New Economist

UK tax hike shock horror

The Institute for Fiscal Studies published its annual “green budget”, providing an evaluation of public finances and an outlook for the official UK Budget, due some time in March. The report and eight accompanying presentations (available online) are well worth a look for anyone interested in the UK economy or public finances. The IFS press statement was reasonably upbeat:

If Gordon Brown vacates the Treasury this year, he will leave the public finances stronger than he found them a decade ago, but he will have presided over a smaller improvement than seen in most other industrial countries, according to the Institute for Fiscal Studies' 2007 Green Budget.

Taking account of inflation and growth in the economy, Mr Brown is spending £22 billion more this year than Kenneth Clarke did in 1996-97 (mostly on investment), but raising £31 billion more in tax. This leaves him borrowing £9 billion less. Public sector net debt is £80 billion lower than in 1996-97 and the government's annual debt interest bill is £21 billion lower.

Of course, the British press glossed over the lower borrowing and public debt - it's all a greedy tax grab! Today's front page story at the Daily Express tells it all: Now we all face higher tax bill

Families will be hit with a tax hike of £13 billion over the next five years as schools, hospitals and other public services face further chaos. Gordon Brown needs to raise the already soaring tax burden by an extra £422 per household.

That is on top of the rises in interest rates, fuel bills and also inflation that have left hard-pressed families now struggling to make ends meet.

...The eye-watering tax rises – outlined in a detailed analysis of the economy – will horrify struggling middle-income families, who have overwhelmingly borne the brunt of funding the Chancellor’s tax-and-spend spree over the past 10 years.

The Times also focuses on the extra tax burden: Brown may have to seek £10bn extra tax, says IFS

Gordon Brown may have to raise taxes by £10 billion and slash another £10 billion from public spending to meet his fiscal rules over the next five years, an independent think-tank says today.

The report ...casts doubt on the strength of the legacy that the Chancellor will leave if he moves to No 10 as expected this summer. It argues that the improvements in the public finances over the past decade are less impressive than than those of most of Britain’s economic rivals. It also estimates that tax revenues have risen over that period by the equivalent of £1,300 a family.

...the IFS says that Mr Brown has pencilled in a £20 billion cut in the growth of public borrowing, financed equally by taxpayers and departmental austerity. His Pre-Budget Report contains plans for public spending as a share of national income to fall by 0.8 per cent, equivalent to £10 billion in today’s terms, as well as an increase in the tax burden of the same amount. That would be the “tightest squeeze on spending” for a decade, the IFS says.

Yes, but just because tax revenues are rising, doesn't mean people are worse off. Ceteris paribus, nominal tax revenue should be expected to increase, as prices rise and the economy grows. Otherwise tax revenue will be an ever diminishing share of GDP.

What matters is whether households are better off, in real after-tax terms. With falling unemployment, Labour's boost to tax credits, and a sizeable increase in real wages over the past decade, most households in the UK are considerably better off than in 1997, as ONS data attests. The Times story makes this point in its last para:

A Treasury spokesman said: “These figures are incorrect, and it is ridiculous to suggest that families are worse off under this Government. As a result of personal tax and benefit measures introduced since 1997, households are on average £950 a year better off in real terms, and tax credits mean that three million families pay no net tax at all.”

Quite. But 'massive tax hike' makes a sexier story.

Booming India

For those wondering when the Indian economy might start to rival China's hectic pace, there have been some encouraging signs lately. Yesterday saw India’s sovereign credit rating upgraded. The FT's Jo Johnson reports from New Delhi:

India finally regained full investment-grade status on Tuesday after a hiatus of more than 15 years, as Standard & Poor’s followed the lead of Moody’s and Fitch in removing the speculative tag from its sovereign credit rating.

The upgrade is symbolic for reformers in the government. S&P had downgraded India’s sovereign rating to junk status in May 1991, during the balance of payments crisis that triggered the start of the reform era.

...Fitch raised India’s rating to investment grade in August 2006, while Moody did so for its foreign currency borrowings in January 2004. Gurchuran Das, an economic commentator, said: “This is long overdue. S&P have been overly cautious.”

The upgrade will open the country’s capital market to a wider investor base, but is unlikely to trigger a re-rating of asset values as both fixed-income and equity investors had priced in the fiscal progress that prompted the move.

India’s financial establishment hailed the change. P. Chidambaram, finance minister, said he was “happy” at the rating agency’s “acknowledgement of India’s improving macroeconomic stability and strength”.

But it's not all good news, as Johnson's piece points out:

India has been a conundrum for rating agencies, which have had to weigh up its weak public finances against its rapid growth, surging foreign exchange reserves, low external debt and easy access to a captive domestic debt market.

India’s public finances are much weaker than those of comparably rated sovereigns. It has a ratio of public debt to GDP – at 85 per cent – that is more than three times higher than China’s. Its interest bill consumes 30 per cent of revenues.

Today India's central bank raised its growth forecast to 9 per cent, raised the official repo rate for a fifth time in a year to curb inflation, and warned of further “signs of overheating”. Cherian Thomas from Bloomberg reports:

Do we need better global economic institutions?

Of course we do.  Ngaire Woods from University College, Oxford, tells us how in her new report for UK centre-left think tank the Institute for Public Policy Research: Power Shift Do we need better global economic institutions? She argues that "the WTO, the IMF, and the World Bank each need to be reformed". Woods sees "three innovating forces" that "are pushing towards a reshaping of international institutions":

The first change is the rewriting of rules by new powers claiming a place on the international scene. Individually, countries such as China, Russia, India, Brazil, Argentina and Venezuela have begun to change the rules governing exchange rates, energy, trade, and sovereign debt rescheduling. The ‘G20’ coalition of developing countries has taken a strong stance on trade. Equally powerfully, emerging markets have voted with their feet – walking away from borrowing from the IMF and World Bank. And they have benefited from it, for instance, when China ignored IMF prescriptions, Malaysia refused IMF assistance, and India postponed capital account liberalisation – in each case actions that helped these countries weather the Asian financial crisis. (emphasis added)

China vs. India - part 2

The Economist's latest Economics Focus compares China and India. The piece, Reading the tea leaves, concludes that "India's boom may be less impressive than it seems":

India has been swept by optimism that its economy can do as well as China's. A recent article in the Economic Times claimed that the growth in India's total factor productivity (TFP), the efficiency with which inputs of both labour and capital are used, had accelerated, whereas China's had slowed owing to wasteful investment. As a result, the article boasted, rising productivity—the main driver of long-run economic growth—is now running neck and neck in the two economies. Close inspection of the numbers, however, reveals that China remains well ahead.

Both India and China have large populations, low incomes and rapidly rising GDP, yet the composition of their growth has been quite different. A recent paper* by Barry Bosworth and Susan Collins, of the Brookings Institution in Washington, DC, explores the sources of expansion in both countries, breaking down total GDP growth into increases in inputs of labour and capital, and gains in TFP. In the period 1993-2004, China's GDP grew by an average of 9.7% a year, India's by 6.5%. Employment increased faster in India than in China, but this was more than offset by a much slower rise in output per worker: only 4.6% a year, compared with 8.5% in China. This reflected both stronger capital investment in China and much faster growth in TFP, which increased at an annual rate of 4% against India's 2.3% (see left-hand chart). Contrary to the popular claim that China's TFP growth has slowed, the authors find that it has accelerated from a pace of 3.6% in 1978-93.

These figures challenge the conventional wisdom that China's growth is more dependent than India's on investment than on efficiency gains. Over the past decade TFP has in fact accounted for a bigger slice of GDP growth in China than in India. Thanks to economic reforms, India's TFP growth has improved from its paltry 0.2% a year in the 1960s and 1970s before the economy was opened up, but it is still much slower than in China. Worryingly, the figures also show that India's TFP grew more slowly in 1999-2004 than in 1993-99. Since 2004, TFP growth has probably spurted (the figures are not yet available), but this may reflect a cyclical boom.

The relative performance of the two countries varies by sector (see right-hand chart). In agriculture, China has enjoyed much faster productivity growth. Indeed, India's TFP growth in farming has fallen since 1993, dragging down overall TFP growth because agriculture still employs a large share of the population. In 1978 it accounted for 71% of workers in both India and China. Now the respective figures are 57% and 47%. India therefore has huge scope to sustain rapid growth by shifting workers from agriculture to more productive jobs in industry and services.

According to conventional wisdom, Chinese workers have shifted largely from farming to factories, whereas India's growth has been driven largely by services, from call centres to writing software. In fact, jobs in services have expanded more strongly in China than in India. Since 1993 the rate of increase of China's service-sector jobs has been four times that in industrial jobs and has exceeded that in India. China's real output of services has not only grown almost as fast as its industrial output, but also faster than India's services.

Indeed, a larger proportion of workers is employed in services in China than in India. However, the share of services in GDP is much smaller in China (33%, against India's 50%), because Chinese industry is so much more productive. India's industrial workforce, including small firms in the informal sector, has been growing much faster than China's—by 3.6% a year since 1993, against only 1.2% in China—but its industrial output has lagged behind China's because its productivity has grown more slowly. This is due in part to rigid labour laws, which prevent the most efficient use of workers, and to a lack of modern infrastructure. Since 1993, China's industrial TFP has grown by an annual average of 6.2% compared with a measly 1.1% in India—barely any faster than before the economic reforms of the early 1990s.

* “Accounting for Growth: Comparing China and India”

Who will replace Gordon Brown?

Who will replace Gordon Brown as Chancellor? I expect the job will go to Alistair Darling, the Secretary of State for Trade and Industry, friend and fellow Scot. But it's not a done deal. Larry Elliott, economics editor at The Guardian, argues that Ed Balls is the most qualified to be the new chancellor but he will not get the job: Two await the call to move into No 11

Brown's impending departure raises two intriguing questions for his mandarins: who will succeed him and will there be any shifts in policy under a new chancellor. Officials are keeping their own counsel over the name of the next chancellor, but the choice boils down to three names: Ed Balls, Alistair Darling and Jack Straw.

Balls is by far the best qualified candidate for the job, but he won't get it. As chief economic adviser, he was the second most important person in the Treasury for most of the Brown era, and when it came to some of the big decisions - independence for the Bank and scepticism about joining the euro - it was Balls leading Brown. Balls is now back at the Treasury, ostensibly in the most junior ministerial job as economic secretary, but every official knows that the lowly title belies his real influence. As Brown has lost interest in the day-to-day running of the Treasury, Balls has - according to some insiders - in effect become the real chancellor.

In a perfect world, it would not matter that Balls has been an MP for less than two years nor that he has been Brown's closest confidant for the best part of 15 years. In the real world, though, there would be a political price to be paid from appointing Balls; it would suggest that Brown wanted to surround himself with diehard Brownites and had taken a bunker mentality with him to Downing Street. Brown thinks Balls needs to cut his teeth in another department before becoming chancellor.

Darling is a supporter of Brown, although he is quite happy to voice independent views and far from the patsy that some believe. He is also competent, which in the current cabinet is a highly prized virtue, and the favourite for the job. The problem, though, is that Darling sits for a seat just across the Firth of Forth from Brown's and in light of the furore about Labour requiring votes from Scottish MPs to impose laws on England that do not affect their own constituents, it might not be thought the smartest of ideas to have politicians from north of the border in the two top jobs in the government, especially if Brown leaves John Reid, yet another Scot, to sort out the mess at the Home Office.

Straw's only experience of an economic brief was more than 30 years ago but that is not considered a major impediment and he is a good each-way bet to become chancellor. His positives are the negatives for Balls and Darling: he is not part of the magic circle around Brown (although he has been careful to keep on good terms with the chancellor) and he sits for an English seat. The row over the wearing of the veil has done Straw no harm; indeed, his popularity rocketed when he voiced his views. David Cameron would struggle to make the same political capital out of Straw as he would out of Balls or Darling and he could be trusted to do a competent job while keeping the seat warm for Balls to return after the next election (assuming Labour wins, of course).

But will a new Chancellor lead to a significant change in policy direction? With Brown as Prime Minister, that seems quite unlikely.

Das (Wasted) Kapital

A new IMF paper by David Dollar and Shang-Jin Wei argues, on the basis of a large sample of firms, that China allocates its capital inefficiently. this claim has been made before, of course - but never with such hard evidence to back it up. Here is the abstract for Das (Wasted) Kapital: Firm Ownership and Investment Efficiency in China

Based on a survey that we designed and that covers a stratified random sample of 12,400 firms in 120 cities in China with firm-level accounting information for 2002-2004, this paper examines the presence of systematic distortions in capital allocation that result in uneven marginal returns to capital across firm ownership, regions, and sectors. It provides a systematic comparison of investment efficiency among wholly and partially state-owned, wholly and partially foreignowned, and domestic privately owned firms, conditioning on their sector, location, and size characteristics.

It finds that even after a quarter-of-century of reforms, state-owned firms still have significantly lower returns to capital, on average, than domestic private or foreign-owned firms. Similarly, certain regions and sectors have consistently lower returns to capital than other regions and sectors. By our calculation, if China succeeds in allocating its capital more efficiently, it could reduce its investment intensity by 5 percent of GDP without sacrificing its economic growth (and hence deliver a greater improvement to its citizens' living standard).

Does economics need a new theory of offshoring?

A good question. It is posed in this week's Economist Economics Focus piece, The great unbundling. Let's enter the world of 'high resolution globalisation':

Globalisation is a big word but an old idea, most economists will say, with a jaded air. The phenomenon has kept the profession's number-crunchers busy, counting the spoils and how they are divided. But it has left the blackboard theorists with relatively little to do. They are confident their traditional models of trade can handle it, even in its latest manifestations. For example, Greg Mankiw, of Harvard University, has concluded that “services offshoring fits comfortably within the intellectual framework of comparative advantage built on the insights of Adam Smith and David Ricardo.”

Ricardo illustrated his insights with the example of Portuguese wine trading for English cloth. But some trade theorists think this metaphor will no longer do. Indeed, two of them—Gene Grossman and Esteban Rossi-Hansberg, of Princeton University—published a paper* last year subtitled “It's not wine for cloth anymore” (see “On the hiking trail”, August 31st 2006).                                         

Ricardo, it seems, did only half the job. He described the first of two “great unbundlings”—as Richard Baldwin, of the Graduate Institute of International Studies in Geneva, has put it in a recent guide†. Trade in wine, cloth and other goods allows production to be distanced from consumption. Countries do not need to grow grapes to enjoy the fruit of the vine; thanks to trade, they can transform cloth into wine instead.

But in Ricardo's world, a country must still take care of all of the separate tasks required to finish the goods it makes. In a country of pinmakers, to take Adam Smith's seminal example, someone must still cut, draw and straighten the wire; fashion and affix the head; then whiten and sheath the finished product, if any pins are to be made at all.

In the second great unbundling, production is spliced and diced into separate fragments that can be spread around the globe. Pin-whitening is done in one country; wire-cutting in another. Some theorists call this the “vertical disintegration of production across borders”. Thankfully, Messrs Grossman and Rossi-Hansberg have a more felicitous phrase: “trade in tasks”.

...As globalisation has advanced, it has become easier to move some of these tasks offshore. For the workers who once carried them out, this has three possible consequences, two bad, one good. Start with the good news. Offshoring makes firms more productive. The tasks that are best kept close to home remain onshore; other tasks can be taken care of in cheaper places abroad. Everyone benefits from this gain in productivity, including the workers who have fewer tasks to perform. For example, Japanese electronics companies continue to flourish in American markets precisely because they have moved their assembly lines to China. 

Meet the Governor

Today's Guardian has a profile on Bank of England Governor, Mervyn King, by Ashley Seager: At school he was a very studious boy and very bright- it was clear that he would go a long way. Apparently he's no softie:

You mess with Mervyn King at your peril. He told an MP on a cross-party committee who suggested he had changed his views on the economy to ensure he got the governor's job: "The cynicism of politicians is not something you should visit on everyone else. I look forward one day to an apology."

He told legendary investor George Soros at the launch of the latter's latest book that it would add "nothing to the world's stock of intellectual knowledge". He does not suffer fools gladly. This has meant he has not always had a smooth path at the Bank. He has clashed with staff whose views differ to his. "He can be pretty ferocious," said a former staff member.

Britain and India: Left for dust

As Chancellor Gordon Brown finishes his first trip to India, The Economist publishes a piece pointing out how that while Britain hopes to profit from its old ties with India, "thus far it has been disappointed".

And yet while India is keeping its part of the deal, growing at 8% a year, Britain has thus far been slow to profit. A report by the House of Commons select committee on trade and industry recently declared that British business had been left behind. Exports have grown slowly compared with those from other big economies (see chart): a baffling mixture of scrap metal and pearls has constituted almost two-thirds of Britain's sales to India recently, the select committee found.

British firms have also been unadventurous investors. Just 0.5% of their foreign direct investment has gone to India in the past few years, although India's share picked up in 2005.

Half of one per cent FDI? How pathetic.

But Britain's failure to invest in (or export to) India is hardly unknown. The most interesting part of the article, Chasing an elephant, discusses those "successful, dynamic immigrants from India who provide a good link to the country they left behind":

Indians began arriving in Britain in large numbers shortly after their country gained its independence in 1947. More than 60,000 came before 1955, about a fifth of whom were whites born in India. This first generation drove buses and worked in foundries and textile factories. Their children moved into white-collar jobs. Later arrivals opened corner shops or ran post offices. The flow peaked between 1965 and 1974, boosted by Idi Amin's decision to expel some 90,000 Gujarati Indians from Uganda, after an angel had told him to do so in a dream. Of the 1m people in England and Wales who described themselves as Asian British (Indian) in the 2001 census, most were born in Britain.

Two new Euro blogs

I have just added to my blogroll two rather impressive European econoblogs:

* Euro Intelligence, by FT writer Wolfgang Munchau and economist Susanne Mundschenk. Styled on Nouriel Roubini's RGE website, it "is free – for an initial period. We will launch a subscription service later this year." So enjoy it while you can. The daily press summary is paricularly helpful.

* Eurozone Watch, by economist Sebastian Dullien and political economist Daniela Schwarzer. It promises "monitoring economics and economic governance of the euro area"

Both promise much - I will be checking them regularly.