In the spirit of the times, with the G20 trying to reshape global policy, and all sorts of changes happening in Britain (we now own several banks, and are running unheard of deficits), I thought this was a chance to strike a more radical pose. What's gone wrong with our economy and what ought we aim to do in the future?
Some ideas from me:
The diagnosis:
The Credit Crunch:
Banks and other financial institutions started trading in derivatives and suchlike that they didn't really understand (or more accurately, thought they understood but didn't). These were not properly assessed, and their regulatory badging from the ratings agency heavily relied on (this becomes an even bigger problem when they are cut up and repackaged - eg the AAA component of a new CDO is actually BBB, it's all wrong). Likewise they started engaging in credit default swaps (a kind of insurance). This is all supposed to reduce risk by spreading it around. But because all the buyers and sellers are the same people it introduces a systemic risk - losses can reverbirate and magnify through the system. Indeed a moral hazard is introduced - you don't have to worry about your bad decisions if you can sell the risk on. But at the same time you're buying up other people's risk (which is based on decisions you didn't make). This might make things better if a 'buyer-beware' attitude prevailed (you'd only take risks you were confident you could sell to sceptical client) but with the ratings agencies badging everything, and everyone believing the system is safe rather than at risk itself, the opposite happens.
So, when people start defaulting on their mortgages, the losses start charting their way through the CDO market. Firstly the losses are far bigger than any of the models predicted (bad maths - see Taleb and Mandelbrot), and no-one's sure where the losses are going to pop up because the mortgages have been cut and re-sold so many times. Through it credit default swaps exposing people to other firms mistakes, and paranoia grips the market. The buyers are suddenly very beware because they don't know where the risks are.
The Real Economy:
Bank credit dries up for businesses causing them to cut back. A lot of the 'real' economy is also built on heavy borrowing (made available from banks making so much money) and taking money out of a property market than was a bubble (fuelled by mortgages that were artificially cheap because lenders could sell the mortgage on). So, when the credit dries up and the market crashes people have to adjust their spending accordingly and bring it more into line with actual productivity.
The Public Finances:
We were already fiscally stimulated since 2001. We've been racking up debt and shovelling it into NHS like it's going out of fashion. Add to that, a lot of capital investment has been financed through PFI, which is dependent on the credit markets, and so are now being underwritten by the government. The PFI are also being used to hide debt, so there's even more debt being accumulated.
Now, with the economy taking a sharp downward adjustment as people get sacked, those in employment see their wages fall, and companies lose profits - tax revenues go down, and spending go up. Traditionally, automatic stabilisers are thought of as unemployment benefit. But, in the UK under Labour a far far bigger component is tax credits for people in work. It's akin to the reverse of the poverty trap - your income declines, so your tax paid declined, but the state (despite the loss of tax revenue) starts paying out more tax credits to you. And so, the public finances start to spiral out of control.
This crisis is especially hard on Britain, because we've become so dependent on the City, and so a recession based on the City will be especially problematic.
The Road Ahead:
Financial Regulation:
- return to buyer-beware
- restoration of the Bank of England, with a look at the system
- look at Glass-Steagall
- move pensions towards defined-contributions and away from defined-benefits. This should be accompanied by splitting pension funds away from the parent companies. This should help corporate governance as companies will not be owning one another, and instead there will be more a division between owner firms (the pension funds) and producer firms (the standard companies)
Work & Pensions:
- any chance of restoring the earnings link to pensions has gone. It's simply unaffordable now.
- we need to urgently scale down the scope of tax credits. They represent a dangerous risk to the health of the public finances.
- US/Australian style welfare reforms are probably needed, but this is politically unfeasible until the economy starts to recover.
Energy & Climate Change:
- there is an urgent need to rebuild our energy infrastructure anyway. The priority ought to be nuclear and renewables, in particular the proposed Severn barrage. Energy is the only way we will make any serious dent in UK emissions, especially if cars switch to electricity or hydrogen cells, and domestic cookers move from gas to electric, and we see a big rise in our electricity demand.
Environment:
- there is an opportunity for ecological restoration. In particular reflooding coastal wetlands is cheaper than conventional coastal defences. Uneconomic farmland could be reforested. Agricultural subsidities ought to switch away from production and towards environment, ecology and culture (we'll never persuade the French or Poles to scrap them).
Defence:
- the military is underresourced and overstretched. It is the most pressing case for budgetary increases.
Education:
- if effective school competition is unaffordable (it involves funding for far more places than we currently have), then focus school budgets on early years provision to prepare kids as well as possible.
- urgently refocus HE spending. Cut student numbers overall. Boost subsidies for priority subjects such as engineering, physics, chemistry and mathematics. Introduce grants and subsidies for postgraduate courses and PhDs.
Health:
- accept that we are now in a period of 'normal' spending increases.
- try to move NHS priorities towards improving quality of life, rather than simply extending lifespan. The demographic challenge means that we are going to need to work for much longer, and we need to be healthy in order to do that.
Housing:
- attempts to rejuvenate the North have failed. If we are to house ever more people in the South then we'll need to have higher density housing. Currently, this has meant cheaply built little detatched houses with tiny gardens. This 'rabbit hutch' planning has to stop.
- instead, high rise ought to be the order of the day - make the apartments deliberately large, minimise communal gardens and instead have public parks (based on the Royal Parks - ie big, with plenty of variety in the landscaping), and have plenty of space for car parking (perhaps nearby multi-story garage).
- where houses are built bring back semi-detatched, build an accessible and usable basement, and have the loft ready-converted.
Regions:
- introduce regional corporation tax rates
- consider regional minimum wages (although this may make it difficult to avoid poverty traps)
Taxes:
- Income tax will need to rise to 45%
- Roll employees National Insurance at least into income tax
- Make reducing corporation tax the first priority of any tax reduction
- The second priority is to increase savings rates. It ought to appall us that the West is begging Chinese peasants for their savings to bail us out.
Transport:
- Eventually replace Heathrow with Boris Island
- High speed intercity rail, and east-west rail lines restored (once money allows)
Europe:
- attempts at a European FSA ought to be resisted - Spanish banks escaped the worst of this crisis because they were regulated differently. Europe-wide regulation could have made everyone like Spain, or it could have made everyone like the UK.
- joining the Euro ought to be ruled out. It's hurting Spain and Ireland very very badly.
- closer co-operation on foreign policy has been shown to be a sham. Britain was far more effective acting as it's own player at G20, rather than having to agree a line with the rest of the EU before the summit.
Some ideas from me:
The diagnosis:
The Credit Crunch:
Banks and other financial institutions started trading in derivatives and suchlike that they didn't really understand (or more accurately, thought they understood but didn't). These were not properly assessed, and their regulatory badging from the ratings agency heavily relied on (this becomes an even bigger problem when they are cut up and repackaged - eg the AAA component of a new CDO is actually BBB, it's all wrong). Likewise they started engaging in credit default swaps (a kind of insurance). This is all supposed to reduce risk by spreading it around. But because all the buyers and sellers are the same people it introduces a systemic risk - losses can reverbirate and magnify through the system. Indeed a moral hazard is introduced - you don't have to worry about your bad decisions if you can sell the risk on. But at the same time you're buying up other people's risk (which is based on decisions you didn't make). This might make things better if a 'buyer-beware' attitude prevailed (you'd only take risks you were confident you could sell to sceptical client) but with the ratings agencies badging everything, and everyone believing the system is safe rather than at risk itself, the opposite happens.
So, when people start defaulting on their mortgages, the losses start charting their way through the CDO market. Firstly the losses are far bigger than any of the models predicted (bad maths - see Taleb and Mandelbrot), and no-one's sure where the losses are going to pop up because the mortgages have been cut and re-sold so many times. Through it credit default swaps exposing people to other firms mistakes, and paranoia grips the market. The buyers are suddenly very beware because they don't know where the risks are.
The Real Economy:
Bank credit dries up for businesses causing them to cut back. A lot of the 'real' economy is also built on heavy borrowing (made available from banks making so much money) and taking money out of a property market than was a bubble (fuelled by mortgages that were artificially cheap because lenders could sell the mortgage on). So, when the credit dries up and the market crashes people have to adjust their spending accordingly and bring it more into line with actual productivity.
The Public Finances:
We were already fiscally stimulated since 2001. We've been racking up debt and shovelling it into NHS like it's going out of fashion. Add to that, a lot of capital investment has been financed through PFI, which is dependent on the credit markets, and so are now being underwritten by the government. The PFI are also being used to hide debt, so there's even more debt being accumulated.
Now, with the economy taking a sharp downward adjustment as people get sacked, those in employment see their wages fall, and companies lose profits - tax revenues go down, and spending go up. Traditionally, automatic stabilisers are thought of as unemployment benefit. But, in the UK under Labour a far far bigger component is tax credits for people in work. It's akin to the reverse of the poverty trap - your income declines, so your tax paid declined, but the state (despite the loss of tax revenue) starts paying out more tax credits to you. And so, the public finances start to spiral out of control.
This crisis is especially hard on Britain, because we've become so dependent on the City, and so a recession based on the City will be especially problematic.
The Road Ahead:
Financial Regulation:
- return to buyer-beware
- restoration of the Bank of England, with a look at the system
- look at Glass-Steagall
- move pensions towards defined-contributions and away from defined-benefits. This should be accompanied by splitting pension funds away from the parent companies. This should help corporate governance as companies will not be owning one another, and instead there will be more a division between owner firms (the pension funds) and producer firms (the standard companies)
Work & Pensions:
- any chance of restoring the earnings link to pensions has gone. It's simply unaffordable now.
- we need to urgently scale down the scope of tax credits. They represent a dangerous risk to the health of the public finances.
- US/Australian style welfare reforms are probably needed, but this is politically unfeasible until the economy starts to recover.
Energy & Climate Change:
- there is an urgent need to rebuild our energy infrastructure anyway. The priority ought to be nuclear and renewables, in particular the proposed Severn barrage. Energy is the only way we will make any serious dent in UK emissions, especially if cars switch to electricity or hydrogen cells, and domestic cookers move from gas to electric, and we see a big rise in our electricity demand.
Environment:
- there is an opportunity for ecological restoration. In particular reflooding coastal wetlands is cheaper than conventional coastal defences. Uneconomic farmland could be reforested. Agricultural subsidities ought to switch away from production and towards environment, ecology and culture (we'll never persuade the French or Poles to scrap them).
Defence:
- the military is underresourced and overstretched. It is the most pressing case for budgetary increases.
Education:
- if effective school competition is unaffordable (it involves funding for far more places than we currently have), then focus school budgets on early years provision to prepare kids as well as possible.
- urgently refocus HE spending. Cut student numbers overall. Boost subsidies for priority subjects such as engineering, physics, chemistry and mathematics. Introduce grants and subsidies for postgraduate courses and PhDs.
Health:
- accept that we are now in a period of 'normal' spending increases.
- try to move NHS priorities towards improving quality of life, rather than simply extending lifespan. The demographic challenge means that we are going to need to work for much longer, and we need to be healthy in order to do that.
Housing:
- attempts to rejuvenate the North have failed. If we are to house ever more people in the South then we'll need to have higher density housing. Currently, this has meant cheaply built little detatched houses with tiny gardens. This 'rabbit hutch' planning has to stop.
- instead, high rise ought to be the order of the day - make the apartments deliberately large, minimise communal gardens and instead have public parks (based on the Royal Parks - ie big, with plenty of variety in the landscaping), and have plenty of space for car parking (perhaps nearby multi-story garage).
- where houses are built bring back semi-detatched, build an accessible and usable basement, and have the loft ready-converted.
Regions:
- introduce regional corporation tax rates
- consider regional minimum wages (although this may make it difficult to avoid poverty traps)
Taxes:
- Income tax will need to rise to 45%
- Roll employees National Insurance at least into income tax
- Make reducing corporation tax the first priority of any tax reduction
- The second priority is to increase savings rates. It ought to appall us that the West is begging Chinese peasants for their savings to bail us out.
Transport:
- Eventually replace Heathrow with Boris Island
- High speed intercity rail, and east-west rail lines restored (once money allows)
Europe:
- attempts at a European FSA ought to be resisted - Spanish banks escaped the worst of this crisis because they were regulated differently. Europe-wide regulation could have made everyone like Spain, or it could have made everyone like the UK.
- joining the Euro ought to be ruled out. It's hurting Spain and Ireland very very badly.
- closer co-operation on foreign policy has been shown to be a sham. Britain was far more effective acting as it's own player at G20, rather than having to agree a line with the rest of the EU before the summit.
No comments:
Post a Comment