Do Trade Deals Create Jobs?

It is not a rhetorical question; I genuinely want to know if there is any sound economic theory in which an increase in trade between developed countries leads to an increase in employment. Basic macroeconomics says no, the benefits of trade do not extend to an increase in the level of employment.

The claim is frequently made in discussion of the EU- Canada trade deal, known as CETA, which is due to be signed today, or the EU - US deal, known as TTIP. The latter is supposed to be capable of boosting EU employment by up to 2 million jobs. The European single market too was promoted on a promise to create jobs. The 1980s Cecchini  report predicted an additional 2 to 5 million extra jobs. But is it true?

Firstly, lets agree that there are real and substantial benefits from trade. A larger market has more scope for efficiency (as Adam Smith argued) and trade allows countries to specialise in what they do best ( as David Ricardo argued). Trade also benefits consumers through increasing variety and reducing prices. So it is reasonable to expect trade to increase national income or GDP.

A starting point in macroeconomics is to recognise the difference between the demand side and the supply side. Short term fluctuations in employment are generally a question of demand. The supply side determines the level of potential income and potential employment. This is sometimes referred to as the economy at full employment.

That is a clue to where the argument is going. The supply side gives us the level of national income at full employment.

Monetary and fiscal policies work on the demand side to boost employment or restain overheating in the short term. Supply side policies affect the structure of the economy - promoting innovation, expanding promising sectors, removing market distortions etc. Supply side policies take time to work but aim to boost productivity over the long term. (A few polices operate on both sides. Increasing investment, for example, boosts demand while the money is spent and increases productivity as the new assets are put to use.)

Policies to expand trade operate on the supply side. For example, trade favours the most efficient producers, encourages the spread of innovation and improves the allocation of productive resources. So effective trade policies increase the potential income at full employment. It has no effect on the definition of full employment.

A simple thought experiment might make this point clear. Suppose we have an economy at full employment which agrees a trade enhancing deal. Does employment increase? That is a rhetorical question; employment doesn't go higher than full!

Paul Krugman explained it well nearly 20 years ago in an article in the Harvard Business Review. Suppose, he said,that the US economy were to experience an export surge. What would the Fed do? It would offset the expansionary effects of the exports by raising interest rates; thus any increase in export-related jobs would be more or less matched by a loss of jobs in interest rate sensitive sectors of the economy, such as construction.

Conversely, he argued, a loss of jobs from competition with imports would trigger a cut in interest rates to increase jobs elsewhere.

Politicians like to claim that their favoured trade policy is necessary for jobs, whether that be TTIP, CETA or even the European single market. Unless someone comes up with a convincing alternative macro theory I intend to remain unconvinced. There may be benefits from trade but jobs is not one of them.

Supply, Demand and the Housing "Market"

For many reasons the conventional story of supply and demand does not fit the housing market. It is a market only in the sense that there are some people selling and some people buying. otherwise talking about a market in housing is likely to mislead.

Nonetheless we can use the old theory to gain insights. I tried to suggest on Twitter a way of looking at the interaction of supply and demand which better fits the facts than the textbook model. I made a mess of it so here is an explanation in more than 140 characters.

My target here is the belief that house prices are rising because demand outstrips supply.

Firstly, the textbook story looks like figure 1.

Figure 1

Here we see that supply is lower than demand. Theory says that in these conditions the price should rise to the equilibrium. So far so good. the problem is that this model explains high prices not rising prices. at best it explains why prices have risen but not why they continue to rise.

To deal with continually rising prices we need to assume that the demand curve is moving rightward faster than the supply curve. This is where the second problem comes in: house-building is stronger when prices are rising.  During the last boom, new housing units were added faster than new household formation. Increasing supply, in this model, means shifting the supply curve to the right, which should lower prices; the opposite happened.

A more realistic model would recognise that the supply curve is nearly vertical, at least in the short run. However for an increase in supply to coincide with higher prices we need an upward sloping demand curve. That gives a model like figure 2.

Figure 2

Notice that supply is still lower than demand at the assumed current price. In the conventional model when this occurs some buyers are willing to pay more to secure their purchase. Thus prices rise until they reach the market clearing equilibrium. In this model too prices rise, but they are rising away from the equilibrium. They just keep going.

To understand why, we need to find a reason why rising prices attract buyers into the market. perhaps people feel the need to buy now before prices rise further. Perhaps they believe that rising prices are making house owners richer and they want to join in. A combination of anxiety at missing the chance to own and the desire to own an appreciating asset are enough. Fear and greed are powerful incentives.

The gap between supply and demand can explain high prices, but the shape of the demand curve explains the dynamic of increasing prices.

Mr Osborne, K21C and the 40%

Are we heading back to 1890s levels of inequality? According to Professeur Piketty we are but with one interesting difference. The top 10%, by wealth, now command around 60% of all wealth in European countries. So who has the rest? Not the bottom 50% who have at most 5-10%. That leaves the 40% in the middle who Prof. Piketty says have a third to a quarter of the wealth.

Where the 19th century elite had all the wealth and inheritance game to themselves there is now a level of capital ownership beyond the top 10% and into the next 40%.  The remaining 50% have as little as ever. He sees this as  a new "patrimonial middle class" who will leave substantial bequests to their descendants. 

His analysis of the French data  is not easy to summarise, but here goes. He estimates the proportion of people born in each decade who will inherit more than the average lifetime earnings of the bottom 50%. For those born in the 50s some 5% can expect a significant inheritance. This is already higher than the cohort born in the 1920s where barely 2% would inherit above his benchmark. However 12% of the cohort born in the 70s can look forward to inheriting at this level, which is higher than the proportion in the 19th century.

I find this intriguing because of its political significance. I wonder to what extent this shift results from a deliberate political project to create a larger segment of society with an interest in conserving the status quo. I have in mind Mrs Thatcher's drive to extend home ownership in the 1980. The privatisation of state assets was also intended to create a permanent base of broader share ownership. Remember her vision of a property owning democracy with wealth cascading through the generations. 

Was this a deliberate strategy to extend the middle class, creating a large voting bloc whose interests were aligned with the rich? More recently Mr Osborne has added to this dynamic with his changes to the pension rules.

There is a hypothesis in economics which says that people save in order to smooth consumption across their lives. So young people borrow to pay for education and buy a house. In their middle years they pay down their debts and build up savings. In later life their savings fund their retirement. If this view is correct then savings would be used up in retirement with nothing left to pass on. Indeed the mechanism to do this is the purchase of an annuity; savings become an income for life.

I don't imagine that increasing the patrimonial middle class was Mr Osborne's primary motivation for abolishing automatic annuity purchases. On the other hand, I can see how it continues the shaping of a conservative leaning electorate. 

I remember too that in opposition Mr Osborne achieved a major success when he made inheritance tax a political issue. He is credited with scaring the Labour government into abandoning plans for a general election in 2007. He uncovered then the salience of inheritance as a political motivator.

I offer this as somewhat speculative thoughts inspired by reading K21CYou could argue that the same shift is happening in countries that were spared Thatcherism. Nevertheless I think there is something here.

K21C and the Boiled Frog

The tax man's taken all my dough,

And left me in my stately home,

I came of age in the 70s and so my formative experience of politics was during the various Wilson administrations and their interruption by Mr Heath. In those days we took for granted that inherited wealth was a thing of the past. Great estates were sold off to pay death duty, stately homes were donated to the National Trust or turned into safari parks and the Kinks sang Sunny Afternoon.

And I can't sail my yacht,

He's taken everything I've got,

We had progressive taxation, governments that saw redistribution as part of their role, and a belief that inequality would continue to diminish. Conspicuous wealth was something we read about in historical novels.

To people of my generation M. Piketty's Capital in the Twenty-First Centuryis a revelation. I feel something like the infamous frog sitting in a pot on a lit stove. I've been aware of the rising temperature for most of my adult life, I've felt the growing discomfort but, at some deep level, I believed that the Thatcher to Blair period was the aberration. I've kept the hope alive that soon the temperature would cool and we would get back to a meritocratic, egalitarian and democratic direction.

M. Piketty has shown that the reverse is true. The postwar period, the 50s to the 70s, was the exception. Inequality of income fell during the first half of the 20th century due to wars and the great depression. The income of the top 1% in the UK was around 17% of national income on the eve of WWII. Wartime restrictions and the post war policies saw that level fall to 8% in the 60s and 6% in the 70s. Since then the share of the top 1% has risen to 14%.

Inequality of wealth also shows a pattern of falling from WWI until the 1970s and beginning to rise from then.The top 10% went from over 90% to 60%and now back to 70%. The rise looks less dramatic than for income. Income inequality is being driven by the exessive pay going to senior managers, what M. Piketty calls the rise of the supermanagers. But there is more; the concentration of wealth also requires inheritance.

Robert Peston pointed out in his book, Who Runs Britain?that today's business oligarchs will leave their fortunes to future generations who may not have the talents of their patriarchs but will have the power that wealth brings to protect their interests. M. Piketty provides some numbers on the flow of inheritance which again shows a u-shape with decline from 1910 until the 1970s followed by a small rise.

His explanation for the tendency of capitalism to lead to ever greater concentration of wealth is summarised in his inequality: r>g. If the rate of return on capital is greater than the growth rate of the economy, then the rich have the ability to add to their wealth faster than national income expands. The very rich are most favoured because they can achieve higher returns on their fortunes and because they spend only a small proportion of their income from capital.

As a mater of fact (but not logical necessity) r has always been higher than g. It is only when taxation of capital income is taken into account that g outstrips r. Again this is a 20th century phenomenon; tax competition and lower population growth make it unlikely to continue into the future.

So that, in a British context, is the political hope for M. Piketty's contribution: to alert us frogs to what is happening. It is time to hop out of the pot and put equality back in the centre of the political discourse.

The Pleasure of Piketty

Very occasionally there is a book which is a joy to read. Even more rare are the occasions when the book is from the non-fiction shelf. I might be unusual in treating economics books as recreation, but Thomas Piketty's Capital in the Twenty-First Centuryis a delight.

The book has two qualities which appeal to me and make it one of the most enjoyable reading experiences I've had outside of science fiction. Firstly, this is study built on evidence. It is not a theoretical text but puts its empiricism up front. Thomas Piketty has assembled datasets, with the help of collaborators and followers, which allow him to look at wealth, income and their distribution over long periods of time and across various, mostly developed, countries. The data is imperfect and he openly discussed the limitations this puts on the ability to draw conclusions, which lends a pleasing honesty to the narrative.

The second great pleasure in this book are the number of fresh ideas the evidence allows him to present. each chapter exposes new insights into the various questions, how much wealth countries accumulate, how income is distributed and how wealth is concentrated. After reading this book the way we understand and think about inequality is completely transformed. The fresh insights just keep coming page after page, chapter after chapter.


Here are a few examples of his key insights.

• In the 19th century European countries had accumulated wealth (or capital) equal to around seven years of national income. That fell during the period of the world wars and the great depression to 2 to 3 times annual income in the 1950s. But it is on the rise again with capital around 4 to 6 times income now.
• As the level of relative wealth fell so too did the income from capital which accrued to the richest individuals. For this reason as well as egalitarian post-war policies, income inequality fell but began rising again from the 1980s.
• Wealth inequality also fell from a high point before WWI (when the top 10% owned 90% of the capital in Europe and 80% in the US). It too has been rising since the 1980s.
• Inequality of wealth has not reached its previous level in part because the second 40% now claims a greater share of wealth, giving rise to what he calls a patrimonial middle class. (I will return, as M. Piketty would say, to this point.)

The book exposes some of the dynamics behind the accumulation of capital and rising inequality. The rate of return on capital is usually (but not necessarily) higher than the rate of growth (r>g). As a consequence, those fortunate enough to own wealth are able to add to the stock of capital and so increase the concentration of wealth.

He argues that the shocks of the world wars and the great depression caused the capital/income ratio to fall from a "normal" level to which it is now returning. That normal level is given by the stability condition β=s/g, where β is the ratio of capital to income, s the saving rate and g the growth rate. So a saving rate of 10% and a growth rate of 1.5% gives a capital around 7 times income.

One conclusion from all this is that the post war period when inequality seemed to be consigned to history was an exceptional period. It is also the time when my generation were forming their perceptions of the world and its political reality. It seems our ideas are falsified by taking a wider historical perspective. (Another point to which I will return).

There is a great deal more in the evidence and analysis in the book than I am able to set out now. There will be much more to say on this book and inspired by its evidence and conclusion. For myself, I am still trying to reconcile the algebra, which I feel he offers more as heuristic than as a model.

This conversation is only just beginning.

I'm Back

I'm back. My long sabbatical is ended and I have returned to my spiritual home at Equals.

I was tempted to break the retreat by some of the big events of the last few months. The passing of Nelson Mandela seemed to be an opportunity to comment on the strange arc of his life as the man who led the ANC to take up arms and then drew on its non-violent tradition with his leadership of reconciliation when freedom arrived. The death of Tony Benn too was a moment when I was tempted. I felt too little of the appreciations written of his life understood that Parliament was his driving passion. He saw in parliamentary democracy the only means of creating a more egalitarian society. But I resisted.

I seem to be returning at the point where equality has returned to the political agenda. Last year there was a bit of  buzz around a French economics book. I waited for the translation and now find that everyone is talking about it. His tour promoting the book in the US (it is translated into American English) has set fire to American political discourse. So given that equality is the theme of this blog I suppose that is where I should start.

The Best Laid Schemes

The plan to give the president of the European commission an electoral mandate has fallen at the first hurdle when the group of European socialists and democrats failed to attract interest from major political figures.

Political circles in Brussels have been buzzing with the idea that the next commission president, to be appointed next year, should be elected through the European parliament elections in June. The plan was that each major political group would identify its candidate for the post in advance and the candidate of the leading party would be elected commission president at the parliament's first session. The plan would make the commission president more like a prime minister than a bureaucrat.

To this end the socialist bloc had set a timetable for primary elections to run from November to February, with the candidate formally chosen at a congress on 1 March. Unfortunately when nominations closed there  was only one name, Mr Martin Schulz, a Brussels insider with no ministerial experience. Currently president of the European parliament, Schulz's only executive experience is as mayor of Würselen in 1987-98.

Since the 1990s the president of the commission has been chosen from among former prime ministers. (The current president was PM in Portugal and the president of the European council was PM of Belgium.) No socialist former (or current) prime minister was willing to stand as the socialist candidate. Nor indeed was any senior minister from any of Europe's recent socialist governments.

The reasons for the lack of strong candidates will be the topic of much analysis and debate. Is the job of commission president no longer attractive enough, now that the council also has its high profile president? Is there a lack of confidence in the process, given that the council still has to nominate the candidate before the parliament can elect him or her? Or are there other reasons?

Having made a commitment to put the candidate at the head of their campaign for the European parliament, socialist parties are now saddled with their uninspiring choice.

Banks: Collecting the Rent

Since the start of the crisis I have been trying to understand how it is that banks (and the finance sector more generally) extract rent from the economy. I once quoted Simon Wren-Lewis asking the right question:

Did innovation and deregulation in that sector add to social welfare, or make it easier for that sector to extract surplus from the rest of the economy?

To explain how far I've got in my thinking, I will need to make some gross simplifications about how banks work. Bear with me, it help to gain an insight into the subject.

The first step is to see that banks profit margin comes from the difference between the interest they pay (to depositors or bond holders etc) and the interest the charge to borrowers. Out of this margin they pay their running costs and the rest is net profit.

The next step is that banks make money from all the loans they have issued, which are recorded as assets on the banks balance sheet. So as a first approximation its rate of profit can be seen as its total net profit divided by its total assets:

profit/assets 

 

Banker however do not pay much attention to this ratio. They are more interested in maximising the return on equity, that is the highest profit for the shareholders' capital.

profit/equity

 

An interesting analysis piece in the FT explained why bankers have an incentive to watch ROE:

...return on equity... is a benchmark that investors use to compare stocks and it is also used in the calculation of bankers’ bonuses.

Now comes the clever bit. We can analyse ROE with this equation:

 profit/equity = (profit/assets) x (assets/equity)
 

The first term in the equation is return on equity (ROE). The second term can be considered to be the rate of profit on its loans or "profit margin". The final term is a measure of how much the bank funds itself through debt rather than equity. So the equation says:

ROE = profit rate x leverage
 



Here is an example. Before the crisis, a high street bank might have had profits of 4 billion on assets of 800 billion and equity of 20 billion. So its ROE was 20%, its profit margin was 0.5% and its level of equity at 2.5% of assets gives a leverage of 40:

20% = 0.5% x 40
 

Notice first how tiny the rate of profit is. For a non-financial company its total profit is the rate of profit times the amount of sales. So to make a decent level of profit banks need to sell lots of loans. That is what happened. Banks turned from being prudent institutions safeguarding our money and making loans to good customers to become selling machines pumping out loans to the next mark customer.

Next look at the level by which ROE is boosted by leverage. A small profit is boosted to a large profit (40 times larger) by using debt. If the bank increased its equity from 2.5% of assets to 4% of assets, it leverage would be 25. In the example above its ROE would fall to  about 12.5%. (Actually not quite as it would need to pay less in interest on the equivalent of 1.5% of assets so its rate of profit would rise slightly.)

The problem is that this level of leverage is dangerous. If it makes loses in one year equal to 2.5% of assets then the equity is wiped out and the company becomes insolvent. For any other type of company it would drive up its cost of debt. Banks by contrast have had an implicit guarantee that the state would come to the rescue.

This then is how banks extract rent, by expanding the amount of loans they make beyond what is prudent, and using debt to magnify the return on equity. In the process they create a highly unstable economy where the public ends up paying the bill.

Two final points. The equation profit/equity = (profit/assets) x (assets/equity) is one of the three equations to explain the crisis that I promised some time ago. The others will follow later. Secondly, I've avoided discussing the Miller-Mogdliani thoerem, partly to keep it simple and partly because I want to post a review of Admati and Helliwig's The Bankers New Clothes before getting into that one.
 

Essex Economics

Definition:

Essex economics is an approach to economics which relates all economic topics or news to the impact on house prices. It is widely followed in early 21st century England.

Example:

Newsnight sent a team to Essex to investigate the impact of low interest rates on people living on fixed incomes including savings. They returned with a report on home ownership in one Essex town and buy-to-let in another.
 

Key concepts:

In Essex economics the only investment considered is purchasing a house; commercial investment means purchasing a buy-to-let property. Interest rates are a major topic as it affects the cost of mortgages. Economic crises are synonymous with falling property values. The most watched indices for Essex economics are known as the Nationwide and the Halifax.

 

The related political economy requires politicians to promise to ensure ever increasing values for residential property. (See eg Help to Buy)

Forever Blowing Bubbles

From time to time it is good to look at the Nationwide's index of house prices to see how overvalued housing still is. I tend to follow the ratio of prices to earnings for first time buyers. This time I have put the long run average on the chart. The long run average for house prices is 3.4 times average earnings for first time buyers.

Source: Nationwide

I'm not sure that the long run average is the right measure of where a sustainable ratio should be. About 18 months ago when I looked at these figures the long run average was 3.3 times. The longer prices remain high the higher the long run average becomes. I once used a trend line from 1983 to 2003 and projected it forward. This gave a flat trend close to 2.9 times.

I previously pointed out the irresponsibility of a government boosting house prices in these conditions. It is pleasing to see that this view is widely shared, at least outside the government's supporters.

I worry more about the consequences of the next fall in prices. The best we can hope for is that house prices stagnate while earnings catch up. Unfortunately at present the opposite seems to be happening.

Update: small correction to improve clarity.

Some Last Thoughts on Saving

I have a few final thoughts on the subject of saving, before I get back to my promised posts on the three equations to explain the crisis.

Firstly, here is the World Bank series on real interest rates, posted for no other reasons than it is interesting to see, and because someone asked about the more recent data.

Source: World Bank

My other thought is what do we mean by saving. A lot of comments concern incentives to save. One idea of saving is someone putting money away for a later date. I think that is what Frances Coppola had in mind when she talked about savers complaining about low interest rates.

The savings data I have used is aggregate saving and so includes negative saving as well as positive. Positive saving happens when people consume less than their income and put the difference in the bank. Negative saving occurs when someone consumes more than their income and fills the gap by borrowing or running down their capital.

So when we think of incentives it is important to see both sides. There is perhaps here a difference of perspective. Looked at from the point of view of banks what incentivises their customers to save or to borrow is an important question. Indeed saving and borrowing are seen as very different activities. To an economist who thinks in aggregates, they are two aspects of the same thing.

The difference between banking and economic perspectives is a big topic and one I would like to explore, when work and family life allow.

One point I haven't touched on is investment, by which I mean the purchase of real capital assets. (The purchase of financial assets is a type of saving.) I tend to look at these things from a simple Keynesian perspective where income is split between consumption and saving; and saving is used to finance investment.

Savings and Real Interest Rates

Following up on yesterday's post, do higher interest rates incentivise saving? Do lower interest rates encourage people to save more to meet a savings target? Or is saving unaffected; people save what is left over after paying for everything else?

It is an empirical question, and so I have tried to find data to provide an answer. I was not happy with my first go because the data I had was for nominal interest rates. To strip out any effects of inflation I have found data on real interest rates from the world bank. Combining this with the ONS data on savings rates (via the BoE) for 1967-2009, I have produced this scatter chart.



Source: World Bank, ONS via BoE

Is there a correlation? I have put a trend line on the data, but don't take it seriously. The R squared is less than 0.01, which means that the savings rate is independent of the interest rate.

On a loanable funds model this implies a vertical supply curve, just like my old textbook said.

The same caveats as yesterday apply. This is one country over one period and done in a rush. Other empirical analyses are welcome.

Savings and Interest Rates

Frances Coppola has been writing about what determines the interest that savers earn on their accounts. On Twitter she asked what do we mean by savers, people who save out of current income or people who hold savings accumulated over time. During the discussion we got into how interest rates affect decisions to save.

To me that is an empirical question. Do higher interest rates incentivise saving?  Do lower interest rates encourage people to save more to meet a savings target? Or is saving unaffected; people save what is left over after paying for everything else?

When I studied macro we had a diagram which showed the loanable funds theory of interest rates. (The interest rate is the price that matches the number of borrowers to the number of savers.) In this diagram the supply curve was vertical, meaning that the level of saving was independent of the interest rate. I always wondered if that really was the case. As I say it is an empirical question.

Using some data I have to hand (The BoE's useful three centuries of data series). I have done a scatter chart.

Source:BoE and others

I have used long run government bond yields as an index of interest rates and the savings rate in the UK from 1948 to 2009. This data is not ideal, but it gives a quick and dirty answer. Other countries and time periods might give a different result.

The answer is that the savings rate is higher when interest rates are higher. The R squared is 0.59 suggesting that interest rates explain 60% of the increase in savings. In the loanable funds model the supply curve would be upward sloping.

The one issue I am aware of is that I have not controlled for inflation. It would be better to use real interest rates, which I will do when I can look for another data series.

Say It Again, Sam

I tweeted, early this morning, a piece by Samuel Brittan in today's FT. I quoted:

No so-called banking union will suffice while these imbalances remain

 Which chimes with my own scepticism that banking union is neither necessary nor sufficient to deal with the Eurozone's problems. Now I am fully awake I have second thoughts. Did I fall into a rhetorical trap? Here is what he meant by "these imbalances":

Since the euro was inaugurated in 1999, German unit labour costs have risen by less than a cumulative 13 per cent. During this time, Greek, Spanish and Portuguese labour costs have risen by 20 to 30 per cent, and Italian ones by even more.

Of course, banking union is not meant to deal with the problem of competitiveness diverging between Eurozone countries. You see the trap. It reminds me of a recent article by Ken Rogoff where he argued that Keynesian stimulus to demand would not work in the Eurozone; what was needed was to fix the banks. So fixing the banks will not resolve the competitiveness problem and boosting demand will not fix the banks and, I suppose, sorting competitiveness will not boost demand.

There are in fact three problems in the Eurozone:

• a financial crisis, in which many banks' solvency is questionable;
• a recession caused by a lack of demand; and
• imbalances in competitiveness (by which I mean misaligned real exchange rates).

A solution for one is not the solution to all. Banking union is intended to deal with the financial crisis, not the competitiveness crisis, and boosting demand is meant to deal with the recession. Where Sir Samuel and Mr Rogoff are correct is that solving only one problem is not sufficient as the three issues interact. So we need to stimulate demand and fix the banks and somehow deal with the effects of different rates of inflation in the Eurozone.

In the heading of this blog, I say that Equals, as in equations, will not fear algebra. I actually have in mind an equation to explain each of the problems. When I find the time I will blog on each.

Economic Policy or Business Policy

A story in today's FT illustrates something I have been thinking about recently. Policies which are good for business are not normally good for the economy. Too often governments present their business friendly measures as boosting the economy. Policies to promote business usually serve the interests of the incumbents. The upstarts and the new businesses which economy friendly policies would encourage have no voice, because they don't yet exist.

The Economist newspaper understands this distinction, although it tends to couch the argument in free market terms. Governments, it argues, should promote competitive markets; businesses prefer markets distorted to give them the sort of advantage that allows them to collect extraordinary profit.

Today's story concerns a falling out between the telecoms industry and Neelie Kroes, the European commissioner trying to update telecoms regulation.

Chief executives from some of the biggest telecoms groups in Europe will meet Ms Kroes today to give their views with Etno, the trade body for the incumbent operators.

Ms Kroes wants to end roaming charges in the EU (an obvious single market measure) and make changes to the way network operators sell space to other phone companies. The industry is furious. I should say "the corporations who benefit from the current arrangement are having a tantrum." They claim that without the profits the current setup provides they will not be able to pay for investment in new generation networks.

(A economist would point out that it is not current profits which incentivise investment but the prospect of future profits as a return on the investment. The source of finance for the investment - retained earnings, new equity or borrowing - is irrelevant. If the incumbents don't want to do it they should move over. New entrants will make the investment and reap the reward.)

What caught my eye was this comment by an unnamed EU official:

"One of the things that is very hard for us to illustrate is that this package will be helpful for thousands of companies that don’t exist yet – even will help them come into existence."

Ms Kroes was particularly blunt:

“There are several stages of grief – from denial to anger to bargaining to acceptance. That applies equally to a person facing a divorce or a company facing the loss of a cash cow," Ms Kroes told the FT. “What will improve investment are measures to improve wholesale price stability and regulatory certainty and measures to remove single market barriers.” 

Neelie Kroes gets the difference between a policy for business and a policy for the economy.

My reasons for thinking about the subject have more to do with British politics. The Conservatives are firmly in the camp of business friendly policies. This should open an opportunity for Labour to position itself as pro-economy not pro-incumbent. Sadly it seems that this opportunity is being missed. I would argue, for example, that the BIS department should become the department for economic development. I favour a dynamic economy of change, challenging the monopoly power of incumbents, removing barriers to entry, facilitating the access of upstarts and mavericks and increasing consumer power in the market.

If a Dutch liberal can get it, can't Labour?

Will TTIP Create Jobs?

Last Monday the prime minister gave enthusiastic backing to the proposed EU-US trade deal, known as TTIP. Among other things he proclaimed:

Two million new jobs

 According to theory trade has economic benefits, but job creation is not one of them. The reason why trade doesn't reduce unemployment is quite simple. The Bank of England and other central banks watch the unemployment rate. When it gets too low (below the "non accelerating inflation rate of unemployment") they tighten monetary policy and so push unemployment back up. So trade deals don't push unemployment below the NAIRU. Of course unemployment fluctuates with the business cycle, but trade impacts the long run, not short run fluctuations.

So where did Mr Cameron get his 2 million figure? I found this study which gives the same number. It claims a sophisticated methodology for its analysis of the employment benefits of  TTIP. Here is where they give themselves away:

the numbers presented below are to be considered long-term results or equivalent to changes in employment independent of the economic cycle. That means, for example, that a 1 percentage point drop in the unemployment rate reduces the unemployment rate during both an upswing and a downswing of the economy by 1 percent.

So if the central bank thinks that full employment (NAIRU) is 6% will TTIP mean that it will accept unemployment at 5 %? No, it will raise interest rates when unemployment falls to 6%.

In the long run all economies can reach full employment with or without TTIP.  Of course cyclical unemployment remains, which even this study accepts is not affected by trade deals.

The Economy Is Not a Race

I've mentioned before the new Tory narrative - that Britain is in a race and the economic challenge can be reduced to its ability to compete. The fact that I hear the same rhetoric from different ministers convinces me that this is a coordinated message.

Of course it is nonsense. One country's economic success can benefit other countries. Stronger growth in the eurozone would generally support growth in Britain.

Samuel Brittan goes off message to demolish the narrative in today's FT, "Politicians should stop their talk of competitiveness" He points out:

for a country or area with its own currency... its competitive position is entirely a matter of its exchange rate

His point not only undermines Mr Cameron's cozy story, it also flatly contradicts the view Mrs Merkel pushes on the Eurozone. For example:

The competitiveness of countries depends on many more issues than just weighing up imports against exports.

Samuel Brittan is right, politicians who see the economy in terms of competitiveness are capable of doing great harm.

The Euro Crisis Can Be Solved

The only solution to the Euro crisis is more Europe, for example* Joschka Fischer said:

The price of the monetary union’s survival, and thus that of the European project, is more community: a banking union, fiscal union, and political union.

 There is not the political will for more Europe, and the longer the crisis goes on the more support for Europe evaporates:

Support for European economic integration is down over last year in five of the eight European Union countries surveyed by the Pew Research Center in 2013.

The only conclusion is that the long grind of austerity in the periphery will continue , or the Eurozone will fall apart.

The pessimism is congealed in this post by James Haley . There are two paths, he says, banking union or grinding internal devaluation. When I read it I thought, no there are other paths. The point of this post is to illustrate one.

The key to fixing the Eurozone crisis lie in repairing its broken banking sector. European banks have yet to recognise the losses on their dubious loans. European countries have not the funds to bail out their banks nor nor to pick up the tab for closing them down. Ireland tried and found itself in a sovereign debt trap.

On the whole, the Eurozone can afford to bailout or close down insolvent banks. That is why banking union is seen as a solution. There is enough room to raise the funds to pay for a programme to resolve and recapitalise Europe's banks.

Here is my proposal. Instead of new permanent institutions we could look to a one-off solution. The institutions for assessing the needs of banks for fresh capital or for closing down insolvent banks already exist. Bank stress tests have been conducted. They can be done again, but this time for real. The ESM has the power to invest directly in banks rather than forcing their home country to take on the debt.

The remaining problem is that this exercise will be costly. The solution is a one-off bond issue jointly guaranteed by all Eurozone countries. The EU already raises funds this way, but on a much smaller scale to support for example the European Investment Bank. Making the exercise a one-off can be used to create incentives for banks to come clean on their problems.

Let me anticipate two objections. One, why would Germany go along with this plan? Two, if it is done once it can be done again.

Germany has been reluctant to see Eurobonds, mainly because of moral hazard. This is different because it would be for a specific purpose, not directly funding individual governments but solving a Europe wide problem. Germany's own banks would benefit, both from recapitalisation and by removing the risks of default by some of their borrowers.

On the second objection. It would be necessary to follow up by making financial supervision more national. This would mean rolling back the single market for this sector so that banks which want to offer services in another Eurozone country would need to create a subsidiary which was separately capitalised and under the supervision of the host country.


*Joschka Fischer is not alone. Yesterday I picked up El Pais in a cafe and found Javier Solana, Felipe Gonzalez and Jacques Delors making the same point.

Exit By Accident

As Mr Cameron loses control of his party, the country is once again heading towards leaving the EU by accident. It is evident that Brexit is supported by a minority of the country's political class. None of the leaders of the main political parties favours the idea, nevertheless we could find ourselves on the outside before the end of the decade.

Mr Miliband has been too astute to fall into the trap of matching the Conservative pledge of a referendum. Not only would that increase the risk of exit by accident, it would legitimise the Tory right and embroil Labour in an issue which is best left to the fanatics, rather than keeping the focus on jobs and growth.

Labour needs a line on Europe that allows us to watch from the sidelines while the other lot tear themselves to pieces. The line should remain that Europe is changing and we should not make a decision until the Eurozone crisis is finally resolved.

We could add that the Euro may not survive another five years. Mr Kai Konrad, who chairs the advisory panel of the German finance ministry, recently declared that

I would only give the euro a limited chance of survival.

The break up of the Eurozone would be immensely disruptive and costly, not just to its members but also to its trading partners. At the same time it would present Britain with a new challenge to help rebuild Europe in a different form.

A European Union after the Euro would be a very different proposition from the present set up. The key lesson of the failure of the single currency would be that integration needs a more cautious and pragmatic approach.

Which is very much what Britain wants from the EU; a sharing of power where there is a clear benefit while avoiding grand schemes driven by dreams of unification for its own sake.

Now is not the time to talk of leaving the EU. It might be worth thinking about how to help the EU backtrack on its single currency.

Umm... Well... Uh... Bye then.

One in Four African Countries May Double GDP This Decade

For a change here is some good economic news. From the World Bank's latest Africa's Pulse:

About a quarter of countries in the region grew at 7 percent or better, and several African countries are among the fastest growing in the world. Medium-term growth prospects remain strong and should be supported by a pick-up in the global economy, high commodity prices, and investment in the productive capacity of the region’s economies.

Seven percent is pretty good. It is not a threshold, or a tipping point, but as a growth rate it has the neat quality that 7% is about what you need to double in size in ten  years. 

Growth alone does not guarantee development, and the report points out that poverty reduction lags behind the economic performance. This is basically good news; for many people the world is becoming an easier place to live.