Avoiding Tax and Panama

The big story at the moment surrounds Panama, which many folk may know best from Prison Break rather than its financial sector. A truly massive leak of confidential files from a law firm (terabytes, not just gigabytes…) is causing embarrassment and more for many leading global figures. UK Prime Minister David Cameron is fending off questions about his family’s involvement with the law firm via his father, while the Icelandic Prime Minister was more deeply embroiled and has already bitten the bullet. Links to Vladimir Putin do not appear to have caused quite so much shock and consternation

What exactly is going on, and why does it matter from a macroeconomic perspective? It must matter, since it pertains to billions of dollars. Economies have billions of dollars (or pounds, or euros) moving around within them, and hence that billions ended up in Panama rather than the places that the people mentioned above are located is of interest.

Towards the end of term we covered the Balance of Payments, which is the financial account of a country – what financial flows go in and out of a country. Clearly, it seems, considerable flows went out of the UK, Iceland, and Russia to Panama, and for what? Money is moved from one place to another usually for some purpose – for example an investment, or to pay for imported goods. The claim, however, is that much of these financial flows were “offshore” – moving of money primarily for the purpose of avoiding paying taxes.

In the case of Ian Cameron, the PM’s dad, their company Blairmore Holdings was based in Panama, it would seem, to avoid paying as much tax as would be paid in the UK. However, as the leaks appear to make clear, major decisions about the firm were still made in the UK (based on documented meetings of board members revealed in the leaks) – which apparently is the test of where a company is “located”. What this makes clear is the difficulty of regulation – definitions have to be made for things that are easy to think about, but harder to pin down the detail of – what is the definition of where a company is located? And once a definition is made in a country’s law, it will provoke those in that country to consider ways in which that law can be avoided. As a result, it’s likely that those involved will claim nothing illegal was done, regardless of the wider moral implications about doing right and wrong.

Economic activity, you’ll learn more as you study further in microeconomic topics, tends to need some level of regulation. However, that regulation need not be a panacea, and need not lead to unintended consequences. The rise of offshore tax havens came primarily in response to higher tax rates in major Western economies, particularly in the 1970s, and of course regulation is something that many in favour of the UK leaving the EU cite as a reason to leave. A very thoughtful friend of mine has noted the link between these two – the UK remains a place for lots of finance taking place onshore, and is so at least in part because of its position within the single market (single market = more customers = more revenues). If that attraction was lost, the UK may need to consider other ways to retain its position, which may include more favourable tax and regulatory arrangements for finance – yet financial markets are precisely the markets where the clamour for “more regulation” has been greatest since the financial crisis.

As with anything in macroeconomics, it’s complicated, but it’s well worth studying!

Basket Case

Enticing picture of coffee from the BBC’s story

In recent weeks we’ve covered inflation, and back at the start of the term discussed the importance of prices in determining all sorts of important economic variables, from national output (GDP) to most recently, the exchange rate.

Inflation is the rise in the general price level over some period of time. What is the general price level? This is determined via a “basket of goods”, supposedly what the average person buys and hence representative of prices the average person faces.

What is the “basket of goods”? The Office for National Statistics regularly updates the basket, which is reassuring, and the most recent updates were announced today: coffee pods are in, but nightclub fees are out. As a nation we are more in a hurry, making our real coffee via Nespresso machines and the like rather than the longer and more drawn out approach using a real coffee machine/pot, while we’re going to nightclubs less, apparently. What do you think?

Brexit Referendum: So it all begins!

As was fully expected, the UK In/Out referendum will happen on June 23. Which way will you vote?

If the 48 hours or so since this was announced is anything to go by, it promises to absolutely dominate all news headlines between now and then. So expect to be thoroughly bored by it all by the time June comes around.

However, please as students of the economy, don’t get bored and switch off until you’ve worked out what the right decision is on June 23. This is a huge decision for the UK economy, as hopefully what we’ve learnt in Intro Macro has taught you already.

Everything we’ve learnt about has had implications and applications in the EU debate.

We started with economic growth, and the kinds of conditions that would foster higher trend economic growth, looking at the supply side of the economy, and Total Factor Productivity. This is the most fundamental question we have to ponder: what impact does EU membership have on our trend growth rate? At the moment, most commentators are focussed on relative positions in the business cycle (UK better, EU not so good). But (1) the work of Robert Lucas was cited in our lectures to point out that trend growth is hugely more important than business cycle fluctuations, and (b) it’s been far from always this way, and indeed for much of the post-war economic history, European growth has been stronger than UK growth. Is that a reason for thinking about staying then? I’d argue probably not, I’d suggest you should think about why it might be that trend growth might increase or decrease.

We covered unemployment after that. Isn’t unemployment higher because of free movement of labour, meaning that cheap labour from Eastern Europe can come over and take all “our jobs”? This argument covers over a lot of important detail. Firstly, there isn’t some fixed supply of jobs, which we alluded to by thinking about shifts in labour demand curves. Hence it may be that by having Eastern European migrants here, more is produced in the UK economy, and hence more jobs become available.

Which jobs are being taken? By and large, it’s lower skilled (or unskilled) jobs. And the problem with these kinds of jobs is that they are equally the first to go in economic downturns, and are the easier jobs to be replaced by computers and automation. Hence unskilled labour is under threat from immigration, but equally it’s under threat from the machines.

We can carry on going through the course so far, and I’ll be trying in lecture to relate things we cover to the EU Brexit debate, since it matters hugely. At the outset I’ll make it clear: I think, having thought a lot about the issues, and looked at the arguments in favour of leaving in particular, that the UK is much better off inside the EU. That doesn’t mean some killer argument for leaving isn’t lurking around the corner, and I’ll encourage you to find that killer argument – it’s very important you, and we as a class, have considered all possible arguments, and been rigorous about them, before deciding which way to vote.

The Economics of Crime

Economists apply economic theories to all sorts of walks of life, not least crime and organised crime (organised crime should reduce overall crime, just as a monopoly reduces output in a market). It might be of interest to find that something as mundane as the money supply, and even the denomination of bank notes, can be hugely important when it comes to organised crime.

This article, by Mike Bird at The Wall Street Journal, points out two things about the money base – the amount of money that a central bank prints and puts out into general circulation – and in particular, the existence of large denomination notes. By large, the main target are the €200 and €500 notes the ECB circulates.

It’s long been accepted that such sized notes are the preserve of organised crime, since such people need ways to carry around large amounts of cash to avoid detection. As such, in the UK we only have a £50 note and nothing larger, and the largest note, er sorry, bill, in the US is the $100 bill.

But there’s another issue at the moment, namely the problem with negative interest rates. The Bank of Japan, Japan’s central bank, recently adopted a negative interest rate. Hence the central bank charges banks who deposit cash reserves at the central bank, rather than paying interest. It is to be expected then that banks will do the same with their customers.

Faced with a negative interest rate, i.e. a charge on depositing money with banks, cash then becomes a better option since it has a zero rate of interest (well, it loses value with inflation but if inflation is low or negative, as it is in Japan, then its value is not changing much or increasing). If large denomination bills like €500 exist, then millions of euros can easily be transported around without requiring large briefcases…

Who said the economics of large denomination notes was boring?…

What is a “theory”?

I’ve mentioned this a number of times in lecture: as we try and follow a scientific approach to macroeconomics, it is important to be aware of what are theories, and what are facts. The BBC today has an article asking “when is a theory ‘just a theory’?”.

The article points out the general point of confusion – when something is so well accepted that it becomes essentially a fact, using evolution as an example. However, evolution remains a theory because it is a theory – a set of ideas about how the world became how it is now from what it previously was, and it is possible (albeit mind-blowingly unlikely) that some new evidence or discovery (some data) might disprove the theory.

Economic theories, in all likelihood, will never reach the same level of acceptedness (to be more accurate: non-rejectedness) as evolution, and as such we should be very clear about what theories are: theories about a “natural rate of unemployment”, for example.

Facts, on the other hand, are events that occur, or as Google defines, “a thing that is known or proved to be true”. The financial crisis, the Second World War, the closing price of the FTSE100, the time of day, are all facts.

Universal Credit: Who Should We Trust?

Last week we covered unemployment benefits, and looked at the extent of Job Seeker’s Allowance (JSA). We also looked at the existence of in-work benefits, and discussed how they are an attempt to avoid a poverty trap – where people can end up worse off when taking a job relative to their position out of work with JSA.

The last government, driven in particular by Iain Duncan Smith, announced plans to replace six benefits with one single payment, called the Universal Credit (UC). Those six benefits are “income-based jobseeker’s allowance, income-related employment and support allowance, income support, child tax credit, working tax credit and housing benefit“.

We discussed in Monday’s Economics Conversations the impact of complex systems administered by governments – they tend to create loopholes and confused incentives, and likely discourage use of them as was originally intended (i.e. to help those out of work to get back into work). Hence simplifying such a range of different payments – which in general are in-work benefits in addition to JSA – ought to, in principle, be a good idea.

However, big changes are being made, and to big complicated systems. Different people will be affected differently by the changes, and what matters most to people is whether they’ll be made better or worse off as a result. We care, by and large, as a people, if those seeking to better themselves and work hard find themselves worse off by changes like these – it makes little sense to discourage people from trying to do better.

But how can we know what the impact will be? Can we trust the government’s own figures on the matter? Can we trust other attempts to understand the impact of changes? Doesn’t everybody have an axe to grind, some bias in their analysis? By and large, over the years, the Institute for Fiscal Studies (IFS) has established a reputation for being as thorough and objective as possible in its analyses of the things governments get up to (and the proposals made by oppositions around election time). As a result, their intervention today on Universal Credit is important.

The title of the press release is informative: “Universal credit cuts support for working families, but helps make work pay where current system creates worst problems”. The UC will be effective in reducing the overall spend on benefits by £2.7bn, the report finds, hence it’s clearly effective in that regard, and further it will “make work pay where current system creates worst problems”: so it will address some cases of the poverty trap. However, the report states that 3.1 million households will be worse off as a result of UC, and 2.3m will be better off, hence the BBC leads with the assertion that “The introduction of Universal Credit (UC) will leave working families worse off on average, the Institute for Fiscal Studies has said”.

It’s well worth a read of the IFS’s actual report, to get a sense of how we go about evaluating public policy as thoroughly and objectively as possible. Not least, it will help you to determine whether indeed, as the government asserts, the IFS “ignored other benefits such as extra childcare”. Usually a quick CTRL+F to search the document is informative. I did a search for the term “childcare”, and found five references to the term in its entirety. On page 9 of the linked PDF document (only 28 pages), the report states “One area where the UC system has been made more generous relative to the legacy system is in the level of subsidy given to childcare costs”.

Remaining in the EU “disastrous”

It seems increasingly likely that the EU referendum we’ve been promised is going to happen sooner rather than later – potentially this year, not 2017 as originally expected.

Given that, the messages being put out by ministers are becoming louder and louder. A prominent Eurosceptic in the Conservative Cabinet, Chris Grayling, yesterday wrote in the Telegraph that staying in the EU would be “disastrous” for the UK.

It’s not clear exactly what it is about “more Europe” (vaguely defined) that would be particularly disastrous as far as Grayling is concerned – this isn’t made clear. Reference is made to immigration, although again immigration is simply implied to be a bad thing, since apparently the current levels should not be sustained moving forward (only half of our net inward migration flows are actually from the EU, it’s worth bearing in mind).

Grayling talks about some aspects of the economic idea behind the EU: the single market, or common market: common standards across countries so that exporters aren’t having to match a whole range of different standards for different countries. There then appears to be a misunderstanding about exactly how that would be achieved, because Grayling complains about “giving the EU more and more scope to involve itself in matters that were once the preserve of national governments.”

If a group of countries all have different product standards and regulations, and they agree a common market where these must be harmonised, then clearly each of those countries must give up powers that were once their preserve. It cannot be that a common market can exist where each country can still decide to set its own regulations a bit different for a bit for some reason or another – that would then cease to be a common market.

Optimism, anxiety and the state of the economy

Yesterday US President Obama gave an annual speech that US Presidents give, called the State of the Union address. Conservative thinkers here think that David Cameron should initiate a similar thing, but that’s by the by. The BBC reports that Obama’s final SOTU (everything it seems gets an acronym in the US) conveyed a message regarding optimism and anxiety.

You may think trivial emotions like optimism and anxiety are utterly irrelevant when it comes to how economic outcomes are determined, but you’d probably be wrong. Indeed, one of the early Keynesian business cycle theories that we’ll cover later in term suggests that co-ordination failures occur because some people are less optimistic and hence don’t do particular things (e.g. produce less thinking they won’t sell all that much), leading others to do the same – the pessimism of some is contagious.

The antidote to such failures of co-ordination might be more co-ordinated positive speak – such as Obama encouraging everyone to be optimistic. It sounds almost silly, but what is the empirical evidence? Here’s some bedtime reading on the matter, work by an economist called Sylvain Leduc who considers business confidence and economic fluctuations. Work I’ve been doing myself suggests that the Bank of England’s Monetary Policy Committee, which determines monetary policy (the setting of interest rates to achieve an inflation target), pays a lot of attention to business confidence when considering the state of the economy.

Measuring ourselves

We take measuring ourselves incredibly importantly. This is true at the individual level (we want to know whether we fit in), but also at the national level – how well are we doing relative to, say, the Eurozone countries?

In order to be able to say anything at all about the latter, we have to have some measurements. The standard measurement we use when it comes to entire economies like the UK, or like France or Germany or the USA, is Gross Domestic Product, or GDP. It’s the value at market prices of all the goods and services produced in an economy over some period of time. It’s everything we make as a country, at the value we place upon it – very broadly speaking.

That it’s not a good measure of welfare is almost universally well known. This article from a very interesting blog (well worth a read if you’re feeling like procrastinating but want to feel like you’ve been at least a little bit productive) notes that by and large innovation doesn’t appear in the statistics either. Relative to even our parents, but certainly our grandparents’ eras, ours is one of mass variety, it’s argued, and this is the result of innovation – loads more great products for us to buy and enjoy.

The very basic economics says this should be good – we can find the products that most suit us in all areas of our lives, and be happier than if we were more restricted in the choices we could make. However, choices have opportunity costs, and opportunity costs may lead to regrets – if one makes one choice, one cannot have done the other similarly enticing thing. If innovations are sufficiently small (the difference between, say, the latest Android phone made by Samsung and the latest one may by LG), we as consumers cannot realistically be expected to be well informed about these kinds of differences and what they mean.

Anyhow, the bottom line is that we use GDP, and we use it in all sorts of ways (not least to determine how much the government should spend). It’s a vitally important statistic, and a huge amount of effort goes into producing it (effort that shows up in GDP) – and we should be aware of its shortcomings, without necessarily advocating its replacement. It’s not clear how any other measure of well-being could appropriately factor in the amount of choice we have, and how differently it affects each of us.

Macroeconomic Uncertainty

Today’s BBC headline is the Chancellor warning about a “‘dangerous cocktail’ of economic risks” facing the UK economy in 2016, suggesting this year will be the toughest since the financial crisis. It’s more politics than economics as one reads what the Chancellor actually said in a BBC Radio 4 interview this morning, representing expectations management: after all the positive talk about the economy by the Conservatives before the election and since, things have changed somewhat in recent months to challenge that outlook.

One of those things was that GDP growth for 2015Q3 was revised down – not by a huge amount, from 0.5% to 0.4% – but a downward revision nonetheless, and along with other downward revisions has meant that the UK grew significantly less in 2015 than was previously thought.

Another is the continued low oil price which, while great at the petrol pump for the paying customer, has mixed impacts on the UK economy which does export oil.

Perhaps most interest, however, is to also consider the Independent’s take on the Chancellor’s recent actions (as well as rhetoric): it talks about the role that economic forecasts played in the Chancellor’s budget giveaway in the Autumn Statement in November, noting that they might have been “potentially unreliable”. We noted here at the time that the budget giveaway did rely heavily on forecasts for GDP growth: governments need forecasts of economic growth in order to project the tax receipts they will get, and the amounts of benefits they’ll have to pay out, which heavily influences the level of the budget deficit/surplus. If growth now comes in lower than was forecast, this will almost certainly mean that the budget deficit will be worse than expected, casting doubt on the ability of the UK economy to meet the Chancellor’s new Fiscal Charter: to balance the budget in normal economic times.

As well as lecturing Introductory Macroeconomics this term and hence covering issues mentioned here in greater depth, I’ll also be lecturing a third year course on forecasting, where we will discuss the kinds of methods that are used to produce the kinds of forecasts that underly government budget decisions like these. Many of our undergraduate students take placements and graduate roles with the Government Economic Service, which could see them being placed in the Treasury, hence right in the centre of the process of generating those forecasts. What you are doing here as a student could play a crucial role in shaping the future of our country!