I have been reading Ha-Joon Chang’s excellent book Economics: The User’s Guide after listening to him summarising its thrust at this year’s Hay-on-Wye Festival of Literature and the Arts. It is very disarming to meet an economist who immediately tells you never to trust an economist, and I will probably return to his thoughts on the limitations of expert judgement in a future article.

But today I want to focus on his summary of the major schools of thought in economics, and what the implications might be for actuaries. Chang’s approach is that he does not completely subscribe to any particular school but does not reject any either. He bemoans what he sees as the total domination of all economic discussion currently (and therefore also all political discussion about running the economy) by neoclassical economists. I think actuarial discussion may suffer from a similar problem.

So what is neoclassical economics? Well it has become almost invisible to us due to its omnipresence, in the way fish don’t see the water they swim in, but its assumptions may surprise you. It assumes that all economic decisions are at an individual level, with each individual seeking to maximise what is known as their utility (ie things and experiences they value). The idea is that we self-interested individuals will collectively make decisions which, within the competitive markets we have set up, result in a socially better outcome than trying to plan everything. This approach has become a very conservative outlook (ie interested in preserving the status quo) in Chang’s view ever since it was further developed to include the Pareto principle in the early 20th century, which says that no change in economic organisation should take place unless no one is made worse off. This limits the scope for redistribution within a society, which can lead to the levels of inequality we see now in parts of the developed world which many are becoming increasingly concerned about, Thomas Piketty included.

Arguments between neoclassical economists in Chang’s view tend to be restricted to ones about how well the market actually works. The market failure argument says that there is a role to play for governments in using taxes and regulations (negative externalities) or in funding particular things like research (positive externalities) to mitigate the impacts of markets, particularly in areas where market prices do not fully reflect the social cost of particular activities (eg pollution on the environment). Another criticism made of neoclassical economics is that it does not allow properly for the fact that buyers and sellers do not have the same level of information available to them in many markets, and therefore the price struck is often not the one which would lead to the best outcome for society as a whole. So the more “left wing” neoclassicalism requires more market regulation to protect consumers and the environment they live in.

The more “right wing” neoclassical response to this is that people actually do know what they are doing, and even build in the likelihood that they are being conned due to asymmetric information in the decisions they make. The government should therefore reduce regulation and generally get out of the way of wealth-creating business. This form of neoclassicalism views the risk of government failure as much greater than that of market failure, ie even if we have market failure, the costs of government mistakes will inevitably be much greater.

And if you draw a line between those two forms of neoclassicalism, somewhere along that line you will find all of the main UK political parties and pretty much all economic discussion within the financial services industry.

And, on the whole, it tends to circumscribe the role that actuaries play in the UK.

One of the major drawbacks of neoclassical theory is that is assumes risks can be fully quantified if we only have a comprehensive enough model. Actuaries are predominantly hierarchists, who believe that they can manage the inequalities which flow from neoclassical theory via collectivist approaches, like insurance policies and pension schemes, and protect individuals and indeed whole financial systems from risk. Since Nicholas Nassim Taleb and others made so much money from realising that this was not the case in 2008, this has probably been neoclassicalism’s most obvious flaw, and the one which has given rise to the most discussion (although possibly not so much change to practice) amongst actuaries.

But there are others. Neoclassicalism assumes that individuals are selfish and rational, both of which have been persuasively called into question by the work of Kahneman and others, who have shown that we are only rational within bounds and make most of our decisions through “heuristics” or rules of thumb. Actuaries have tried to reflect these views, some of which were originally developed by Herbert Simon in the 40s and 50s, particularly in the way that information is communicated (eg the recent publication from the Defined Ambition working group), but have very much stayed at the microeconomic level (very much, according to Chang, like much of the Behaviouralist School themselves) rather than exploring the implications of this theory at a macroeconomic level.

Neoclassical theory is also much more focused on consumption than production, with its endless focus on markets of consumers. One alternative approach is that proposed by the Neo-Schumpeterian School, which rightly points out that, in many markets, technological innovation is considerably more important than price competition for economic development. The life-cycle of the iphone, from innovation to temporary market monopoly to the creation of a totally new market in android phones is a case in point. Actuaries have done relatively little work with technology firms.

Another school of economic thought which is much more focused on production is the Developmentalist Tradition, which believes governments can improve outcomes considerably by intervening in how economies operate: from promoting industries which are particularly well-linked to other industries; to the protection of industries which develop the productive capability of the economy, particularly infant industries which might get smothered at birth by the more established players in the market. This tradition clearly believes that the risk of government failure is less than the potential benefits of intervention. The failure of productivity to pick up in the UK since 2008 has been described as a “puzzle” by the Bank of England and other financial commentators. Perhaps some clues might lie outside a neoclassical viewpoint.

The Institutionalists have looked at market transaction costs themselves, pointing out that these extend way beyond the costs of production, and could theoretically encompass all the costs of running the economic system within which the transactions take place, from the courts to the police to the educational and political institutions. They have suggested that this may be why so much economic activity does not take place in markets at all, but within firms. I think actuaries have started to engage with failures in pricing mechanisms recently, particularly where these have environmental consequences such as in the case of carbon pollution and the implications for the long term valuations of fossil fuel reserves on stock markets.

The Keynesians I have written about before. They are probably the most opposed to the current austerity policies, pointing out how, if a whole economy stops spending and starts saving when in debt, as an individual would, the economy will stay in recession longer and recovery (and therefore the possibility of significant deficit reduction) will be slower. The coalition government in the UK have neatly proved this point since 2010.

I could go on, about the Classical or Marxist Schools which have been largely discredited by historical developments over the last 200 years, but which still have useful analysis of aspects of economics, or the spontaneous order of the markets believed in by the Austrian School. However my point is that I think Chang is right to highlight that there is a wider range of economic ideas out there. Actuaries need to engage with them all.

Tweet about this on TwitterShare on FacebookShare on Google+Share on LinkedInPin on PinterestShare on TumblrEmail this to someone

Sometimes the best explanations of things come when we are trying to explain them to outsiders, people not expected to understand our particular forest of acronyms, slangs and conventions which, while allowing speedier communication, can also channel thinking down the same tired old tracks time after time. Such an example I think is the UK Government Actuary’s Department (GAD) paper on Pensions for Public Service Employees in the UK, presented to the International Congress of Actuaries last month in Washington.

Not a lay audience admittedly, but one sufficiently removed from the UK for the paper’s writers to need to represent the bewildering complexity of UK public sector pension provision very clearly and concisely. The result is the best summary of the current position and the planned reforms that I have seen so far, and I would strongly recommend it to anyone interested in public sector pensions.

There are two points which struck me particularly about the summary of the reforms, designed to bring expenditure on public service pensions down from 2.1% of GDP in 2011-12 to 1.3% by 2061-62.

The first came while looking at the excellent summary of the factors contributing to the decline of private sector pension provision. Leaving aside the more general points about costs and risks, and those thought applicable to the (mainly) unfunded public service schemes which have been largely addressed by the planned reforms, I noticed two of the factors thought specific to funded defined benefits (DB) plans:

  • A more onerous burden on trustees of plans, including member representation, and knowledge and understanding; and
  • Company pension accounting rules requiring liabilities to be measured based on corporate bond yields.

As the GAD paper makes clear, the Public Service Pensions Act will result in a significant increase in interventions on governance in particular in some public sector schemes. The Pensions Regulator’s recent consultation on regulating public service pension schemes is also proposing a 60 page code of practice be adopted in respect of the governance and administration of these schemes. This looks like the “onerous burden” which has been visited on the private sector over the last 20 years all over again.

The other point is not directly comparable, as company pension accounting rules do not apply to the public sector. However, as pointed out by the Office for National Statistics (ONS) this week, supplementary tables to the National Accounts calculating public sector pensions liabilities will be required of all EU member states from September this year onwards, to comply with the European System of Accounts (ESA) 2010. These are carried out using best estimate assumptions (ie without margins for prudence) and a discount rate based on a long term estimate of GDP growth (as compared to the AA corporate bond yield required by accounting rules).

The ONS released the first such tables published by any EU member state, for 2010, in March 2012. This for the first time values the liabilities in respect of unfunded public sector pension entitlements, at £852 billion, down from £915 billion at the start of the year.

I think there is a real possibility that publication of this information, as it has for DB pension schemes, will result in pressure to reduce these liabilities where possible. An example would be one I mentioned in a previous post, where mass transfers to defined contribution (DC) arrangements from public sector schemes following the 2014 Budget have effectively been ruled out because of their potential impact on public finances. If such transfers reduced the liability figure under ESA 2010 (which they almost certainly would) the Government attitude to such transfers might be different in the future.

The second point concerned the ESA 2010 assumptions themselves. There was a previous consultation on the best discount rate used for these valuations, ie the percentage by which a payment required in one year’s time is more affordable than one required now, with GDP growth coming out as the preferred option. Leaving aside the many criticisms of GDP as an economic measure, one option which was not considered apparently was the growth in current Government receipts, although this would seem in many ways to be a better guide to the element of economic growth relevant to the affordability of public sector provision. Taking the Office for Budget Responsibility (OBR) forecasts from 2013-14 to 2018-19 with the fixed ESA 2010 assumptions for discount rate and inflation of 5% pa and 2% pa respectively gives us an interesting comparison.

ESA v OBRThe CPI assumption appears to be fairly much in line with forecasts, but the average nominal GDP and current receipt year on year increase over the next 6 years of forecasts are 4.47% pa and 4.61% pa (4.72% pa if National Accounts taxes are used rather than all current receipts) respectively. A 0.5% reduction in the discount rate to 4.5% pa would be expected to increase the liability by over 10%.

Another, possibly purer, measure of economic growth, removing as it does the distortions caused by net migration, would be the growth of GDP per capita. If we take the OBR forecasts for real GDP growth per capita and set it against the long term ESA 2010 assumption of 1.05/1.02 – 1 = 2.94% the comparison is even more interesting:

Real GDP v ESAIn this case the ESA assumption is around 1% pa greater than the forecasts would suggest, making the liability less than 80% of where it would be using the average forecast value.

The ESA 2010 assumptions are intended to be fixed so that figures for different years can easily be compared. It would clearly be easy to argue for tougher assumptions from the OBR forecasts (although the accuracy of these has of course not got a great track record), but perhaps more difficult to find an argument for relaxing them further.

Whether the consensus holds over keeping them fixed when and if the liability figures start to get more prominence and a lower liability becomes an important economic target for some of the larger EU member states remains to be seen. However if the assumptions cannot be changed, since public sector benefits now have a 25 year guarantee in the UK (other than the normal pension age now equal to the state pension age being subject to review every 5 years), then the cost cap mechanism (ie higher member contributions) becomes the only available safety valve. So we can perhaps expect nurses’ and teachers’ pension contributions to become the battleground when public sector pension affordability becomes a hot political issue once more.

We can poke fun at the Government’s enthusiasm to take on the Royal Mail Pension Plan and its focus on annual cashflows which made it look beneficial for their finances over the short term, but we may also look back wistfully to the days before public sector pensions stopped being viewed as a necessary expense of delivering services and became instead a liability to be minimised.

Tweet about this on TwitterShare on FacebookShare on Google+Share on LinkedInPin on PinterestShare on TumblrEmail this to someone

A recent piece of research into how the way people spend their money changes as they age got me thinking about how age might currently influence a particular household’s own Consumer Price Inflation (CPI).

The Office of National Statistics (ONS) produces a monthly inflation report for each major sector of expenditure, alongside the updates for CPI. The latest of these, out yesterday, showed CPI falling to 1.6%, finally less than wage inflation in the UK. However CPI is based on an average basket of goods to determine how people’s cost of living is increasing and this of course differs from person to person. In particular, the spending habits of the population, when split by the age of the household reference person (the ONS term for what used to be known as the “head of household”, when it was always the man of the house even when that house was owned by the woman: this was changed in the 90s), differ markedly.

CPI by age

The graph is based on the latest splits available of spending by the 12 categories used by the ONS to determine CPI (these are from 2012, although the overall averages these figures provide give CPI figures of 0.1% or less different from the actual figures so I think they will do for illustrative purposes).

What we can see straight away is that the gap between CPI for under 30 year old households and the 65-74 year old households has shrunk from around 0.8% pa to around 0.5% pa. However, under 30 year olds are still experiencing consistently higher inflation than the rest of the population. In fact this section of the working population are still experiencing inflation well in excess of the average wage inflation of 1.7% announced today.

The big winners since July have been the 30-44 year olds, with their households down to 1.5% pa inflation from 2.7% pa at the start of the period. And if your head of household is between 50 and 74 you are now experiencing average inflation year on year of only 1.4% pa.

The people who have not won quite so much (other than the under 30s) have been the over 75s, with their households at 2.6% pa at the start of the period and at 1.6% pa (ie bang on the average) at the end. Interestingly, the under 30s and over 75s have an average inflation above the headline rate, and everyone in between is coming in below it.

Why the differences? Well the change in the inflation rate has varied hugely amongst the 12 categories of spending.

CPI constituents

Food and non-alcoholic drink inflation has fallen from 3.9% to 1.7%, Clothing and footwear from 2.5% to 0.2% and Transport from 1.5% to -1.0%, so any sector with spending habits weighted towards these areas is going to have done better than average. The 30-64 year old households spend between 5.9% and 6.1% on Clothing and between 15.9% and 16.7% on Transport compared to the averages of 5.6% and 15.2% respectively. However the over 75s spend 18.8% of their income on Housing, fuel and power, which has seen inflation remain stubbornly high at 3.1% pa, and have higher than average spending on Health (4.6% against 1.5% average) and Household goods and services (8.3% against 6.8% average), both of which saw an increase in inflation over the period. Education appears to be in a world of its own, with inflation falling from 19.7% at the start of the period to 10.3% at the end. Perhaps fortunately for those placing a lot of faith in the headline rate, Education does not account for more than 3% of spending in any group (it’s 3% for the under 30s) and only 1.6% overall.

So, as always, the picture is more complicated than the headline rate. And, when it comes to inflation, age matters.

Tweet about this on TwitterShare on FacebookShare on Google+Share on LinkedInPin on PinterestShare on TumblrEmail this to someone
Source: Wikimedia Commons - Original work of the US Federal Government - public domain

Source: Wikimedia Commons – Original work of the US Federal Government – public domain

Placebos are medicines or procedures “prescribed for the psychological benefit to the patient rather than for any physiological effect” according to the Oxford English Dictionary. Originating as a way of doctors to clear their consulting rooms of people they did not feel could be helped with real medicine, placebos’ status, as Ted Kaptchuk makes clear, underwent a dramatic fall from acceptability after the Second World War and the general adoption of the randomised controlled trial to establish the efficacy of medical treatments. The lack of research since into the various aspects of treatment collectively called “the placebo effect” (Kaptchuk is a notable exception to this) is bemoaned by Kaptchuk, who feels an important element of successful treatments is not getting the attention it deserves.

This may be changing. After all, the impacts of placebos and nocebos (from the latin meaning “I will do you harm”, these are as mysterious as placebos, but make you feel worse rather than better) can be dramatic. Ben Goldacre does a five minute routine on them here (warning: it’s a bit rude). A recent Horizon documentary also looked at placebos, with the suggestion that they might have had an impact on the UK Olympic Team GB cyclists as well as in more serious cases like those of Parkinson’s sufferers.

Why am I talking about them? Because, in a more general way, to quote Seth Godin: “A placebo is a story we tell ourselves that changes the way our brain and our body work”. Godin asks why, if a placebo can make wine taste better and improve the way your back feels, we should be squeamish about discussing them.

The main reason, of course, is the feeling that it is unethical to promote treatments and products which have no scientific basis. This also explains why people operating within professions – whether medical or otherwise – are so wary of them. Professions see themselves, in the Baconian tradition, as bodies of people with expert knowledge using that expertise scientifically for the benefit of society. Placebos do not fit into this world view at all.

Imagine two pensions actuaries: Actuary A is a very experienced practitioner, known for years by many of his clients and a trusted source of wisdom. Everything he says, which he conveys with a practised seriousness and sonorousness, interspersed with frequent not-completely-discreet stories about the antics of other people he has met in his long career, is accepted by his clients like tablets of stone brought down from the mountain.

Actuary B is a young relatively newly qualified actuary. He has just obtained his scheme actuary certificate after toiling away in the background providing much of the analysis and calculation work underpinning the consultancy provided by the more senior actuaries in the firm, including Actuary A. He is seeking his first scheme actuary appointment, and has been trouping along to trustee meetings behind Actuary A for some carefully selected clients which the firm would like to move from A to B. B realises quickly, confirmed by his first trustee meeting where one of the trustees looks him up and down quickly and tells him that he doesn’t trust anyone with shiny shoes, that these clients have been selected because of their particular reluctance to pay the elevated charge out rate of Actuary A. Unfortunately this does not mean that they are keen to see a cheaper actuary installed on their schemes, quite the reverse in fact. The trustees who are most incredulous about the fees associated with actuarial advice seem also to be those who set most store in the mystical wisdom of Actuary A and his booming voice.

Now if I say that I think there are placebos at work here I do not mean that these clients are not receiving carefully constructed advice, appropriate to their needs and in compliance with all legislative and regulatory standards. What I am saying is that, from the lack of shine on Actuary A’s shoes, to the gravitas (I think it used to be referred to by a different generation as “bottom”) brought to bear on any particular issue by Actuary A, there are many things which do not add anything to the quality of advice (which in some cases has been almost entirely constructed by Actuary B), but which are valued at least as much (if not more, in Actuary B’s view) by the client.

As Simon Carne has pointed out recently, supported by John Reeve in this month’s The Actuary, the physical advice is subject to an ever increasing body of regulation, to the point where some clients might be deterred from even asking an actuary the time. However, everything about the environment in which the advice is conveyed – from the tone of voice; to the way the actuary sits; to the degree of direct eye contact; to the choice of gestures used; to, where meetings are held at the firm, the whole experience of someone entering the building and being led into a room deliberately designed to make an impression – is not. In the same way that a presentation is not just the collection of slides put together on PowerPoint, we need to give more recognition to the fact that the advice that is valued by clients is a lot more than that which is written or even spoken.

Although, judging from the number of times I have had to be the bearer of bad news (with the expectation that that will be the case preceding me and therefore helping me in delivering that message in many cases), perhaps the more usual term for this element of actuarial advice should be nocebo rather than placebo.

Tweet about this on TwitterShare on FacebookShare on Google+Share on LinkedInPin on PinterestShare on TumblrEmail this to someone

Towers watson surveyAs a quick illustration of the differences between how businesses in the UK and Germany approach change this chart from the recent Economist Intelligence Unit research carried out for Towers Watson takes some beating. To UK eyes, an insane proportion (45%) of German businesses are proposing to make physical changes to their workplaces by 2020 to accommodate a greying workforce. There is an even more dramatic contrast when the issue of flexible working hours is raised. Less than half of UK businesses intend to offer more flexible working hours by 2020, compared to over three quarters of German businesses.

Neither are we interested in training our older workers apparently. Only 28% of UK businesses intend to ensure that the skills of their older employees remain up to date, compared to 48% of German businesses.

So where are UK businesses preparing to manage change then? Giving employees more choice over their benefits is cited by 60% of UK businesses, compared to 45% in Germany and the European average of 48%.

But is this the positive step it is presented as? It seems unlikely to me that these UK businesses that don’t want to invest in older workers’ working environments or give them flexibility over hours or location or train them is interested in providing any choice over benefits that doesn’t also cut their costs. There are going to be some battles ahead over exactly how the pensions changes in the Budget are to be implemented. Judging from this survey, they are going to be hard fought.

Tweet about this on TwitterShare on FacebookShare on Google+Share on LinkedInPin on PinterestShare on TumblrEmail this to someone

drawn down colourMy father used to regularly paraphrase Benjamin Franklin at me about nothing being certain except death and taxes when I was growing up. However, having spent the turn of the century advising members of small self-administered schemes how to navigate the 6 (some claimed there were in fact up to 13) different tax regimes for pensions which then applied so as to get the maximum possible benefit from them, I was a cheerleader of the tax simplification which the 2004 Finance Act brought in and which demolished all that.

Now it seems that actuaries are no longer going to be necessarily required for members of defined contribution (DC) schemes to get at their savings. In an age of increasing uncertainty about both death and taxes, I find myself cheering this too.

But why stop there? In their consultation document, the Government states that:

With the right consumer guidance, advice and support, people should be able to make their own choices about how to finance their retirement. Everybody’s circumstances are unique and it should not be for the State to dictate how someone should have to spend their savings.

It then adds:

Those who want the security of an annuity will still be able to purchase one. Equally, those who want greater control over their finances in the short term will be able to extract all their pension savings in a lump sum. And those who do not want to purchase an annuity or withdraw their money in one go, but would prefer to keep it invested and access it over time, will be able to purchase a drawdown product.

So the question has to be asked: why are these freedoms and choices not to be extended to defined benefit (DB) members as well?

The reasons the Government have advanced for the change are equally compelling when applied to DB:

  1. There is a lack of choice for people at retirement, which has become more of an urgent concern now that auto enrolment is boosting DC membership. This is even more the case for DB members who are already numerous (although getting less so daily), as their only choices are how much cash to take up to the 25% tax free limit and (up to a point) when to retire. The other freedom DB members have, of course, is to transfer out, although this freedom makes everybody feel very nervous and is possibly about (see below) to be snuffed out altogether.
  2. Current regulations deter innovation. This is, of course, why defined ambition as an idea has been so slow to get off the ground.
  3. Restrictions on cash commutation imply a lack of trust of members to be able to decide how they spend their savings.
  4. The concern that the annuity market has not maximised income for scheme members. This is mirrored by the high cost of de-risking via bulk annuities, which is the ultimate “flight path” for most DB pension schemes, and which many argue has resulted in a big drag on the growth of UK PLC.

All that would be required to extend these freedoms would be to allow DB members to commute as much of their benefits at retirement, whether for cash or income drawdown, as they wanted, with the rest taken as pension as now.

To be fair to the Government, they do acknowledge the logic of extending the freedoms set out in the consultation to DB members in section 6. But then something strange happens.

Firstly, for public sector schemes, as they are mostly unfunded, the Government says it is concerned about the negative cashflows of members transferring out. If 1% of public service workers did so, the joint Treasury/HMRC analysis is that the net cost would be £200 million. This, I think, provides a revealing peak into the world of state funding, where taking on the Royal Mail Pension Plan was seen as positive for Government finances and off balance sheet private finance initiative (PFI) contracts continue to be negotiated offering doubtful value to the state. It doesn’t matter how much things cost over all, it seems, as long as you are only paying out a bit at a time. The Government often behaves in this respect like the victim of a pay day loan shark. Depending on the commutation terms offered, extended commutation has the potential to solve the public sector pension crisis in a way that Hutton’s Pensions Commission didn’t quite manage to.

Not even considering the option of allowing greater commutation from the schemes themselves, the Government has already decided to ban such transfers from public sector to DC. There is to be no consultation on this.

For private DB schemes, the Government says the decision is “finely balanced”. They are worried about all of those currently captive DB pension investments being spent on Lamborghinis. This rather contradicts the earlier declaration of trust in pensioners to make appropriate decisions about their retirement – after all appropriate investment in support of regular income in retirement (which would presumably be recommended by the “guaranteed guidance” to be offered to DC members) should not differ markedly from the equivalent investments in DB schemes. Whether DB schemes invest on a longer-term basis than individuals is, as the Kay Review made clear, uncertain.

However the Government is very concerned about financial markets – they have section 6 of the consultation devoted to nothing else. It is almost as if individuals can be trusted to look after themselves, with a slightly bigger safety net and a bit of advice, but financial markets cannot.

Again, the Government is not consulting on extending commutation of benefits, but solely on the transfer issue. And apparently removing the current right of all members of defined benefit schemes, except in exceptional circumstances, as proposed with public service defined benefit schemes…must be the government’s starting point, unless the issues and risks around other options can be shown to be manageable.

Even if the Government does manage to stop people pouring out of the exits before April next year, this has to be bad policy. To provide more freedom and choice to one group of pensioners and at the same time to remove a longstanding freedom (and one available at the point members joined the schemes) from the other groups is clearly unfair. What is worse, with an election looming, it is likely to be unpopular.

By the way, one of the things that stands out for me in this whole consultation is the use of State with a big S and government with a small g. It is as if typography alone could portray the “State” as big and bad and “government” as on the side of the little guy. I have done the reverse here.

So, if you DB members want to stop the flickering light of Freedom and Choice dying before it even got going, I advise you not to go gentle but to rage, rage and respond in large numbers to questions 9 and 10 of the consultation in particular. You have until 11 June.

Tweet about this on TwitterShare on FacebookShare on Google+Share on LinkedInPin on PinterestShare on TumblrEmail this to someone

The most interesting figures I have seen so far in all the noise of the Scottish independence debate come from the Government Expenditure & Revenue Scotland report for 2011-12 (the latest figures available). This report compares the effect of various approaches to splitting oil revenues. It does, being a Scottish report, focus on the impact on Scotland. However, extrapolating from their published figures, the impact on the rest of the UK are just as interesting.

Scotland and oil

The net borrowing in the Public Sector Accounts for the UK as a whole is shown in blue at the bottom next to the Scottish position with no oil revenues, with the deficits of an independent Scotland and the rest of the UK shown both in £ billions and as a percentage of their respective GDPs above under two separate scenarios. One assumes oil revenues are split per capita, the other that they are split by geographical share. I have assumed no change to economic activity in the UK as a whole due to independence, an assumption I admit may be shaky but for which I have seen no authoritative alternative to date.

On this basis, the rest of the UK’s deficit in 2011-12 as a percentage of its GDP would be 7.7% with a per capita split and 8.5% with a split by geographical share, compared to the 7.9% of GDP for the UK as a whole in the Public Sector Accounts. So one measure increases the rest of the UK’s deficit as a proportion of GDP (the approach the Scottish National Party prefers) and the other reduces it.

That is presumably why it was worth the UK Government relocating to Aberdeen for today’s cabinet meeting to discuss the future of the oil industry. There is a lot at stake.

Tweet about this on TwitterShare on FacebookShare on Google+Share on LinkedInPin on PinterestShare on TumblrEmail this to someone

Economists have recently developed a new term, to describe the nature of income inequality in the United States in particular. They call it fractal inequality, although I am unsure whether Benoit Mandelbrot, the inventor of the whole idea of fractals, would be that impressed. He died in 2010, with the application of fractals to financial markets that he presented in his 2004 book The (Mis)behaviour of Markets, still waiting to be fully taken on board by the risk and investment communities even after the 2008 crash.

A fractal is something that looks pretty much the same however much you zoom in or out on it. A cloud is one example. An equally beautiful example is the Mandelbrot Set (shown below), where a remarkably simple formula creates shapes of infinite complexity.

Source: Wikimedia Commons. Created by Wolfgang Beyer with the program Ultra Fractal 3.

Source: Wikimedia Commons. Created by Wolfgang Beyer with the program Ultra Fractal 3.

The reason it has come up in economics is that people are paid unequally. Very unequally. And even within the 1% of people who are paid unequally from the other 99%, people are paid unequally. To the extent that it starts to look a bit fractal. See what you think of these two graphs, taken from the HMRC personal income by tax year statistics:

earnings of 1 v 99income of 1

So what about increasing inequality between the 1% and the 99%, as discussed from a US perspective in the first link above? In the UK it has certainly increased, but the rate depends on which time periods you compare. The range provided by HMRC is from 1999-00 to 2011-12. In this period of 12 years, the total income 99% of the population live below increased by 52%, compared to an increase of 41% in the median income (ie the total income 50% of the population live below). Compare this to the 7 years from 1992-93 to 1999-00, during which the total income 99% of the population live below increased by 54% (ie more than the 12 years for which records exist since) compared to a 25% increase in the median income.

The message seems to be that it’s getting worse but not as badly as it used to be.

 

Tweet about this on TwitterShare on FacebookShare on Google+Share on LinkedInPin on PinterestShare on TumblrEmail this to someone

A little history: less than 80 years ago, in 1938-39, there were only 3.8 million income taxpayers. This was clearly not enough for a nation on the brink of World War 2 and by 1948-49 (statistics were only collected every 10 years in those days) the number had almost quadrupled to 14.5 million, or around 29% of the UK population (estimates are approximate as there was no census in 1948). Today, there are around 30 million taxpayers, or around 47% of the UK population which, even allowing for the 16-17% uplift in the number of taxpayers caused by the move to individual taxation (rather than counting married couples as a single tax individual as previously), represents nearly a 40% increase in the proportion of the population paying tax since the late forties.

The latest Her Majesty’s Revenue and Customs (HMRC) release on income tax paid by percentile of taxpayers has been seized on by others in the continuing political battle over a future 50% tax rate, but I want to focus instead on one of the other political slogans thrown around in the last few years: the Oxford English Dictionary’s word of the year for 2011 (despite the fact that it is two words) the Squeezed Middle. That the middle has been squeezed is not in doubt, as the graphs below will show. But is this a failure of the income tax system? I think the data suggest otherwise.

First of all, if we look at the proportion of earnings subject to income tax that are paid as tax, they are probably a lot lower than you would think. Obviously this does not include national insurance contributions or Council Tax, both of which are considerably more regressive, but as you can see the percentage did not get above 15% until the top 30% of taxpayers in 1999-00 and the top 12% in 2011-12, with the proportion reducing for everyone below the top 10% of taxpayers until you get to the more complicated interaction between tax and benefits for the bottom 15%. The Squeezed Middle has not been squeezed by the tax man.

percentage tax

We need to be a little careful here, as there has been an effort to move people out of tax through increases to the tax threshold above inflation between 1999-00 and 2011-12. However the percentage of the population paying income tax resulting from this has hardly moved (if anything, it has increased slightly since 1999-00 when it was around 46%), so although the comparison may be approximate, in my view it should still broadly hold.

But the Middle has been squeezed, as the following graph (of earnings in excess of consumer price inflation (CPI) by percentile) shows:

real earnings

Yet even here, the impact of tax has reduced the depth of the squeeze. At the top end, the top 1% do not on average appear to have seen the sort of runaway increases in earnings seen in the United States. To see what has happened at the lowest point of the smile, the median point where exactly 50% of taxpayers earn more and 50% earn less, we can track the median earnings in 1999-00 terms (adjusting for the increase in CPI since then) up to 2011-12 as follows:

median real earnings

It is clear that the squeeze has been an entirely post 2008 crash phenomenon, with real incomes increasing quite reasonably until then. Interestingly, the tax burden as a percentage of income had already started to fall before the crash, with the process accelerating since then.

The Government’s proposal to target a budget surplus by the 2018-19 tax year, to be achieved by spending cuts rather than tax rises, means that this tax burden is unlikely to change if the Conservatives or a coalition they dominate win the next election, according to the Institute of Fiscal Studies, with 60% of cuts in public spending still to come. Labour have also committed to a budget surplus by the end of the next parliament, with a 50% tax rate reintroduced, but only to the top 1% of taxpayers and offset by a reduction in the starting rate for everyone to 10%. So whoever wins the Middle appear to be safe from an increase in income tax at least.

Both parties appear to be depending on increases to incomes (and/or possibly spending unsupported by incomes which could generate more VAT revenues) amongst the Middle so that unincreased tax rates can still meet the gap between their spending plans and the tax take elsewhere. So let’s all hope that the Squeezed Middle start getting paid properly soon.

Tweet about this on TwitterShare on FacebookShare on Google+Share on LinkedInPin on PinterestShare on TumblrEmail this to someone

Unemployment

We are only six months into the Bank of England’s new regime of giving forward guidance about what circumstances might lead them to adjust the Base Rate and they are already in a bit of a mess with it. Whether forward guidance is abandoned or not is still in the balance, amid much confusion. However, much of this confusion seems to be due to the challenge that events have provided to the assumption that the Bank of England could make reasonably accurate economic predictions.

It turns out that not only did the Bank not know how fast unemployment would fall (not a surprise: the Monetary Policy Committee (MPC) minutes from August make clear that they suspected this might be the case), but neither did they know, when it did fall, what a 7% unemployed economy would look like. The Bank has been very surprised by how fragile it still is.

Back in August 2013, when unemployment was still at 7.7%, the MPC voted to embrace the forward guidance which has now fallen on its face. This said that: In particular, the MPC intends not to raise Bank Rate from its current level of 0.5% at least until the Labour Force Survey headline measure of the unemployment rate has fallen to a threshold of 7%, subject to the conditions below.

The “conditions below” were that all bets would be off if any of three “knockouts” were breached:

1. that it would be more likely than not that CPI 18 to 24 months ahead would be at 2.5% or above (in fact it has just fallen to 2%);

2. medium-term inflation expectations no longer remained “sufficiently well anchored” (the gently sloping graph below would suggest it hasn’t slipped that anchor yet); or

3. the Financial Policy Committee (FPC) judged monetary policy posed “a significant threat to financial stability”. More difficult to give an opinion on that one but, looking beyond the incipient housing market bubble, it is difficult to see that monetary policy is causing any other instability currently. Certainly not compared to the instability which would be caused by jacking up interest rates and sending mortgage defaults through the roof.

Source: Bank of England implied spot inflation curve

Source: Bank of England implied spot inflation curve

So it seems that there has been no clear knock out on any of these three counts, but that the “threshold” (it was never a target after all) of 7% is no longer seen as significant a sign of economic recovery as it had been believed it would only last August.

Fun as it is to watch the illusion of mastery of the economy by the very serious people flounder yet again, as what is an intrinsically good piece of economic news is turned into a fiasco of indecision, I think the Bank is right to believe that it is far too early to raise interest rates. I say so because of two further graphs from the Office of National Statistics (ONS) latest labour market statistics, which were not included in their infographic on the left.

The first is the graph of regional unemployment, which shows very clearly that large areas of the UK are still nowhere near the magic 7% threshold: the variations are so wide and, in austerian times, the resources to address them are so limited that it makes sense not to be overly dazzled by the overall UK number.

Regional unemployment

The second is the graph of those not looking or not available for work in the 16-64 age group since the 1970s. As you can see, it has recently shown a very different pattern to that of the unemployment graph. In the past (and borne out by the data from 1973 to around 1993) the number not available to work has tended to mirror the unemployment rate as people who could manage without work withdrew from the job market when times got tough and came back in when things picked up. However in the early 90s something new started to happen: people withdrawing from the job market even when unemployment was falling. There has been a steady increase in their number until it finally started to fall only last year. So what is happening?

Not in labour force

One of the factors has been a big increase in the number of people registered as self employed, rising from 4.2 million in 1999 to 5.1 million in 2011. However, many of these people are earning very little and I suspect that at least some of them would have been categorised as unemployed in previous decades. There must therefore be some doubt about whether 7% unemployed means what it used to mean.

The Bank of England have shown with their difficulties over forward guidance that it is very hard to look forward with any degree of precision. It should be applauded for admitting that it doesn’t know enough at the moment to start pushing up interest rates.

Tweet about this on TwitterShare on FacebookShare on Google+Share on LinkedInPin on PinterestShare on TumblrEmail this to someone