent experience:


China preps QE-lite




The dollar and other exchange rates - excellent article about the "games" being played as countries try to gain an export advantage via weak currencies:


The dollar joins the currency wars




What about trade agreements? This article looks at the benefits, and stumbling blocks, of the TPP for Pacific rim Latam:


Will the TPP help Latin America?




Last on this list is an article on the ECB's role in the Greek crisis; this harks back to the Royal Academy lecture given by Willem Buiter, which promoted the idea that central banks now hold the balance of power. Have a look at this video on the impact of a Greek exit (looming ever closer), then skim-read the article to get a sense of the role of CBs in a modern economy:


Who is the real villain in the Greek drama?

Last minute revision for AS students:

A very handy website from tutor2u that covers all the macroeconomic topics (some are not in the AQA syllabus):


tutor2u macroeconomic revision

China, growth and migrant labour

http://www.ft.com/cms/s/0/211df974-ee47-11e4-98f9-00144feab7de.html?siteedition=uk#axzz3ZGdSboaN

China’s ‘migrant miracle’ nears an end as cheap labour dwindles

Gabriel Wildau in Shanghai

China’s labour force is shrinking and the “migrant miracle” that powered its industrial rise is mostly exhausted, removing the factors that propelled the country’s meteoric development, according to leading economists.

The transformation will lead to slower growth, reduced investment and a loss of export competitiveness, they warn, increasing the urgency of implementing ambitious economic reforms aimed at finding new sources of expansion.

FirstFT is our new essential daily email briefing of the best stories from across the web

Today the Financial Times begins a series of articles on the end of the migrant miracle — the three decades of breakneck economic growth fuelled by the unprecedented migration of labour from the unproductive farm sector to work in factories and on construction sites.

Broad consensus has emerged that China has reached its “Lewis Turning Point” — the point at which the once-inexhaustible pool of surplus rural labour dries up and wages rise rapidly. Nobel-prize winning economist Arthur Lewis argued in the 1950s that a developing country with surplus agricultural labour could develop its industrial sector for years without wage inflation as it absorbed that surplus.

“Now we are at the so-called Lewis inflection point. I made this forecast in 2006, and today there is no need to change it,” said Ha Jiming, chief investment strategist for private wealth management at Goldman Sachs in Hong Kong and formerly chief economist at China International Capital Corp, the country's first Sino-foreign joint venture investment bank.


“The working-age share of China’s population peaks this year at 72 per cent, then it will start to fall rapidly, even more rapidly than what we saw in Japan in the 1990s,” he added.


Cai Fang, vice-president of the Chinese Academy of Social Sciences, a think-tank that advises the government, estimates that China’s potential gross domestic product growth decreased from 9.8 per cent in 1995-2009 to 7.2 per cent in 2011-15 and 6.1 per cent from 2016-20.


A shrinking labour force is one of the main drivers. Since Deng Xiaoping launched market reforms in 1978, 278m migrant workers from rural villages have moved to work in the cities.

FT Series

End of the migrant miracle

At the turning point
A shrinking labour force from rural areas is driving huge economic change
Video: China at the Lewis Turning Point
The end of surplus labour has profound implications for the Chinese economy
Data blog: Three things we learnt on China migration
How the flow of labour from countryside to city in China has powered three decades of growth
China’s great migration

When China’s 170m rural migrant workers head home it is the biggest movement of people on earth

But reallocating labour from farm to factory — resulting in higher overall growth as workers’ productivity soars — is now mostly complete.


“From 2005 to 2010, the growth rate of migrant workers was 4 per cent. Last year it was only 1.3 per cent. Maybe this year it will contract,” said Mr Cai.


China faces the more difficult task of raising productivity within the urban sector through improved capital allocation, technology and management acumen.

The second trend is an ageing population and the effects of the one-child policy, which has started to influence the number of young workers entering the labour force. As in developed countries such as Germany and Japan, the ranks of the elderly are rising. Ma Jiantang, director of China’s National Bureau of Statistics, said the population aged 15 to 60 peaked in 2011.

“The excess rural surplus labour is nearly exhausted — China is reaching its Lewis Turning Point,” the World Bank said last year.


Economists debate the precise date of the turning point based on inconsistent data and contrasting theoretical models. Some say that due to varying regional labour market conditions, it is more precise to speak of a “turning period” rather than a single point. But the basic measure is not in doubt.

More video

“The fact that we have now passed the Lewis Turning Point is 100 per cent,” said Ross Garnaut, an economist at Australian National University and co-editor of a collection of papers on China.

Additional reporting by Ma Nan

Revision video - bit of macro & bit of micro:

15 minutes of key concepts that is intended as an outline at the start of a college course (US), but it does contain terms and explanations that you ought to be using in essays:

The Economics of Politics - A2s please note

I hope you all now realise the importance of having "current context"; without it your essays are like an unseasoned sauce - yes, it is food, but it doesn't add much to the eating experience.

With that thought, you should be reading this blog religiously. These articles, for instance, put the current fiscal position, and the promises of our esteemed candidates, in perspective. It would be a shame if you got a question where you could use this material, but you assumed that if you understood the principles of tax and spend that would be enough:

We can take out without paying in — that’s the Miliband illusion

Camilla Cavendish Published: 26 April 2015

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ELECTIONS are great for nosy writers like me. Everyone is a potential voter. What surprises me is how much intimate information I can elicit just by uttering the word “election”. Total strangers launch into detailed descriptions of their personal finances. How much they earn, what they pay in rent or mortgage, what they are getting in benefits. Many people have seen their benefits fall (not pensioners, whose entitlements have been cherished and embellished by the coalition). Even with inflation down, they remember that they felt better off under Labour. 

People are not immune to the argument that there is no money left. Most understand that we can’t spend beyond our means for ever. And they are quick to accuse other people of taking too much from the state: the lazy neighbour; the divorcée on legal aid; the family who inherited their council house. Yet decent, hard-working people feel strongly about any threat to their own entitlements. No one is particularly grateful that the coalition has allowed them to keep more of their own money before they start paying tax — the policy that Tories and Lib Dems boast about. Nor do they thank the government for a recovery they have either not yet felt or have already banked. 

This is human. Social psychologists such as Robert Cialdini have extensively documented the ways in which we feel losses more deeply than gains. Heartfelt proofs of Cialdini’s thesis flooded my inbox in 2013, when the government decided to remove child benefit from households where one parent was earning more than £50,000 a year. Many high earners were furious. A Church of England vicar wrote to me complaining that his daughter, who had five children, could not possibly manage without it. It didn’t seem to occur to him that she could have chosen to have fewer babies. Or that it was not fair for a household earning at least twice the national average income to expect other taxpayers to chip in. 

We all want someone else to take the pain. The rich dread the mansion tax. The poor dislike the benefit cap. Frontline public sector workers loathe wage freezes. The salariat who have worked long hours to get promoted into good jobs resent the landed gentry and the super-rich who, as The Sunday Times Rich List shows today, are continuing blithely on an upward trajectory while others struggle. 

No democracy finds it easy to tolerate cuts in public spending. Our politicians have been brought up to spend, not cut. Since the financial crisis, indebted western governments in hock to international lenders have struggled with electorates that do not want to face the harsh new reality, especially when average wages have been falling. Low interest rates have inflicted terrible damage on savers, especially the elderly, in Europe and America. But the “easy money” of zero interest rates has inspired less protest against governments than spending cuts. 

As the world becomes ever less secure, and so do our livelihoods, we seek comfort in illusions. One is the mantra that “I’ve paid in, so I’m entitled to take out”. We pay seemingly endless taxes — income tax, council tax, national insurance, VAT — but more of us than we imagine may actually be net recipients of state largesse. 

Three years ago the Centre for Policy Studies think tank tried to work out how many people were receiving more in state aid, health and education than they were paying in taxes. It calculated that 53% of households received more in benefits than they paid in tax in 2010. Even the middle fifth of earners were getting more on average than they put in, according to this thesis. Only the top two-fifths of households were paying their way. 

You can quibble with the exact figures, for various reasons. What is more important is how they have changed over time. Even if you exclude pensioners, who have been increasing in number and so inflating the recent figures for net recipients, the proportion of working-age households that seem to have “taken out” more than they “paid in” has jumped from 29% in 2000 to 40% in 2010.

This is a dramatic change however you cut the numbers (which the Office for National Statistics provides on its website). It was partly a consequence of Labour’s higher spending on public services, funded by borrowing. It was also a result of Gordon Brown’s determination to expand the scope of the welfare state. As chancellor, he increased the number of households in receipt of tax credit from about 700,000 in 1997 to something approaching 4.7m by 2010. By creating a whole new class of benefit recipient, he gave more middle earners a stake in the status quo. This made it even harder to tell voters the truth when the money ran out.

For all the huffing and puffing about austerity, the coalition has only begun to slow public spending. This has inflicted real pain, particularly on social care budgets, because the government has had to spend so much on debt interest. But with an ageing population, if so many working people are net recipients rather than contributors to the state, public spending levels are unsustainable. 

There are only two alternatives to cutting spending: borrow more or raise taxes. There is a limit to both, though. Borrowing sounds nice and distant — unless you’re Greek, or Spanish, even French. And the limits to how much the government can soak the rich were demonstrated by Friday’s announcement that HSBC, fed up with paying the bank levy that George Osborne has just hiked again, is thinking of quitting London. 

Osborne has managed to extract unprecedented wads of money from the wallets of the rich. What Ed Miliband likes to call “Cameron’s tax cut for millionaires” — the reduction of tax rate on those earning over £150,000 a year from 50% to 45% — has resulted in the top 1% of earners paying 28% of all income tax. The richest 0.5% now pay almost three times the total tax paid by the bottom half of all taxpayers. Infuriating though some of the super-rich may be, living in their bubbles of bling, this makes it rather important that they do not leave the country. 

What, then, is the real choice at the election? On Thursday the Institute for Fiscal Studies (IFS) predicted that a Conservative-led government would cut spending by about 18% in unprotected departments, if it sticks to its deficit goal; and that a Labour-led government would increase national debt by about £90bn, despite its claim to be “relentlessly focused on the deficit”. 

The IFS accused Labour of being “considerably more vague” about its plans. That’s saying something, given the Tories’ reluctance to detail their spending cuts. 

Secretly, we voters want it both ways. Despite it being impossible, we’d like fiscal responsibility without pain. That is what Ed Miliband is selling. The fact that so many people would like to believe this illusion is, I guess, a victory for Gordon Brown. 

camilla.cavendish@sunday-times.co.uk

We’ll need much more than an umbrella to shield us from the approaching storm

Philip Aldrick

 

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Published at 12:01AM, April 25 2015

Elections have a remarkably telescopic effect on political thinking. Hardly long term to begin with, the debate all too often ends up compressing the nation’s future into only five years. For economics, given its pretensions to shaping history, the whole experience becomes rather petty.

Take the disputes over where the Tories will find £3 billion to lift the 40p income tax threshold to £50,000, or whether Labour can raise £1.2 billion from a mansion tax. Set against the dismal long-term prospects for the UK’s public finances, it’s all noisily irrelevant — a bit like watching two people squabbling over an umbrella while a tornado tears up the street behind.

Make no mistake, a storm is brewing. The true state of Britain’s public finances is dire — far worse than suggested by the official figures, which are simply bad. According to the Office for National Statistics, borrowing in the past financial year was a mighty £87.3 billion, or 4.8 per cent of GDP. As awful as that sounds, it was better than hoped. Unfortunately, it wasn’t the whole story.

Britain’s public finances are calculated in a rather generous way, in line with European Union rules. The real cost of public sector pensions, as well as future commitments on private finance initiatives and nuclear decommissioning, is ignored. If we lived in UK plc and the nation’s finances were subject to the same scrutiny as a company, the reported level of borrowing would almost double.

In the year to 2014, this “accounting deficit” was £77 billion larger than the official deficit. Using the same rules, there was also £450 billion more debt, largely because of unfunded public sector pension promises. The figures come from the “whole of government accounts”, a formal measure of the country’s long-term financial challenges. Those are real costs that one day will have to be borne. So the deficit today is arguably closer to £160 billion — about a quarter of government revenues. Britain’s debt is also larger than the national income, rather than four fifths its size. And that’s the good news.

Unless more savings are made, the deficit will rise by another £70 billion in today’s money by 2060 purely as a result of the country’s changing demographics. As intergenerational dependency rises, with more old people reliant on fewer workers to pay their pensions and cover the cost of their healthcare, the hard yards made in the past five years will be undone.

The OBR reckons that borrowing will automatically increase by 4.7 per cent of GDP, putting the UK’s public finances back on to an “unsustainable” trajectory. If net immigration falls below 100,000 a year or productivity growth, which has stagnated since the crisis, fails to recover to 2.2 per cent a year, the public finances will look even worse.

Which brings us back to the general election. The longer these problems are ignored, the more expensive they become.

In its 2014 Fiscal Sustainability Report, the OBR presented two ways of dealing with the debt by 2060. The first was a one-off £15 billion additional dose of austerity in 2020, amounting to 0.9 per cent of GDP. The alternative was to do 0.3 per cent a decade, amounting to a cumulative tightening of 1.7 per cent of GDP — almost £30 billion in today’s money. Both are workable solutions, but the OBR’s projections clearly demonstrate that delaying has a price.

Looking over a narrow five-year horizon, none of this shows up. As a result, unsurprisingly, the problems always end up being the next government’s problem.

For once, though, this election is different. The Tories plan to start paying off Britain’s debt by 2018. Assuming that they held power until 2030, the Institute for Fiscal Studies reckons that UK debt would be down from 80 per cent to 52 per cent of GDP. That would be £270 billion less than under Labour, according to the IFS, although Ed Balls disputes its assumptions. The Tory plans don’t go far enough to address the long-term state of the public finances, but they are a big step in the right direction.

For the first time since 1992, there is a chasm between the parties on the economy. Paul Johnson, director of the IFS, has been banging this particular drum for months. Russell Brand and his acolytes say that politicians are all the same, but this time they are — emphatically — not.

Put simply, the Tories want a small state to afford low taxes and prudent public finances. Labour balks at what that would mean for public services. Labour offers compassion today, the Tories a plan on the public finances for tomorrow. Ultimately, however, there can be no escaping the demographic juggernaut. Seen through our grandchildren’s eyes in 2060, the Tories would look compassionate against a Labour party in denial.

One assumption that the OBR makes in its fiscal sustainability analysis is that tax thresholds and benefits will be uprated in line with earnings growth rather than inflation beyond 2020. It’s hard to see how that could hold once the debt started to spiral, which would mean more people being dragged into higher rates of tax at the same time as inequality between those in work and on benefits widened — the worst of both worlds.

There are legitimate questions about whether the Tories can honour their promises. If the recently dissolved parliament is any guide, they will break their rules and deliver a slower deficit reduction than pledged in their manifesto. But, for once, at least they are fronting up to the long-term threat and aspire to give the country economic shelter. An umbrella, after all, really isn’t going to help, given the size of the storm clouds approaching.

Philip Aldrick is Economics Editor of The Times

Encouraging inward investment - or not!

Another piece from the Daily Telegraph; this one outlines how, because it is hard to cut spending, governments can create a climate where they drive away the very businesses that create the income streams from which tax revenue is drawn:

Sponsored

Both Switzerland and California are more competitive than the UK. If they can be damaged, and if businesses start to leave as they start beating up on companies, then the impact here will be far worse.

Switzerland is the fourth richest country in the world, measured by per capita GDP Photo: Alamy

By Matthew Lynn

6:15PM BST 20 Apr 2015

42 Comments

What are the most competitive, successful economies in the world? You could make a case for Singapore, and increasingly for Dubai. But measured over the long-term, they would probably be Switzerland and California. Nowhere else really comes close, whether measured by income per head, or the vibrancy of their companies and entrepreneurs.
 

And yet, both have been flirting with anti-business populism. In Switzerland, a series of referendums have sought to limit executive pay, and to restrict immigration. California, along with New York, has been pushing up taxes to finance more generous state spending. There are signs already that is having an impact – and not in a good way. The numbers of companies moving to Switzerland is starting to fall sharply. Workers are leaving California for lower-tax states.
 

There is a worrying lesson for the UK. Both Switzerland and California are more competitive than we are. If they can be damaged, and if businesses start to leave as they start beating up on companies, then the impact here will be far worse. We may imagine that when it comes to the crunch, companies will stay here – but the evidence suggests that is a very foolish assumption. The reality is, business is more mobile than ever, and it won’t stay where it isn’t wanted.
 

The wealth of both California and Switzerland has been evident for years. Switzerland, with its formidable banking industry, and its depth of engineering, pharmaceuticals and consumer goods giants, is the fourth richest country in the world, measured by per capita GDP. The three above it are either tax havens or oil states. California, with its Silicon Valley tech powerhouses, and its massive entertainment and software industries, is an economic power all by itself. With a GDP of $2.2 trillion, according to Bloomberg calculations, it has just overtaken Brazil to become the world’s seventh-largest economy. It has already overtaken Italy and may edge past France quite soon.
 

So these are not slouches. They are two of the most hyper-competitive economies in the world, home to companies and industries with deep roots, and with skills and infrastructure that very few can match.
 

And yet both have been succumbing to a popular politics that takes aim at business. In the past year or so, a series of referendums in Switzerland have directly targeted big corporations. In 2013, voters backed a proposal that would give shareholders a direct veto over compensation, and banned big payments to incoming and outgoing executives. Another vote proposed limiting the pay of the most senior executive in a company to 12 times the most junior person – that didn’t pass, but it got 35pc support. On a separate issue, last year the country voted in favour of strict quotas on immigration, including from the European Union – the Swiss are, of course, not members of the EU, but had allowed its members free access.

You can argue about the rights and wrong of any of those proposals. Maybe executive pay has got out of control. It is quite legitimate to believe that too much immigration undermines communities. What you can’t dispute is that big business is deeply opposed to both initiatives. Companies don’t want to cap the pay of their top people, and they want to hire the best workers from anywhere.


So what impact has that had on the Swiss economy? This week we found out. A report from the Conference of Cantonal Economic Directors found that the number of foreign firms setting up in Switzerland fell by 8pc last year, to its lowest level in a decade. The number of new jobs fell by 21pc. It is not just that firms are not coming – they are leaving as well. Yahoo! shifted its European HQ to Ireland. So have companies such as the security firm Tyco.

There may be other factors. The soaring Swiss franc has made the country cripplingly expensive. But then it has always been pricey – it is only since it started bashing businesses that businesses have started to stay away.

Something similar is happening to California. For all its digital prowess, it also levies some of the highest state taxes in the US. With personal income taxes of 12pc on top of federal taxes – while many states have none – it is the highest taxed state in the Union. It has been ramping up labour protection, environmental legislation and business taxes. Chief Executive magazine has voted it the worst place to do business in the US. One report calculated that it took two years to get all the permits necessary to open a restaurant in the state, compared with six to eight weeks in Texas.

The result? People are moving out. A recent report from the American Legislative Exchange Council found that the five highest-tax states, led by California, lost 4m workers over the past decade, while the five lowest increased their population by roughly the same amount. Toyota has just moved its North American headquarters from California to Texas. Overall, the number of businesses in California is dropping by 73,000 a year.

There is a clear message for this country. Our political class has been ramping up the anti-business rhetoric as the election campaign unfolds. Labour’s Ed Miliband can hardly get through a speech without denouncing predatory capitalists for one thing or another.

The Liberal Democrats are constantly wheeling out diversity and environmental initiatives. Ukip appears to have decided that big business is as much the enemy of ordinary people as the EU. Even the Tories, while in practice easing some regulation, and doing a good job on cutting corporate taxes, appear nervous of speaking up for enterprise.

That may be a costly mistake. The UK has plenty of competitive advantages. We have an enviable record in creating jobs, lots of start-up companies, a stable political and legal system, a world-beating finance industry and some manufacturers that can take on the world. We have some of the lowest corporate taxes. Inward investment continues to pour in, one reason for the economic recovery.
But if we think we are as fundamentally competitive as either Switzerland or California then we are kidding ourselves. We might tell ourselves that companies will stay in Britain because they have roots here, even if taxes go up a bit, and regulations get a bit tighter. It is too much hassle to move, runs the argument.

The Swiss and the Californians have told themselves the same thing, and found out the hard way that it isn’t true.

 

Five things you could use in essays:

From the Daily Telegraph:

By Matthew Lynn

4:44PM BST 19 Apr 2015

38 Comments

Protecting the NHS. Improving education. Fighting climate change. Devolving power to the regions. Controlling immigration. Lots of very familiar issues feature in the main parties’ election manifestos, to be debated in the run-up to May 7.
 

Even some fairly minor issues will get their few minutes in the spotlight. The Greens have helpfully raised the issue of rabbit hutches, and whether they are cruel or not. The Liberal Democrats are promising to investigate a cycleway to run alongside the proposed HS2 high-speed rail link from London to Birmingham. If you don’t have much else to do, you could easily fill up the coming days uncovering all kinds of minor and fiddly initiatives that one party or another is cooking up.
 

And yet, many equally important issues will not be discussed at all. If you just take the economy, there are five major discussions, each with significant choices to be made, that are just as crucial as anything any party is talking about. Such as? Tax simplification. The euro crisis. Robotics. Our trade deficit. And an ageing workforce.

 One of the striking aspects of the political debate is how wealth creation seems to have been largely forgotten. There are plenty of promises of more spending, and much debate about whether we should move a bit faster or a bit slower on reducing the deficit. But how might we create a richer economy? Or what challenges might threaten our prosperity? No one seems bothered. But there are plenty of trends that we should be thinking harder about. Here are five:
 

First, tax simplicity. Whether you think the state should be spending 35pc or 45pc of GDP, which is about the range of options on offer, our tax system has become horrendously complex. It started under Gordon Brown, but has continued under the Coalition. Tolley’s Tax Guide now comes in at a whopping 16,000 pages, more than even the smartest accountant can comprehend.

Complexity is a far bigger problem than tax avoidance, which all the parties bang on about endlessly, even though the UK is hardly a country with much of a culture of dodging taxes. All the evidence suggests simpler tax systems generate more cash for the Treasury, and make it easier for businesses to grow. High but simple taxes are still better than high, complex ones – simplification is more about stripping out red tape than cutting the overall amount paid.

Second, the euro. Britain’s biggest economic problem by far is that our largest neighbour and biggest trading partner has locked itself into a dysfunctional currency system that is trapped in a depression. The biggest risk over the next five years is a chaotic collapse triggered by an accidental Greek exit from the currency. Who knows how much damage that could do to the UK economy? It could knock 3pc or 4pc off our GDP. There is not much point in the UK just crossing its fingers and hoping for the best. Greece clearly won’t make it within the single currency.

We should be coming up with a plan for it to get out, with generous loans from the US, the IMF, and indeed ourselves, to get the country through a difficult period. It is going to happen one day, so it might as well happen in an orderly, planned way. If we put that forward, we would be taking out the number one economic risk we face.

Third, robotics. If you haven’t already got one of the whizzy new robot vacuum cleaners, you soon will. It will – sort-of – tidy up your house. Robotic chefs that will whip up a meal for you are on the way, while the driverless car that will take the kids to their ballet classes and collect you from the pub after a few drinks is just around the corner.

Robotics will soon be the biggest technology since the internet, and arguably a lot bigger. But both create two challenges. How do we make the UK a world leader in what will be a huge industry? (One answer – being one of the first countries to license driverless cars would be a help). And how do we cope with the inevitable disruption to traditional careers that robotics will create, and re-skill people so that the transformation does not simply create lots of unemployment? Neither will be easy – but the earlier you start discussing it, the better.

Fourth, our trade deficit. The UK’s trade deficit hit £2.86bn last month. As a percentage of GDP, it is now above 5pc, and it is higher than at any point since the Lawson boom of 1989. Now, you can argue that in a world of floating exchange rates, and with free movement of capital, trade deficits don’t matter any more. And maybe you’d be right. The trouble is, do you really want to bet your economy on that theory? Every country that has run deficits on that scale has been plunged into a crisis sooner or later – Spain was the latest example, with deficits of close on 10pc of GDP before the euro crisis overwhelmed it.

The truth is, we’d be wise to start planning ways to get that down, targeting a cheaper currency if necessary. While we are at it, we might want to have a discussion about whether we want near-zero interest rates forever, with all the potential distortions of the market they create. Or would we prefer an economy that rewarded saving – which, as it happens, might have a smaller deficit as well?

Finally, an ageing workforce. As life expectancy increases, and pension systems come under greater pressure, we will need to do more to encourage those in their sixties and seventies to work longer. Some evidence from the US shows they can be more productive than younger people, because they have had more time to develop the soft skills such as communication and teamwork that are valued by companies. But businesses will need to be encouraged to get them back into the workplace, and pension systems may well need to be reformed to ensure it is worth their while. How productive the those aged 65-75 are, and what percentage of them are in employment, may well be the key determinant of how prosperous our economy is in the 2020s.

Right now, only 10pc of the over-65s are working nationally, although it is 12pc in London – and it is probably no coincidence the capital is one of the richest parts of the country. If we could get that up to 20pc, or even 50pc, it would make a huge difference to GDP.

Each of these issues is probably more important than most of the stuff being discussed during the campaign. They are certainly more important than rabbit hutches or cycleways. They might even wake up an electorate often disengaged from politics. But the main parties are remaining silent on all of them.