Truss has promised an emergency budget. 

The top priority will be to deal with the inflationary and cost of living impacts of the rise in gas prices that will be announced for October.

And the economy is likely to go into recession. This may not be avoidable but the new Chancellor will want to ensure that it is as short as possible and will want to minimise the pain it causes.

Beyond that, the new Chancellor will have to get to grips with a series of problems. 

He or she will have to reconcile pressure to reduce a rising tax burden with bringing the fiscal deficit under control. 

There will be a need to improve incentives to work while at the same time protecting the poorest in society. 

The greening of the economy is likely still to be a priority while at the same time the Chancellor will want to avoid this creating inflationary cost increases. 

Meanwhile many parts of the public sector are claiming funding shortfalls while at the same time public sector costs are rising. 

And the UK’s perennial problems of balance of payments deficit and weak productivity seem to have been enhanced by the aftermath of the pandemic. 

The reorientation of UK trade promised by Brexit is also only just starting to make progress.

There is a major need to make the UK more productive and more competitive.

Then there are structural questions like the independence and mandate of the Bank of England and whether the Treasury itself should be broken up.

Where to start?

The initial priority must be inflation and the cost of living. The Treasury will have prepared some options, many of them likely to be unpalatable to Truss. Though the effect of higher than expected inflation combined with fiscal drag gives some headroom – possibly as much as £60 billion by 2024/25, though again the Treasury is likely to downplay the scope.

My advice would be to assume a lot more headroom than the Treasury/OBR is suggesting. They will of course retort that this will risk higher interest rates. But these are coming anyway – we are likely to see interest rate policy increasingly determined by the need to defend sterling against the impact of a highly hawkish Federal Reserve Bank. A bigger deficit may have some impact on interest rates but it is quite likely that it will be marginal.

This would leave scope for raising benefits by current rather than retrospective inflation. They were raised in April by the Consumer Price Index (CPI) rise for September 2021, 3.1%, and would be likely to be uprated again next April by the September 2022 CPI which is likely to be around 10%. But the higher gas prices will hit in October and it would make sense to carry out the April uprating 6 months early. Benefits are currently running at £80 billion so a 10% rise would cost £4 billion for 6 months. Moving up pensions in line as well would cost a further £2.5 billion for 6 months.

Truss has promised to reverse the national insurance increase and the corporation tax increases announced by Sunak when he was Chancellor. Expect Treasury pushback on this. Combined these are predicted to raise over £30 billion per annum by the mid 2020s when the adjustments reach fruition. These estimates are probably on the high side, particularly when the likely tax losses if companies restructure or move abroad in the face of higher taxes are fully taken into account.

Because the costs of the early uprating of benefits are temporary, there is perhaps £20-30 billion further scope for additional measures besides the reversal of the NIC and corporation tax hikes if we assume £60 billion of headroom by 2024/25.

 A 2.5% permanent reduction in the VAT rate would in the short term (and even the long term according to many models) bring inflation down by over 1% and delivering an equivalent boost to living standards. But it would cost £20 billions and use up much of the headroom.

Reversing the failure to index tax allowances and thresholds could cost as much as £40 billion, depending on how retrospective this is. But if indexation started from the next budget the cost would be much smaller, perhaps no more than £10-15 billion.

Although these tax cuts would eventually affect the economy and could have a significant impact on inward investment, they are unlikely to make a major boost to the supply side of the economy in the near future. Most worthwhile supply side improvements affect the economy only gradually – indeed it took until the late 1990s before many of the Thatcherite reforms from the early 1980s really started to bear fruit.

If the government is going to be relatively generous by inflation proofing benefits, it can probably be a bit tougher on the other side of the coin, making the provision of universal credit more dependent on willingness to work. Up to a million workers seem to have disappeared from the workforce (as I predicted in Reaction Life as early as May 2020). The cost of living will force some of them back to work but the government should also reintroduce the sanctions previously linked with universal credit now that there are jobs available again.

Once the emergency budget is out of the way, the new Chancellor and Prime Minister can look at more structural issues like the Bank of England mandate and the structural reform of the Treasury. 

The Bank of England has had a chequered track record in recent years, both in forecasting and decision making. Yet few economists think that politicians would be better at interest rate and other monetary decisions, particularly if they are heavily reliant on Treasury officials who also failed to predict the recent inflation. A change of mandate to targeting nominal GDP could make sense but much more important is to force both Whitehall and the Bank to take into account the diversity of views available from the private sector when both forecasting and making policy. Obviously I am talking my own book but the UK has one of the largest and liveliest private economics consultancy sectors in the world, generally consisting of economists who are just as skilled as and much more on the ball than those in Whitehall.  

One of the biggest weakness of economic policy making in the UK has been the failure to draw on these private sector skills and over-reliance purely on those with a public sector or academic history. The problem is enhanced by the UK private sector’s ability to attract those whom we think are more able and rounded economists away from those sectors. These bright people are a resource which has been ignored for far too long.

In addition, economists with a greater belief in the impact of monetary policy than is the current academic and Whitehall consensus need to be appointed to the Monetary Policy Committee. Monetarism isn’t a panacea but the absence of attention paid to its recommendations looks to be a key factor in recent policy failures.

Should the Treasury be broken up? This has been tried before by Harold Wilson’s government in 1964 which set up a separate Department of Economic Affairs (DEA). For the first ten years of my working career I was effectively the apprentice to (and eventually successor to as Chief Economic Adviser of the CBI) Sir Donald MacDougall, who had been the Director of this Department. 

Sir Donald’s take on why the previous attempt to break the Treasury up failed was that it was due to the failure to devalue in 1964, thus subjecting the UK to a series of balance of payments crises where the short term priority of keeping the pound’s value up reinforced the Treasury’s continuing primacy.

Meanwhile the DEA’s energies were subsumed into preparing a voluminous ‘National Plan’ ( not so voluminous that the late Sir Samuel Brittan could avoid being blamed for allegedly having lost it, though Sir Samuel claimed it had merely been left behind some files!). This plan, assuming 4% growth and sharply rising productivity, seemed to be based on the idea that if employers and employees could talk together, barriers to improved investment and better utilisation of labour would miraculously disappear.

With the pound floating and trade union power in the private sector much diminished, would now be a time to break up the Treasury again? The answer depends on whether a clear role for the new DEA can be established. Many of those who want such a body believe that the key reforms that could drive higher productivity in the UK require decisions from government. On the other hand, the UK’s most successful tech sector is the so-called Flat White Economy which I identified, now well over 10% of GDP, which allegedly flourished because of lack of involvement from government. The lack of success of Rishi Sunak’s Future Fund does not bode well for the government in trying to pick winners. One wag once described a government’s industrial policy as “more losers picking governments than governments picking winners”.

But in the modern world, the government and the private sector are again being drawn into greater interdependence. Transport policy, environmental policy, levelling up policy and energy policy need to be integrated with the post Brexit need to make the economy more competitive. Until now policies in most of these areas have been developed with little economic input and little assessment of the likely economic costs. If a clear role for a new department covering economic affairs could be defined, then there is a good chance that it could succeed in a world very different from Sir Donald’s 1960s. Provided it has clearly defined responsibilities. Probably it will do its best work in stopping and potentially rolling back uncosted and badly thought out proposals from other government departments, though to do this it will have to have the authority to override badly thought out legislation, especially on transport and the environment.

With an election due within not much more than two years, the new Prime Minister and Chancellor will only get early tasters of the results of any economic changes they make. And in such a short period, luck will play a major role in determining whether they appear to be successful. On one scenario, the recent falls in shipping costs, food prices and oil prices will feed through to make the economy look much less unhealthy next year. Combined with a helpful budget, by next year the worst could be over. On the other hand, the Ukraine war is precariously poised; Chinese troops are undergoing training near Taiwan and the Middle East again risks boiling over. All these could worsen the scenario, just when the ammunition box had already been raided.

So whoever is the next Chancellor will have to hope that he or she is one of Napoleon’s ‘lucky generals’.

Douglas McWilliams is Founder and Deputy Chairman of Cebr.

Sir Howard Davies has probably the best calibrated political antennae of anyone I’ve ever met. His political judgements are invariably shrewd and he fully understands the interplay of politics and administration, having worked in the Foreign Office, Treasury, McKinsey, CBI, the Bank of England and the City.

He is, then, ideally placed to write about some of the key economic controversies of the past quarter-century in his new book, The Chancellors. And he has the connections to have interviewed all the key players, both politicians and officials. 

In some ways, this makes the book a successor volume to the late Sir Samuel Brittan’s classic The Treasury under the Tories (and its own updated volume Steering the Economy), which was a key textbook for those of us (including Davies himself) who studied economics in the early 1970s. His new book partly fills the same role, being extremely readable and covering much of the same ground as Brittan’s.

However, anyone wanting fully to understand the economic issues of the period would need to supplement the book. Davies handles the main left of centre criticisms of policymaking adequately and by implication of the “Treasury view” (too much austerity, not enough borrowing while money was cheap, rising inequality etc.). Academics like Simon Wren-Lewis and the Institute For Fiscal Studies (IFS) get quoted frequently in the book, as does the left-wing lobbying organisation the Resolution Foundation. But there is a much wider range of critiques of policy, particularly from the centre-right of British economic policy making, of which Davies seems unaware.

The biggest problem of the book is that it treats the UK as if economic policy could be made in a vacuum. In my Gresham Professorial Lectures in 2011/12, I explained how the impact of globalisation and changing technology on the relationship between the UK and world economies has been seismic. Without explaining or understanding that, judgements about optimal policies have an element missing.

For example, one of the consequences of China’s advance from being 3.6 per cent of the world economy in 1990 to about 18 per cent today is that Chinese savings have grown from below 2 per cent of world GDP to 8 per cent today. The consequent rise in the global savings rate has contributed to a demand deficiency in the West, to which the authorities have responded with ever lower interest rates. 

When sitting on the Bank of England’s Monetary Policy Committee from 2006 to 2011, Andrew Sentance (who was, like me, a former economic advisor to Howard Davies when he was Director-General of the CBI) made the, in retrospect, correct case that low-interest rates — except as a short term temporary cyclical response to circumstances —when persisted with over the longer term, eventually damage the structure of the economy by more than enough to offset any short-term benefit to demand. When he first made the criticism, he was a lonely figure, and now his views are shared by many.

Davies compliments Gordon Brown’s management of the economy as Chancellor without giving much heed to the problems that were being papered over. I pointed out consistently in the early 2000s that excessively loose monetary policy — resulting from the Bank of England too slavishly following an inflation target in the special circumstances of a time when the terms of trade had adjusted dramatically in the UK’s favour as a result of cheap goods from China — was creating the problems in the housing and assets markets which eventually spilt over into the Great Financial Crisis (GFC).

In his evidence to the House of Commons Treasury Committee in 2007, Tim Congdon offered a similar perspective to mine, that excess monetary growth had created an unsustainable asset price boom, though his criticism related to the policy regime and its failure to incorporate monetary growth targets, whereas mine had related to the interpretation of the inflation target.

For Davies, the financial crisis seems to come as an extraneous event out of the blue that has little relationship with the policies that had preceded it. To be fair, the initial triggers for the crash came from the US, when the collapse of the subprime mortgage market led to the deleveraging that in turn led to the need for bailouts of banks (mainly commercial banks in the UK where, in effect, Robin had tried to play Batman and indulge in high paying risky lending without the shrewd instinct for self-preservation of the mainstream investment banks) and the collapse of institutions like Lehmans.

But in the UK, these problems had been building up in the preceding years in all the assets markets, especially housing, as a result of loose monetary policy and weak regulation (for which Sir Howard Davies himself had a degree of responsibility) and the crisis would have occurred at some point anyway. 

One of the most interesting passages in the book comes from the fact that Davies, who tries hard to be fair-minded with the criticisms of the “Treasury view”, largely accepts that the increases in public spending during the period leading up to the GFC led to an unbalanced fiscal policy. But what Davies doesn’t cover is how little value was achieved from the increase in public spending.

The data on public sector productivity is imperfect, though the UK has tried harder than most to make it accurate. But over the period when New Labour was in power from 1997 to 2010 the currently available data shows that public sector per capita productivity fell by 2.3 per cent, while productivity in the market sector rose by 23.6 per cent. One of the reasons that Margaret Thatcher kept the public sector on such short rations was that she feared that in the absence of credible public sector reform (and Brown resisted such reform) much of any increase in spending might be wasted.

Davies relies heavily on international comparisons for investment and R&D statistics. Here his lack of practical economics knowledge shows up. Besides globalisation, the other seismic change that has affected the economy and how it is measured is the rise of technology. Davies appears to be unaware that the UK’s main growth sector is what I have called the Flat White Economy. This has accounted for around half of GDP growth since the financial crisis and is now bigger even than manufacturing.

It is not so much a tech sector but a tech-using sector. It is astonishingly badly measured — a study carried out by my Cebr colleagues for the Creative Industries Federation discovered that creative exports were understated by at least 30 per cent. The sector is probably responsible for the bulk of UK investment and yet, since most of its investment is software and is typically expensed, it largely fails to get into either the investment or the R&D statistics.

Even the GDP from the sector is normally understated, often being treated as an input rather than as an investment. Since most of the companies are fairly new they often take years to get into the measurement net. Practical working economists tend to be aware of statistical deficiencies and know when either not to rely on the relevant statistics or when to adjust them.

One suspects that Davies’ former Treasury colleagues are similarly unaware. The author quotes former Chancellor Denis Healey as claiming that “the Treasury commands the best brains in a civil service that has no intellectual superior in the world”, yet the same Denis Healey was quoted in the Observer in 1975 pointing out that the then CBI Economic Adviser Sir Donald MacDougall and his team of six (actually there were only three of us) were “running rings round the Treasury”.

I’ve generally been impressed by the intellect of my friends in the Treasury, but many of them lose many of the benefits of this intellect to a combination of lack of practical knowledge and being too arrogant to learn from people who know different things and have a different experience.

This is currently showing up in the explosion of inflationary pressures. Both the Treasury’s forecasting arm, the Office for Budget Responsibility and the Bank of England have consistently failed to predict this and the subject is barely touched on in this book. There needs to be an investigation into why official forecasters have done so badly at a time when plenty of us in the private sector have foreseen the problem. 

Inflation is now likely to reach five times the target level. My own guess is that the forecasting failures result from arrogance and groupthink. For example, there has never been a monetarist appointed to the Bank of England’s Monetary Policy Committee. Major efforts have been made to promote diversity of ethnic origin and gender (and for all I know sexual orientation). It appears that the diversity of economic opinion is less highly prized.

For all this, Sir Howard Davies’ book is worth reading. But to get a full understanding of recent macroeconomic issues, a student would have to combine reading it with a book by someone with a different point of view. There is a clear gap in the market — I wonder who will fill it?

So no surprise then.

More interesting is the Bank’s new forecast. It now forecasts double-digit inflation in the autumn and zero growth (which almost certainly means recession) in the four quarters to Q2 2023. The forecast is now very similar to that produced by my Cebr colleagues two months ago in reaction to the invasion of Ukraine, though the Bank’s forecast inflation peak is now very slightly higher than my colleagues’ prediction.

Some have criticised the interest rate rise as too little given past inflation. It is certainly true that with inflation eroding the value of assets at coming up for 10 per cent a year, a paltry 1% cost of money won’t discourage borrowing. But the proper measure of real interest rates (at least as an operational tool) is the comparison of the current cost of borrowing with the expected move in asset prices.

Here, borrowing may not look so cheap. It is hard to see house prices continuing to rise into all the headwinds of the current economic situation unless the Ukraine position is magically transformed. Equities look likely to continue to slide. Bonds, having already been routed in recent weeks, might just hold up.

The latest official data already shows that 12-month monetary growth (M4) has slowed from a peak of 13.7 in February 2021 to 5.4% in March 2022.

With public borrowing also falling very sharply, partly because of the impact of inflation on the erosion of tax thresholds and allowances, it does look as though the country is going into recession with both the Treasury’s and the MPC’s feet hard on the brakes.

We were unlikely to emerge from the inflationary consequences of supply shortages, the resurgence of the pandemic in China and then the Ukraine war without the economy suffering considerable pain. But it does look as though the authorities have mistimed their tightening – they failed to end furlough early enough and then have raised taxes too much this year.

Now the MPC may be compounding the effects this by raising interest rates too late.

Douglas McWilliams is Deputy Chairman of Cebr, the economics consultancy.

Essentially the answer to the first question is yes. World growth has slowed and is probably currently negative on a monthly basis. The answer to the second question is hopefully not.

Three factors have led to falling GDP – the invasion of Ukraine, soaring energy and commodity prices around the world squeezing living standards and the resurgence of Covid in a China which has very limited immunity. These have all triggered sharp falls in consumer and business confidence. Meanwhile, the supply problems from the economy emerging from the pandemic have been exacerbated by the Covid related returns to lockdowns in China. And economic policy makers like the UK Treasury, who are often behind the curve, are still fighting the battle against inflation, reducing deficits and the rates of monetary growth in many countries quite sharply.

Some of what we are seeing will be temporary. The Chinese Covid situation will probably be resolved either by success in beating back the pandemic or by a change in policy. The fact that supply shortages are one of the driving forces behind inflation means that there is scope for a boost in output as the supply problems are resolved (though this will almost certainly take longer than the conventional wisdom expects – it took till mid 1975 before the supply crisis of 1972/73 was resolved).

One also expects that the fiscal and monetary tightening that each country has carried out, assuming that other countries would not do the same, will probably be eased eventually, if a bit late in the new economic cycle that is emerging.

But the key factor that might change the prospects would be a resolution of the war in Ukraine. Here the increasingly conventional wisdom is that the war may grind to a stalemate for 5-10 years with no resolution and the continuation of sanctions. If this happens, weaker demand will eventually bring down the price of oil, while the price of gas might rise less than is commonly expected. But food shortages will continue to keep inflation high.

Cebr’s UK GDP forecast on this assumption is that the UK economy would stagnate or decline in the quarters to early 2023 but would start to grow modestly thereafter. Because of our international exposure we are quite a good litmus test of what might be going on at a world level.

But it is possible that the conventional wisdom could be wrong. If the Chinese decided to intervene in the Ukraine dispute and pressured the Russians to do a deal (possibly by threatening not to buy their oil or commodities), sanctions could be deescalated and the prices of many commodities would fall back after a few months.

It was probably over-optimistic to have expected that the world could have managed to cope with both a pandemic and a fairly major war and escape unscathed. The aftereffects of both could remain with major economies for a long time. So even if the Ukraine problem is settled more quickly than is expected, we are assuming a period of economic stagnation for quite a few years thereafter.

Douglas McWilliams is founder and deputy chairman of Cebr, the economics think tank.

In London, where high house prices are meant to hit hardest, the rise since mid-2016 has been even lower – only 11.4%. This is well below both price and earnings inflation and represents a fall in real terms.

It is only in the past year, where excessively loose monetary policy has boosted asset prices, that house prices even in London have decisively risen faster than inflation. In the 12 months to February UK house prices are up 10.9%, London prices 8.0%, against consumer price inflation of 5.4% (though rising) over the same period.

The factor that has done much more than any to boost house prices is cheap mortgages. A five-year fixed rate mortgage cost 6.4% in June 2008 before the financial crisis, 2.54% in June 2016 after the Brexit vote and 1.79% in February this year. Indeed, in September 2021 when house price inflation was especially strong, the rate had fallen as low as 1.29%.

It is ironic that discussion about house prices generally is based on their unaffordability and yet what has actually caused the recent rise in prices is the increasing affordability of servicing a mortgage as a result of monetary loosening.

And yet those who point to the unaffordability of housing have a point. For those already on the housing ladder or with parental cash to spare (The Bank of Mum and Dad, BOMAD – a concept which my consultancy Cebr invented – at least partly finances 56% of all first time buyers), the cost of housing is mainly the repayment cost of the mortgage.

But for those trying to get on to the housing ladder without parental support, the main impediment is the deposit. It is hard to get a mortgage of more than 90% of the value of a property so the final 10% has to be found from savings – which is hard to find on modest salaries, especially when faced with high London rents.

But even the recent rise in UK house prices will be hard to sustain in the near future. Over the next two years home buyers are likely to face the headwinds of higher mortgage rates, squeezed living standards from higher inflation, probably rising unemployment, and higher taxes from the failure to index tax allowances and bands and from the national insurance contribution rise. On top of this, the stamp duty holiday, which rekindled the housing market in 2020, came to an end in 2021 and this will have a hangover effect.

Most analysts decry the UK’s low rate of housing starts. Yet the recent record is less bad than might appear. Housing starts in England in 2021 were 175,000, roughly the same as the previous peaks in 2019 and 2007 and slightly higher than the projected rate of household formation of 160,000 a year.

It is hard to believe that the economy can surmount its current woes of excess inflation leading to squeezed living standards without a recession. This will surely bring house prices down.

But be careful what you wish for. For most people, the pains caused by recession are even greater than those caused by high house prices.

Douglas McWilliams is founder and Deputy Chairman of economics consultancy Cebr.

Although arguably the Blair government politicised government, for example by appointing one career politician (Ed Balls) as Head of the Government’s Economic Service and another (Keir Starmer) as the Director of Public Prosecutions, the problem is much more intrinsic than simply recent abuse of government patronage. The public sector and the left have been historically intertwined. 

But whereas in the past this has been just one fact amongst many with which Tory politicians have to deal, the level of suspicion between the Tory government and the public sector is now at a level where it is seriously damaging the government’s ability to run things. 

In just two months four major public sector scandals have been revealed: the obstructions in the Ministry of Defence to arming the Ukrainians; the failure of the Home Office to manage the acceptance of Ukrainian refugees; the health service failures that lead to the deaths of mothers and babies in Shrewsbury; and the revelations of skiving and shirking at the DVLA. At least the first and the third of these have cost lives.

All this is in addition to officials who persistently (unlike many of us in the private sector) failed to forecast and prepare for rising inflation and who seemed unaware of the impact of shortages until they had been around for nearly a year. And a Sage committee that was disbanded for giving bad advice from flawed models during lockdown (this again cost lives). While the government’s own civil service head of ethics was fined for an illegal lockdown party on the eve of the Duke of Edinburgh’s funeral where she brought along her own karaoke machine.

Some tension is inevitable between civil servants, who see themselves as guarantors that conventions are upheld, and ministers, who might be keen to make things happen quickly. And the tension is exacerbated by faults on both sides. It ought to be possible to make both ministers and their civil servants more effective without scrapping the public service ethos.

Since the Northcote Trevelyan reforms, the UK civil service has been largely uncorrupted (at least in the sense of taking bribes) and has had an ethos of trying to run the country effectively. 

The pre Northcote Trevelyan civil service (prior to 1854)was lambasted on the second page of the report with the following description: 

“Admission into the civil service is indeed eagerly sought after; but it is for the unambitious, or indolent or incapable, that it is chiefly desired. Those whose ambitions do not warrant an expectation that they will succeed in the open professions where they must face the competition of their contemporaries, and those whom indolence of temperament or physical infirmaries unfit for active exertions, are placed in the civil service, where they can obtain an honourable livelihood with little labour and at no risk; where their success depends on their simply avoiding any flagrant misconduct; and attending to moderate regularity to routine duties; and in which they are secured against the ordinary consequences of old age or failing health by an arrangement which provides them with a means of supporting themselves after they have become incapacitated”.

The report concluded that the civil service needed “core values of integrity, propriety, objectivity and appointment on merit, able to transfer its loyalty and expertise from one elected government to the next”. 

These values have merit and this article tries to find a way of making it possible to combine these values with working for right wing governments.

If it is not possible to reform the relationship between the government and the public sector and especially that with the civil service, there is a genuine risk that civil servants might be replaced by political appointees. It might seem attractive to a Tory minister, when faced with what appears to be obstruction, simply to get rid of the top of the civil service and replace it with politicians. But this would lose years of knowledge. The system only works (in a ramshackle way) in the US because of the importance of state and local governments where apprentice politicians/civil servants can cut their teeth. In the UK’s largely unitary system, placing those with no administrative experience in charge of departments would make maladministration endemic.

There is a better way, which, though it may mean that right of centre governments can’t get away with everything that they want, will have many fewer damaging side effects.

My suspicion is that the root of the difference between the right and the civil service is the gap between those who learn from books and those who learn from experience. Civil servants (and indeed many academics and journalists) learn most of what they know from books. Only slowly and in a limited way do they learn from experience. They miss those things that are obvious to any salesman or accountant about making sales happen and the books look good. They miss many of the tricks about managing expectations that are critical to managing employees. 

I have often claimed, only part jokingly, that I have learned more economics in pubs and bars than in lecture theatres. It was in a bar in Beijing late at night where the boss of one of the big four accountancy firms explained that in China companies routinely understated their profits dramatically (by an amount that when I did the sums turned out to be about 2% of world GDP!) so as to limit their payouts to their private investors. What do they do with the money I asked? It all goes into the property market where they buy with cash in the names of nominee companies. This was backed up by my experience on the Marconi board when we were in discussions with Huawei. The proposed deal did not come about because Huawei claimed that their profits undervalued their shares. The level of understatement of profits in China and the misallocation of investment that follows has international macroeconomic consequences, as well as explaining the Chinese property market.

I don’t think many civil servants learn much about how the world economy works in pubs!

Those of us who know both the theory and the practice often observe an extraordinary level of arrogance from those who only know the theory. Sometimes the arrogance reflects a non-gregarious background as school swots who lack social skills. But mainly it reflects their failure to meet and know others who have different experiences from themselves. There is a similar problem of mainly meeting others with similar experience in the private sector, but because social skills are so much more necessary for advancement in the commercial sector where generally you have to be able to sell your product against competition rather than simply imposing a law telling people what to do, those in the sector make much more of an effort to get on with and understand people with different views than do those in the public sector.

When I was dealing with the civil service trying to get the government to reverse their policy on abolishing the VAT Retail Export Scheme, which had led to the UK leading the world for shopping tourism and to Bicester village becoming the second largest tourist attraction other than the British Museum, I was shocked by the combination of arrogance and incompetence which the Treasury officials showed. Their analysis was described in the Administrative Court as “full of schoolboy errors” and a senior Treasury official told me a series of direct lies including the preposterous claim that to reverse the policy would “break the administrative code”. The real live fact of Bicester Village seemed to mean nothing to him against his models which, like those of Sage, were shown to be badly flawed.

My proposals for improving the working relationships between civil servants and right of centre governments are twofold.

There should be compulsory “diversity” training for civil servants to open their minds to the views, ways of thinking and ideas of those from other than a civil service background. Rather than focussing on “diversity” training for dealing with minorities, they should first learn to deal with the huge majority of people who are not civil servants. Once they can do their day job, then is the time to ensure they can work with and understand minorities.

There should also be training for anyone who wants to be a Tory Minister or a Tory special adviser on how Whitehall works. Dominic Cummings identified part of the problem (though how anyone can think Whitehall suffers a shortage of weirdos or eccentrics, as he claimed, is bizarre) but was on some kind of an ego trip. He had no idea how to make people work with him and unnecessarily antagonised them. One could run a training course on how to be effective in Whitehall simply by describing what Cummings did and training people to do the opposite.

Whitehall has its ways of doing things. If you work with the grain it can often be surprisingly easy to achieve what you want. But if you confront the official machine, it will confront you. And it generally has the resources to fight you to a standstill.

Special advisers or SPADs are likely particularly to need to learn. These slightly wet behind the ears apprentice politicians tend to gain advancement by slavish support for their ministers leading to the aggressive and bullying behaviour satirised by Armando Iannucci in “The Thick of It”. In a world where civil servants often seem to be obstructing, for people who have not yet learned how to make things happen, resorting to bullying and shouting can be the default option. But of course that just entrenches positions.

Many civil servants have what might seem to those on the right a surprising loyalty to doing their job properly and helping whoever is in power. If you pull the correct levers they will generally do what they should do, even against their own personal policy preferences. There are some at the top who got a bit too big for their boots, particularly during the Brexit debate, and thought they could tell the politicians what to do. And some probably got a bit too chummy with their counterparts in the European Commission and didn’t realise till too late that these counterparts were deliberately trying to get revenge for Brexit by damaging Britain. But the bulk of civil servants, if you tell them clearly what you want them to do, will try their best to do it.

If you want to have a fight with the civil service, pick your ground. Make sure your position is really well prepared. Make sure the issue is important enough to be worth fighting for. And don’t fight so many battles at the same time that they interfere with each other. As Michael Heseltine, a veteran Whitehall warrior, once told my then boss Sir John Banham, a Minister who loses a battle takes a very long time to recover.

Finally, too many civil servants feel free to leak against their Ministers. There is always a tension between encouraging freedom of speech and a civil servant’s obligation to support the government of the day. And often the leaks are encouraged by the behaviour of Ministers and even more by that of SPADs. But people can’t work together if they can’t explore options without the fear of them ending up often misrepresented in the newspapers. Given the amount of surveillance we are all now under, I’m pretty sure that it would be technically possible to limit leaks.

The newspapers would be less fun, but that’s a small price to pay for better government.

Douglas McWilliams has worked in and with Whitehall for 48 years. He is currently Deputy Chairman of Cebr.

But not all the cards dealt to the Chancellor have been duds.

He has been helped by the OBR’s forecasts, which have been generally pessimistic since the start of the pandemic. As a result, they now believe that GDP in nominal terms in 2022 will be nearly 2% higher than they thought as recently as 6 months ago despite the strong negative impact of the invasion of Ukraine. Had that not happened their GDP forecast would have been 4% too low. Cebr’s fiscal drag model suggests that the 4% extra GDP would have generated £60 billion of additional revenues; even post invasion the forecast 2% upgrade generates an additional £30 billion (the OBR’s calculations in this case turn out to be the same as the Cebr’s – which might be cause for alarm!). Some of this would have had to be offset through the higher debt servicing costs both from higher interest rates and from higher payments on inflation-linked bonds, but it still leaves the Chancellor with plenty to redistribute.

In addition, higher than expected inflation will generate an additional £20 billion of revenues if wage increases are modest and £40 billion if they are less so, compared with £8 billion originally planned from his freezing of income tax allowances and thresholds to 2025/26.

Of this additional £50-70 billion of additional revenues which effectively result from bad forecasting and stealth taxes, the Chancellor today returned to the taxpayer three sums of money: a temporary 5p reduction in fuel duty until next March worth £2.4 billion; a £6 billion rebate from a rise in the National Insurance threshold and a £6 billion cut in the basic rate of income tax from April 2024. Compared with the extra revenue it is small beer, though presumably he will plan to distribute more apparent largesse in future years.

The Chancellor has been lucky that the UK’s tech economy, with relatively little help from him, has been powering GDP ahead – indeed the buoyancy of tax revenues hints that the tech economy (and hence GDP) could well be much larger than is officially measured. The OBR’s attempt to explain the buoyancy of receipts in Box 3.1 on page 88 of its Economic and Fiscal Outlook March 2022 concludes “other factors must be at play”.

Where he does not seem to have much of a feel for the economy is in understanding what can be done to help growth. He and his Treasury colleagues specialise in attempted bribes to businesses to spend more on investment, on training and on officially described R&D. It is fair to say that in general all these schemes have had their difficulties – the apprenticeship levy and rebates work in some areas (particularly those for apprenticeships working with historic vehicles) but seem to have failed in many other areas of business and the total number of apprentices is falling. The superdeductions to encourage R&D and investment also seem to have failed. Cebr’s own practical experience of trying to participate in these schemes is that by the time the officials ring fence such schemes to avoid what they call fraud, the barriers are such that the net benefits to the companies using the schemes are low. Often they only work had the company been intending to make the investment without the tax incentive. In particular, the definitions of R&D that make it eligible for the various tax bribes mean that much innovative spending fails to jump through the hoop.

Instead of meddling with schemes to try to make companies do what the government, rather than the company, wants, would it not be simpler and more effective to let businesses keep more of their own money? But instead, corporation tax is being raised from 19% to 26%.

As recently as 2015, the UK ranked 11^th in the international tax competitiveness scale with a score of 71.5. By last year we had slipped to 22^nd with a score of 61.8.

So the measures announced today will not help improve competitiveness. They do a little to help with the cost of living crisis. They do not offset the Chancellor’s own stealth taxes.

If the Chancellor wishes to lose the tax of being a high tax Chancellor, he will have to do much more in future budgets.

Douglas McWilliams is Deputy Chairman of Cebr, the economic consultants.

With a cosmopolitan population and a greater range of international links than virtually any other country and with much of the population concentrated in a small area in Southern England, you might expect that the economic performance of the UK should have been more severely impacted by Covid than most other countries. In fact, the performance has been about average so far and will probably move up the league table when the statistics get revised upwards as they often do, especially in periods of major change.

But the game is not over until it’s over.

And full judgment has to be suspended until countries have dealt with the inflationary consequences of the pandemic. Most countries expanded both fiscally and monetarily, with the huge 20% jump in the US money supply during spring 2020 making it possible for other countries to take economic risks without fearing a devaluation against the dollar. These policies worked well but the boost to demand has combined with disruptions to supply to generate inflation. Only when this has been subdued will we be able to measure the full economic cost of the pandemic.

The UK has a more flexible labour market than other similar countries and in theory that should limit the extent to which inflation spreads and will make it easier to subdue. But the more flexible labour markets have also pushed corporate wage costs up faster than in other countries, though much of the increase has been in signing on fees and bonuses and not just in wages. This means that the cost effect should disappear quickly when labour shortages come to an end.

Initially, the measured lockdown effect for the UK showed a much bigger fall in output, of over 9%, than other major countries in 2020. Cebr’s World Economic League Table for 2022 shows the UK in the bottom quartile for growth that year, accompanied only by Spain of the main economies and in between Argentina and the Philippines. Incidentally the largest fall, of 56%, was in Macao as gambling revenues disappeared.

But a proportion of this reflects the way in which the UK’s public sector is measured. The Atkinson Committee was set up by Gordon Brown in the hope of making New Labour look good as it tried to improve on measuring the public sector more accurately by output rather than by input. In fact, since management of the public sector was not one of New Labour’s strong points, the new measurements made much less difference than he had hoped.

Generally, the Atkinson improvements make the UK figures look more realistic than input-based figures. But since revenue, which is the main way of measuring productivity in the private sector, is not a realistic measure in government, output has to be measured by proxies such as patients seen and pupils taught face to face. And many of these proxies were particularly badly affected by the pandemic.

Internationally comparable figures suggest the real hit to the UK was about a decline of 7%, still in the bottom half of the table but probably not much worse than might have been expected, given the UK’s potential susceptibility.

The UK was one of the first countries to deploy the vaccine and although the lockdown from the Kent variant of the disease reduced some of the vaccine deployment’s beneficial consequences, eventually the economy recovered strongly. The UK was one of the fastest recovering countries in the year 2021, with only China and India of the major economies growing faster. Of course the same problems that made the 2020 figures understate UK performance helped overstate the growth in 2021, though because teaching and seeing patients face to face haven’t fully recovered to pre pandemic levels, the overstatement is by about 1% only.

By the end of the year GDP had recovered to its pre pandemic level, roughly on a par with most other Western economies.

Many economists try to measure the longer term economic effects of the pandemic by the extent of so-called scarring, the extent to which GDP long term is reduced from trend. Sadly, there are no good measures of this. Indeed, Cebr’s interviews with tech companies and others suggest that in some areas growth has been boosted by the forced adoption of working from home and remote working technologies.

On the other hand, the willingness to work since the pandemic has not recovered with both some older people reluctant to return to work and some young people to start work. Compared with pre pandemic trends we are short of roughly a million employees, 3% of the workforce, although their impact on GDP might be about half that.

I have been observing the trend toward either not working or working in low productivity lifestyle jobs for a number of years since I first wrote about The Lifestyle Economy in 2018. It seems that the pandemic has increased the numbers in these categories. In theory this is another form of scarring. But if people are doing what they want to do, who are we economists to say it’s a bad thing? On the other hand, work is taxed so those who get their satisfaction from working also contribute by paying for public services. Lifestyle or leisure are untaxed so there is no beneficial spillover effect unless reduced stress and disease or increased caring for those who would otherwise be a claim on public resources are a consequence.

Looking at the rest of the world, two countries stand out.

Taiwan, with its past experience of bird flu, managed the pandemic most successfully from an economic perspective. The country managed to hold its number of cases below 20,000. And it suffered fewer than a thousand deaths. GDP actually rose by 3.2% in 2020 and by 6% last year. It followed a very strict lockdown policy but took action very early.

Sweden adopted the opposite approach to Taiwan and had relatively limited lockdowns. But GDP declined by only 2.8% in 2020 and rose by 4% in 2021.

The two major economies, China and the US took very different approaches as might have been expected from their respective ideological positions. China still has an aggressive zero-Covid policy. Yet its economy has been affected only to a limited extent – growth was positive in 2020 and powered ahead by a further 8% in 2021, despite being the origin of the disease. The US largely left policy to state and local governments. GDP declined by less than average at 3.4% in 2020 and rose by 5.7% in 2021.

Comparing these different countries hints that the more extreme policies, aggressively applied, worked best. Either halt migration and have early and aggressive lockdowns to achieve zero-Covid as was the trend in East Asia or follow a relatively relaxed approach, leaving much action to personal choice as in the US or Sweden.

Both seem to have produced better results than the somewhat half-hearted lockdown policies followed in many parts of Europe often following flawed modelling results from academics and doctors. The European lockdown policies seem to have been heavily influenced by the early experience in Italy where the initial scale of the pandemic did in fact overwhelm their public health system. In retrospect the lockdowns and the associated economic damage seem to have been largely unnecessary except in the early phase of the disease. But those making the decisions did not know that they could get away without locking down, and the political risk of refusing to lock down when advised by academics and doctors whose prediction flaws took time to expose made it hard for the politicians who made the decisions. I find it hard to blame them, though the groupthink of those who advised them should have been avoided.

Longer term all countries have increased their public debt to levels not previously seen outside wartime. Because the key economy, the US, took the lead, other countries were able to follow. With inflation now real and much of debt indexed, these costs will remain when the pandemic has gone away. This debt is likely to be the most real long term effect of Covid.

Douglas McWilliams is Deputy Chairman of Cebr, the economic consultants.

If sanctions are to be effective they will have to force Western countries to reduce their dependence on Russian products and business. While sanctions are likely to extend to non-energy sectors, the aggregate effect on the global economy of this will be small. More importantly for global growth, an effective set of sanctions must eventually include not buying Russian oil and gas for Continental Europe and not allowing the UK legal system or the City of London to be used by Russian companies amongst other measures. In line with the above, Germany announced this morning that it would halt the certification of the Nord Stream 2 gas pipeline in reaction to the Russian military action.

An accelerated transition away from fossil fuels would be costly, while a hit to the City of London (currently about 7 to 8% of UK GDP) would reduce not only the incomes of bankers and lawyers but many others dependent on their incomes. There would also be an impact on the UK property market if the government decides to make a fire sale of Russians’ property or, worse, have their assets frozen or confiscated.

A US-led rearmament boom would normally boost the world economy but much less so at present when economies are limited by supply shortages and inflation. The impact, unless financed by higher taxes, would be to increase both these supply shortages and inflation.

Russia is a key supplier not just of energy but also many metals including aluminium, cobalt and copper. It is also well provided with international reserves and can probably sit out a boycott that lasted less than two to three years.

So any international action will likely not only add to the current inflationary binge, possibly bringing inflation close to 10% in the main Western economies, but also should slow down growth quite rapidly.

World GDP growth in 2022 had been forecast to be about 4% at the turn of the year. Rising inflation has been edging this down and it might fall as low as 2% with the inflationary spur from the conflict with Russia if severe sanctions cause a much more serious spike in energy prices, pushing oil towards $130 and gas to 300p a therm with corresponding moves in metal prices. This would mean no growth at all for the rest of the year, possibly with some quarters of contraction, which would mean getting close to a recession (on the technical definition of two consecutive quarters with negative growth).

Perhaps the biggest issue that will determine how severely the West is affected by the issues with Russia is whether there is the cohesion and willpower to put up with sanctions on the scale that might eventually affect Russia. The analysis above suggests that action could be costly, particularly for living standards that are already under pressure.

Will voters be willing to accept an enhanced squeeze? The answer to that question will determine the scale of the hit to the world economy.

Douglas McWilliams is Deputy Chairman of Cebr.

Displaying its policy wonk origins, Michael Gove’s long-awaited white paper on levelling up the United Kingdom and one of the government’s flagship policies, is full of historical analogies and quotes. 

The 322 page epic starts with a tour d’horizon going back 7,000 years, the middle part is a detailed analysis of productivity differentials between regions, somewhat bedevilled by being based on out of date statistical definitions, while the end is a sort of “greatest hits” where virtually every type of regional policy that has been tried since the 1980s is repackaged.

Its biggest weakness is that it has neither analysed in any depth why the current regional disparities exist nor why the UK’s most successful local growth initiative in recent years, East London’s Flat White Economy, emerged. 

Without understanding either of these, the White Paper’s recommendations are likely to prove an expensive hotchpotch. One fears that much of the funding will be frittered away on various politicians’ pet schemes without doing much to solve the underlying problem.

The key analytical statement in the white paper is its analysis of the impact of globalisation:

“These dynamics of the global economy have benefited the UK overall, improving productivity, increasing wealth and driving up living standards through more innovation and competition. These dynamics, however, have not had the same positive economic and social impacts across the UK. While London and much of the South East have benefited economically, former industrial centres and many coastal communities have suffered. This has left deep and lasting scars in many of these places, damaging skills, jobs, innovation, pride in place, health and wellbeing.“

But this is extremely shallow. Most of the current disparities existed long before the recent bout of globalisation. The Jarrow marches were in the 1930s, the first regional disparities task force in the 1920s. And the global free trade of the 19^th century was what lay behind the success of Manchester, Birmingham, Glasgow, Belfast and the other great cities throughout the UK. 

Blaming everything on globalisation stands in the way of understanding how to make poorer areas richer.

A better approach than that in the White Paper would be to understand the nature of path dependency and see how areas that have become depressed then become unattractive to the skilled and talented and so their process of immiseration is continued. They get bogged down in despair. The physical infrastructure deteriorates. Breaking into this circle of causation is not easy but has to be undertaken before the depressed areas start to revive.

What is also essential is to move away from the 1960s style analysis that throwing money at the problem will solve it. This was tried and didn’t work. Which is not to say that government spending isn’t needed – but it has to be focussed on specific problems which are often different in different places.

Those who wrote the white paper see the problems of the depressed parts of the UK as a lack of capital of various different kinds to match the surplus labour that is available. But capital is in fact fairly easily available and government initiatives from the 1950s onwards have thrown infrastructure, investment grants and other finance at the problem. One of the side effects of this approach has been to create a class of well remunerated bureaucrats in the regions who often act as a barrier to solving the local problems.

Studying the Flat White Economy that emerged in the East End of London gives plenty of clues to how to solve the problem.

First, the extent of the previous deprivation in the East End needs to be understood. The 2000 planning white paper observed that “Many of the areas of East London identified by Charles Booth in the late 19^th century still show up today as having the worst social deprivation. In three wards in Tower Hamlets, over 80% of children live in households that depend on means tested benefits.” In the tail end of the 20^th century the level of deprivation meant that property was cheap and students and artists moved in. When Cebr moved to the border between Islington and Hackney in 2000 the area was reputed to have the greatest concentration of artists per square mile anywhere in the world.

The area’s strength in arts and film plus its cheap accommodation and its relatively central location with easy access to central London meant that as the web site design industry started to take off, East London became a natural location. Then the area became fashionable and success bred on success.  As a result the cost of housing in Shoreditch rose by 858% between January 1995 and November 2021 compared with 388% for the country as a whole.

The East End of London benefitted from luck. But as Gary Player used to say, the harder I practice the luckier I get. The biggest stroke of luck was the UK’s very early take off in online retail, roughly twice as fast as the other main European economies. This meant an early take off in online marketing. As the UK for many years had been the European centre for advertising there was a natural match between the East End’s artistic and creative skills and the burgeoning demand for websites and digital marketing.

The second stoke of luck was immigration. Immigration from all round the world but particularly from the then depressed economies in Eastern Europe (newly joining the EU) and Southern Europe (where the Euro had caused mass youth unemployment). Most of the immigrants were young and technologically literate. This provided not only a labour force but also a source of creativity. 

Most studies that analyse the source of artistic creativity shows that migrants who leave the comfort zone of their own countries show greater creativity. The analysis in my book about the East End’s renaissance The Flat White Economy showed that not only did these immigrants boost their own creativity but also that of the native population with whom they worked. As creativity is the raw material of the new knowledge economy, much as coal and iron were for the industrial age, this is critical in the creation of the knowledge economy.  

The third stroke of luck cannot be replicated elsewhere which is the proximity of the East End of London to the City. Which meant that the UK’s booming fintech sector was almost bound to move there. Fintech is now the strongest driving force of the Flat White sector.

So what lessons can be learned?

First, the ‘I’ word cannot be ignored. The White Paper mentions immigration 6 times. In each case explaining how Brexit has permitted immigration to be controlled. Yet there is no way in which regions with histories of low entrepreneurship and excessive dependence on the public sector can possibly revive without the entrepreneurial push from immigration. People with no history of starting businesses do not become entrepreneurs overnight. Reviving regions will need to attract striving people to kick start their businesses. It’s not just in the UK that migration is the key – for example the bulk of Silicon valley startups were started by migrants. Until Brits become more innately entrepreneurial, we will have to rely on our migrants for much of our entrepreneurialism as well as to boost our creativity.

Second, ignoring London is a mistake. One of the UK’s greatest national strengths is London and its cosmopolitan and exciting life. People from everywhere want to visit London – on the border between China and Mongolia 3 years ago an immigration official told me when I explained where I lived – “to visit London would be my dream”.

Far from stopping the ‘brain drain’ from the regions to London as is proposed in the White Paper, the regions need to build a circular brain drain where people go to London, make the connections that you can in a cosmopolitan capital, and then return to their own region to use their new found skills and connections to build up new businesses. Regions need to be connected with London, not to ignore it.

Third, regional cities will have to become aspirational to attract young people. This partly means building up local universities teaching on site, partly ensuring development of the clubs, bars and music venues that make places attractive to young people. One of the US’s most thriving tech hubs is Nashville, based on its historic music roots. Young people, particularly those who spend most of their lives behind screens, need to socialise. The places that look most attractive for socialising are often those that attract most skills.

Fourth is the realisation that most digital jobs aren’t actually digital. I’ve been explaining this to disbelieving techie people since I was Chief Economist at IBM UK in the 1980s. It’s still true today. Most of what becomes enabled by tech is not tech itself but something that uses tech. Website design is an example, creating mainly jobs for designers, not tech experts. Though investment in digital skills is important, helping people with other skills use tech is the real prize.

Finally, this vision of the knowledge economy is largely city based.  That is largely because cities, with their opportunities for socialising, tend to attract the pools of labour that are essential for a knowledge economy. There seems to be a particular desire to socialise for knowledge workers who are stuck in front of screens all day. Generating the sorts of venues that encourage this is pretty well impossible except in towns and cities.

What about devolution? The early experience is mixed. The danger is that devolution is used to funds the development of relatively authoritarian local one party states in regions which often discourage the development of alternative sources of power and influence. But devolution at its best can allow for different experiments in generating local growth that can be compared. Each successful experiment should lead to imitation.

Going back to the White Paper, other than the need to encourage immigration, which is crucial, many of the ideas that might make development of the knowledge economies in the regions of the UK are actually contained in it. But so are a whole host of other policies which could sidetrack both resources and energy. 

The key message is that any successful regional development initiative has to start from entrepreneurial businesses, not from government officials who are more likely to obstruct development than promote it. Tees Valley Mayor Ben Houchen wants the power to cut taxes to attract businesses. Margaret Thatcher’s enterprise zones provided tax holidays. Even Harold Wilson’s Selective Employment Tax and Regional Employment Premium tried to cut the cost of labour in regional areas through tax rebates.

The scope to cut local taxes would almost certainly do more than a whole host of government spending initiatives to help start to bridge the regional divide. But any policy that doesn’t attract creative and entrepreneurial immigrants is unlikely to do much to solve so entrenched a problem.

Douglas McWilliams is Deputy Chairman of Cebr the economics consultancy. His book, The Flat White Economy, chronicles the emergence of London’s tech sector. He has also been Chief Economist for IBM UK.

I spent nearly ten years of my life at the CBI campaigning against Denis Healey’s National Insurance Surcharge (a deliberate act of revenge after CBI encouraged the Liberals in the Lib Lab pact to vote to reduce income tax) and eventually after many years of what one CBI Director General called the Chinese water torture treatment we finally got the surcharge rescinded in 1985. There are very few arguments against National Insurance increases that I haven’t deployed.

But claiming that they don’t raise revenue is not one that cuts much ice even with me, let alone the Treasury.

However, there are taxes that currently exist that could be cut without loss of revenue. Indeed in some cases (generally after a few years) the tax cuts would generate more revenue. In theory the Chancellor could even abolish the planned NI increases AND cut these taxes and still end up with cash in the bank. Of course Treasury officials, who tend to be unreasonably cautious about the benefits of cutting taxes, will deploy their arguments against. But many of these Treasury arguments are specious – indeed those against the VAT Retail Export scheme (see below) were described in the Administrative Court recently as ‘containing schoolboy errors’.

Stamp Duty

The 40% fall in housing transactions from their Q1 peak to their Q4 level last year after the stamp duty rates returned to their previous levels shows the extent to which property transactions are affected by stamp duties. Short term tax holidays work partly by shifting the timing of transactions but that effect washes out eventually. 

But my colleagues at Cebr have looked at the long term impact of keeping the holiday permanent. Even then £4 billion of initial revenue loss is offset by increased revenues of between £2-4 billion gains elsewhere. But replacing the high rates (as much as 12% and in some cases 15%) with a low rate of at most 3% across the board would almost certainly generate more revenue, not less.

The withdrawal of allowances from those earning more than £100,000 

This is a dog’s dinner of a tax, one of the remnants of Gordon Brown’s fag end administration and announced so that it would not come into effect until he had left office. It’s well known that the key to efficient taxation is to keep marginal rates low. So what did he do – he raised the marginal rate of tax to 62% on the rise in income from £100,000 to £125,000 by phasing out tax allowances for those earning over £100,000. In effect imposing a massive marginal tax rate not on the very rich but the sort of aggressive middle managers who the country most needs. And the April rise in NI takes this marginal rate up to 63.25% It’s worth noting that this means that out of every £1,000 you earn, you pay £632.50 additional in tax. Leaving you with only £367.50 in income. Research in the US shows that those earning above $100,000 are especially sensitive to marginal rates of tax with an income elasticity of 0.57, nearly one and a half times that of lower income earners. This implies that restoring the allowances would have little or no long term cost.

The VAT Retail Export Scheme

This is a scheme where overseas visitors can purchase and reclaim their VAT when they return home. It worked so well that pre pandemic Bicester Village rivalled the British Museum as the UK’s largest tour attraction as tourists from the Far East and Middle East flocked there for the shopping. Rishi Sunak scrapped the scheme after being told by his Treasury officials that post Brexit he would otherwise have to extend it to all comers instead of those from outside the EU.

The Treasury seemed to base their claim on the assumption that only a million applications for VAT returns were made. This, as was pointed out in the Administrative Court, was only one of a series of schoolboy errors in the Treasury calculation – in fact many tourists from the Far East travel in groups and the group guide handles the VAT reclaims which is why there are fewer claims than the number of tourists affected. 

Cebr’s calculation showed that far from saving money, high value tourism from the Middle and Far East would crash post abolition and that it would cost the Treasury around £500 million a year. Obviously tourism has crashed though clearly most of that is the pandemic. But we estimate that, as tourism returns, reinstating the scheme would generate that lost £500 million.

But what would make more sense would be to extend the scheme to visitors from the EU. This would generate additional revenue if on a smaller scale (£100 million or so) and allow for big retail parks near the Channel ports as the post Brexit need for lorry parks diminishes. It would also prove especially irritating to the French….

With tourism returning, countries around the world will be doing what they can to get more than their share. Here is an easy way. And it would make money too!

Corporation tax 

The Chancellor seems to be operating under the delusion that high corporation tax rates generate revenues. In which case why did the Irish fight so hard to retain their low 12.5% rate? In reality cuts in Corporation tax lose revenues only in the very short term and normally raise them in the longer term. 

Simulations on Cebr’s model show that it would take fewer than 5 years for a corporation tax cut to 15% to start to raise revenue and that 10 years on GDP would be up as much as 7% and tax receipts up by nearly £20 billions. Why wait?

Dividend tax

The UK’s top rate of dividend tax, 38.1% on incomes over £150,000, is one of the very highest in the world and is a huge disincentive to savings. Moreover it is set to rise to 39.35% in April.

Most of the theory on optimal taxation suggests quite low rates, if any, on dividend taxation. Mankiw and his colleagues write ‘Both statutory tax rates on capital and measures of effective tax rates remain far from zero, the level recommended by standard optimal tax models’.

The reason for the high rate in the UK is to reduce the incentive for high income taxpayers to pay themselves in dividends rather than income. But the disincentive to building up profitable companies is considerable. And it’s not clear that the higher rates of dividend taxation have in fact yielded additional net revenues.

Top marginal tax rates

For many years the UK’s top marginal rate was 40% and the country prospered. But Gordon Brown, in yet another booby trap which he left for his successors, put the rate up to a nominal rate of 50%. George Osborne managed to get the rate down to 45% (actually 47% with the NI Surcharge) and it is due to go up now (including the surcharge) to 48.25% in April.

Cebr’s analysis of the impact of the 50p rate was that the alleged £2.5 billion that it raised initially were on course to becoming a £1 billion loss after 5 years. And of course when the tax was cut revenues went up, even grudgingly admitted by the Treasury.

Reversing the recent trend and getting the tax back down would improve the country’s economic finances as well as making it more attractive to outsiders.

The importance of low taxes has increased in recent years. 

First, both business and people have become increasingly globally mobile. Higher taxes are shooting yourself in the foot in the race to attract high value business and people. 

Second, post pandemic, there has been a supply side crunch. People are no longer so willing to work even a full 5 day week let alone long hours. The break in routines caused by working from home has caused people to reconsider whether to work at all let alone long hours. One of the most attractive features of leisure time is that it is not taxed. This means that the economic cost in reduced effort from high marginal rates of tax has risen and that optimal marginal tax rates have fallen even from the revenue maximising 40% calculated a few years ago.

Perversely the less willing people are to work, the more they have to be incentivised by lower taxes. But the good news is that taxes CAN be cut without harming fiscal rectitude if the cuts are targeted carefully.

Douglas McWilliams is the founder and Deputy Chairman of Cebr, the economics consultancy.

The proximate causes are supply shortages and especially the energy shortage. But underpinning this is the 27% rise in M2 in the year to last February and the 13% rise in the year to last November. Together with expansionary fiscal policy this is adding to the imbalance between demand and supply. Not factored into these inflation figures but likely to affect those for early 2022 is the impact on labour shortages of the Omicron variant.

The massive fiscal and monetary expansion in early 2020 was part of a deliberate attempt to prevent the pandemic induced downturn from turning into a prolonged depression. It worked just a bit too well and, even some of us who supported the initial expansion were worried more than a year ago about the failure to turn the tap off as the economy bounced back. The authorities and particularly the Keynesian economics establishment haven’t exactly covered themselves with glory, first refusing to accept that higher inflation would be likely, then making a series of dog ate my homework excuses for why it was only transitory. Now that it has proved not to be, the issue is how to deal with the problem.

Federal reserve chairman Jerome Powell, not an economist himself, gives the impression that he feels his experts have let him down and seems to be adopting a hawkish stance. The next test for this will be the 26 January Federal Open Market Committee where there is a good chance that a new higher target for the Federal Funds rate will be announced.

Looking further ahead, what has to be done to deal with the inflation? Because we are in uncharted territory few have much of a feeling for how much medicine has to be applied. My best guess, and I don’t pretend it’s anything more than a hunch based on looking at these issues for nearly 50 years, is that the rate rise that might be necessary to slow the economy down could be surprisingly small – perhaps less than 250 basis points. 

But the reason that I think this to be the case is because I suspect that asset markets are likely to face an overgeared reaction to such a rise. In Cebr’s Top Ten forecasts for 2022, I surmised that we could see a 15-25% fall in asset prices over the next 18 months, pulling growth down virtually to a standstill during 2023. That, and the associated sharp rise in unemployment, should be enough to bring inflation under control.

None of this is great news for President Biden or indeed the leaders in other Western economies facing essentially similar issues.

Cynics pointed out that the main factor that had changed since the September testimony was that Powell had since been reappointed by President Biden and could therefore now say what he wanted to say. Technically, he still awaits confirmation by the Senate but if his appointment were to be derailed on account of his apparent change of mind the US markets would take a much bigger pasting. It is unlikely that the Senators would want to be seen to cause such a market collapse hitting the wealth of their constituents.

There are three key follow up questions. Is Chairman Powell right to be more concerned about inflationary prospects? What does this mean for the likely course of policy in the US? And how will the likely more aggressive trend in US policy tightening affect other countries including the UK?

We at Cebr have been closer to the inflation hawks than the doves consistently through this cycle. Although we are not by any means hard line monetarists, we do accept that the amount of money in circulation affects the real economy, especially through its influence on asset prices. And the jump of a fifth in the US money supply in first part of 2020, with double digit growth still continuing, has been an important factor boosting property prices and sustaining equity and bond prices. On top of this the supply disruptions caused by Covid are abating only slowly and are now expected to continue through the first half of next year. Prices of many commodities have slipped back from their peaks of a few weeks ago but most now seem to have stopped falling. Unfilled vacancies in the US are also historically high at 10.4 million compared with a pre pandemic peak of 7.5 million leading to upward pressure on wages.

So, we are glad that Chairman Powell, like the repenting sinner, has come over to our side. While the purists amongst us find it hard to admire his apparent duplicity, his approach was probably that most likely to ensure that President Biden appointed a Fed chairman who was concerned about inflation.

The markets have now priced in an orderly pace of tapering of quantitative easing with bond buying ending around April next year and probably two rises in interest rates thereafter in 2022.

And yet inflationary expectations have been consistently trending upwards and it seems quite possible that the policy tightening (in reality policy being made slightly less loose) could be accelerated compared with current market expectations.

Emerging markets typically react in a more highly geared fashion to US monetary policy changes and it seems possible that countries like Turkey and Argentina will be forced to respond.

What about the UK? Many of the inflationary signals in the UK mirror those in the US with a tightening labour market, supply shortages and permissive monetary policy driving asset price inflation. And the UK’s uncomfortable post Brexit trade transition means that policy makers would be unlikely to want to follow a monetary policy that pushes up the exchange rate. 

So for them, the likely faster pace of tightening in the US makes it easier for the MPC to tighten policy without risking an upward surge in sterling. Moreover, tightening in the US, plus its knock-on effect in other countries, will remove some of the international inflationary momentum. And while the impact of the Omicron variant is as yet uncertain, we suspect that UK rate rises will be a bit faster than is factored in by the consensus view, with a lift off in interest rates on the books as early as February.

The author is deputy chairman of Cebr

We need to be a little careful with this because the basis for comparison was the pandemic affected 2020 so year-on-year data may be misleading. Moreover, lower paid workers were dropping out of the labour force at a higher rate during the pandemic which has further contributed to inflated wage growth readings. However, the ONS itself claims that these distortions are unwinding now. The data show private sector earnings up 6.6% in the year to Q3 and total average earnings up 5.8% when including the public sector, whose pay often lags behind. Taken together with the jump in the headline consumer price index from 2.9% in September to 3.8% in October on the CPIH measure, the data on wage and price inflation is powerful evidence that inflationary pressures are taking root.

For a long time, lazy economists have predicted the trend inflation in the following year by subtracting from the rise in private sector wages the rise in trend productivity to give the trend in unit labour costs. These are currently rising at just over 5%.

It is possible that inflation next year will be less than this because some of the peaks in energy, commodity and shipping costs may subside. But it is hard to see inflation in a year’s time anywhere near the Bank of England’s target rate of 2%. It looks as though the authorities are way behind the curve in understanding what is going on in both the goods and labour markets and hence in their understanding of the scale of inflationary momentum.

What is interesting is that the same authorities who played a blinder in designing innovative policies to prevent unemployment rising are the ones accused of losing the plot on inflation. How can this be so?

First, it is not unusual for people to get one thing right and another thing wrong. Approaches to policymaking that can work in one set of circumstances can fail in another. At the start of the pandemic officials worked through the night to deal with a theoretical but real problem – that the economy could wind itself into a deflationary spiral during lockdown, with incomes and employment falling, leading to reduced spending power which would have further exacerbated the problem. They were probably aware that they might pump in too much monetary and fiscal stimulus. But they felt that this was a risk worth taking. My judgement was the same and I think they deserve a lot of credit for this.

Post pandemic, however, they seem to have been slightly unaware of the economic trends. My New Year’s prediction for UK GDP growth in 2021 was 8%. It looks now as if it might come in slightly lower but not far off. Yet as late as March, the OBR was forecasting growth of just 4%. The difference goes a long way to explain the lack of understanding of inflationary trends.

Essentially, those economists who only relied on official statistics got it badly wrong. Those who were able to augment the statistical information with an understanding of what was really going on from their own business experience (and some of us have the perhaps unfair advantage of many years of listening to the business vibes and have a sense of how to interpret them) were closer to understanding what was happening. I’m still surprised that Whitehall and the Bank routinely pay so little attention to what the most experienced outsiders think, but that is their choice. Sometimes government statistics and theory are enough. But often they are not and when, as a result, the authorities make policy mistakes – like inflation – they will receive criticism to go with the deserved praise for when they get it right.

The author is deputy chairman of CEBR and the author of The Flat White Economy.

As someone living in Tenterden, England’s sparkling wine capital and our equivalent of Rheims (our St Mildred’s church is pretty good too, even if it can’t compete with Rheims Cathedral), I can hardly complain about the tax cut on English sparkling wine in today’s budget.

But otherwise the Chancellor is hoping that economic growth and a fairly lax fiscal stance will bail him out as inflation subsides.

The economy is clearly overheating and yet has a substantial budget deficit. At the same time the UK is dropping in the tax competitiveness league tables. With demands for increased public funding on a range of services and economic pressures on the other hand, one would have expected the Budget priorities to be reducing inflationary pressure, easing the supply constraints and reforming taxes and public services to get more from less. But we have a budget that is essentially tax and spend, though at the end the Chancellor claimed that he hoped to manage pre-election tax cuts. He is clearly hoping that the supply problems will simply go away.

He has been helped by his team’s earlier forecasting errors last March which meant that the UK’s economic growth has been running strongly ahead of assumptions. But his forecasts are put at risk by the extent of the inflationary pressures. Although it is technically the task of the Monetary Policy Committee to handle inflation, Sunak will get the blame if it all goes wrong. And UK officialdom has appeared dangerously complacent in the face of rising input prices, shortages of goods, shortages of labour and upward wage pressure, all fuelled by fiscal and monetary laxity. The inflation forecast in the Budget for 2022 has now caught up with Cebr’s forecasts with a prediction of four per cent inflation next year, even after the freezes on fuel and alcohol duties. The Chancellor is betting on inflation falling back of its own accord in 2023. Given the earlier forecasting errors, he can’t rely on his officials getting it right.

There is a new fiscal framework, slightly more lax than before. One’s suspicion is that this won’t help if inflation appears to be running out of control where the real pressures on the MPC will come from the financial markets, not the framework. Public spending has been boosted, by a total of £141 billion over the next five fiscal years. And although there are tax reliefs announced in the Budget, they pale into insignificance compared with the £17 billion a year tax rise from the National Insurance hike announced a few weeks ago and the expected yield of £7 billion from changing the system of pensions uprating.

Many of the policies adopted in the Budget reflect the fruits of research carried out by my Cebr colleagues including the changes in alcohol duty, draught relief in pubs, the freeze in fuel duty, the increased funding for the arts, the rates relief for retail and hospitality and the tax reliefs for maritime. We also approve of the reduction in the Universal Credit taper to make work pay.

Will it all work and help Rishi Sunak’s premiership ambitions? It all depends on whether inflation falls in 2023 as he forecasts. If it does, a very confident Budget might well be seen as a vote winner. If it doesn’t, all bets are off.

Douglas McWilliams is founder and deputy chairman of Cebr, the economics consultants.

Over the last week we have heard the Governor, Andrew Bailey, hint at an early rate rise overturning earlier hints that interest rates rises were on the cards for next year, while MPC member, Silvana Tenreyro, has argued that there was no need to raise rates because the markets had already anticipated a rise.

This lack of a clear communication from the Governor leaves the markets with mixed messages, leaving traders and investors to scratch their heads over what to expect.

At least with the previous Governor, Mark Carney, they knew what to anticipate: his statements were treated as contra-indicators, so far off beam was his understanding of the UK economy. Today the markets only think the Bank is confused – under Carney they would routinely bet he was badly wrong.

Underlying all this confusion of what to do next is that the Bank doesn’t understand what is happening to the UK economy. It has routinely failed to understand that in the modern tech based economy, the economic relationships have changed dramatically.

 Because so many of the parts of the economy which are growing are in sectors that get badly measured by the statisticians, you need to build in the likelihood of statistical understatement into your understanding of what is actually happening. 

At the same time, the labour market is rapidly changing shape too. Many older people, having got used to not commuting over the last 18 months, are not likely to get back into the rat race as they now know they do not have to spend four hours a day commuting.

It also seems as though the Bank doesn’t want to know what is happening on the ground. When I offered to help the previous BoE Chief Economist Andy Haldane, for free, to bring him up to speed with the modern economy and suggested that some of my commercial rivals would probably also be happy to do so, his response was arrogantly dismissive of a few decades worth of economic understanding. 

With the current bout of inflation the Bank has told us first that it was a blip, then that it was temporary. Now the new chief economist has claimed that the temporary period might be extended, temporarily maybe. Or not. No one knows.

There seems little realisation that against a background of huge monetary and fiscal expansion during the lockdown period to stave off many of the secondary impacts of the pandemic (where at the time the authorities played a blinder in my view), it was likely that the response might be an inflation overshoot that would then need to be reined back in. 

The effect is doubled up by the fact that the US economy is also in bubble territory and even the Eurozone, which conventionally lags behind, is picking up. The Chinese have deliberately acted to burst their property bubble, for both political and economic reasons. But in the West the authorities have so far done little.

We are so far into uncharted territory that anyone who is certain about what might happen next is making it up. But my guess is that the rise in price inflation and the shortages of many goods, combined with labour shortages, will create a pay price spiral. 

There is plenty of monetary kindling out there to keep the inflationary fire burning. And so rates will probably rise much more than anyone currently thinks to create a recession to bring down this spiral. 

Which is why it would make sense, and would reduce the total requirement for interest rate rises, if the process of raising rates were to start when the MPC next presents its findings on Thursday 4th November, the day before bonfire night.

The author is deputy chairman of CEBR and the author of The Flat White Economy.

And there are very few ideas so silly that they don’t have a grain of truth in them. In this case there are plenty of individual examples and some professions where cheap immigrant labour has prevented sensible automation or has undercut wages. 

But in most professions, preventing shortages with foreign labour has also permitted additional growth that has bolstered the economy leading to higher wages on average.

 In the more creative and digital sectors, the influx of talented migrants has boosted creativity not only of the migrants but also the indigenous labour force and led to the emergence of what I have called The Flat White Economy which is now the UK’s key economic driving force.

So the idea that Brexit will permit higher wages is largely, though not completely, wrong.

But not only is it wrong, but also (to misquote either Talleyrand or more probably Fouché’s comments about the killing of the Duc d’Enghien) it is a mistake. Most economists know that you can’t vote yourself rich. The only way in which living standards can be improved sustainably is by raising productivity. This can emerge from becoming more skilled or through processes being automated. 

Simply raising wages without raising productivity at best leads to higher unemployment and at worst to a strengthening of the emerging price-wage spiral that may require a recession in the middle of this decade to be brought to a halt. Anyone who lived through the 1970s will know that risking a return to such a spiral is especially foolish.

So the spectacle of Tory politicians including the Prime Minister indulging in a species of hate speech against businessmen who are struggling to overcome the effects of lockdown is not only unedifying but also bad economics.

Road hauliers kept the country alive, literally, during government imposed lockdowns, despite being hit with low traffic zones, fines, removal of tax breaks and nearly inhuman Covid imposed restrictions like being held in their vehicles and not even being allowed to leave them to go to the loo. 

Ministerial criticism is especially inappropriate in these circumstances – humble apologies would be more suitable. Ministers blaming the road haulage Industry, which has paid £120 million in apprenticeship levies and only received £10 million back in training grants, for lack of investment in training seem peculiarly unfortunate. 

I have personal experience of setting up one of the government’s apprenticeship schemes and have seen for myself how the government’s own rules made it unworkable for the private sector.

But Ministers have reserved their worst ripostes for Simon Wolfson, founder of Next. In response to Lord Wolfson’s claim that the country needed more immigration to overcome supply shortages and secure growth the Prime Minister claimed that business had been “mainlining” cheap immigrant labour for years before Brexit. 

He hit back specifically at Lord Wolfson, suggesting he wanted “uncontrolled immigration” and added that business hasn’t been investing into skills or infrastructure.

The criticism of Lord Wolfson is factually incorrect. His recent article in the Evening Standard merely echoes arguments that my Cebr colleagues and I have made persistently that the way in which immigration is currently being run in the UK manages uniquely to combine damage to the economy, harshness to those coming to the UK and maximum ineffectiveness as the flow of dinghies filled with asylum seekers arriving in Kent demonstrates. 

There are better ways to run an immigration policy without simply allowing everyone in. If the government ran the country as well as Lord Wolfson runs his business we would not have the current problems.

The extent of Ministers’ apparent rage at the business sector that essentially bailed the government out during lockdown suggests a degree of paranoia in government circles.

It wouldn’t be surprising that after 18 months of fighting the pandemic which has imposed considerable stress on those in Whitehall, they have forgotten how much the country owes to the resilience of the business sector. 

Often people working in Whitehall dream the illusion that they are the ones who make the country tick, especially if lockdown causes them to lose direct contact with the ordinary businessmen who do the dirty work of actually keeping the economy moving. 

The decline of business representative organisations from the days when they were run by household names like Laings, Costains, McAlpines, Cadburys and Sainsburys (I was a mere minion amongst them) often replaced by commentariat chameleons angling for an honour, has added to Whitehall’s insulation from the front-line of business.

Moreover, the challenge that they have chosen for the immediate future, that of achieving net zero, will make life especially hard for the business sector and will also cut real wages anyway.

Some of the government’s announced plans in recent months, like raising taxes on both businesses and employees, and the aggressive pushing of climate change policies without ensuring the necessary infrastructure to make them work, have given the impression that through the pandemic they have lost touch with economic reality. 

The attacks on business back up this impression. Unless those Ministers with relatively recent business experience can bring it to bear and shift the government back on course, the risk is that the economy will spiral out of control, with rising inflation from higher wages, shortages and government imposed costs leading eventually to a savage recession. 

Like the most useful forecasts, it would be best if the warning is heeded and as a result the forecast is proved wrong.

Douglas McWilliams is Deputy Chairman of Cebr the economics consultancy which he founded. Previously he was the Chief Economic Adviser of the CBI.

The debate about the funding of social care has reopened the arguments about the inequality of wealth distribution in the UK between the old and the young.

The generally accepted narrative, aggressively promoted in Lord Willetts’ book, The Pinch – How the baby boomers took their children’s future – and why they should give it back, and the subject of a leading article in the latest Spectator by editor Fraser Nelson is that the rise in house prices has promoted an unintended redistribution of wealth from the young to the old which needs to be reversed.

At first sight this seems plausible. Everyone knows that UK house prices are sky-high and that they have risen consistently over the years. The difficulty for young people finding accommodation, especially in Central London (at least pre-pandemic) is also very obvious.

And yet. Cebr research for Legal and General published last month shows that older people have been increasingly forced to stay in the labour force because of a lack of sufficient wealth to pay for their old age. The proportion of UK over-50s having to work has risen from 31 per cent in 1992 to 40 per cent in 2020 and is set to reach 47 per cent by 2030.

If the Willetts/Nelson narrative were true, it would be unlikely that nearly half of those over 50 would be forced to have to keep working to pay for their old age.

So what is really going on?

To understand what is happening, the key point that needs to be remembered is that money is only worth what you can buy with it. It is easy to get fixated on the crude figures but any sensible analysis about the distribution of wealth should focus on the spending power generated by that wealth, not just on the crude numbers.

And when the veil of what economists technically call “money illusion” is drawn back, what emerges is a very different picture indeed from that which is assumed by those who accept the conventional wisdom.

The bulk of the rise in house prices that has taken place over the past 30 years has been driven by the fall in mortgage rates. The amount spent on housing in relation to incomes has been remarkably stable. Average mortgage payments as a percentage of average earnings peaked in 2007 at 50 per cent but have since fallen back to 32 per cent – close to the long term average. While house prices have risen, mortgage rates have fallen and roughly over time the two have offset each other. The government’s experimental series for rents only covers the period since 2005. But since then rents have risen by 33 per cent compared with an average earnings increase of 39 per cent (and the 39 per cent was held down by the pandemic!). The RPI data for housing rent goes back further and in the period since 1997 this has risen by 75 per cent compared with average earnings, rising by 83 per cent over the same period. So in relation to earnings rents have gone down, not up.

The baby boomers who purchased property in the last quarter of the 20^th century made huge sacrifices to make these purchases at mortgage rates of 15 per cent and more. One of the reasons that I am such a bad skier, relying on strength to compensate for lack of technique, is that I simply couldn’t afford a skiing holiday before I was 35 because of the crippling costs of mortgage repayment. Young people today would laugh not just at my skiing technique but at the thought that people in the 1980s and 1990s prioritised paying mortgages over going on holiday.

Meanwhile, the cost of retirement has sky rocketed. In 1979 it cost only £55,600 to buy an annuity at age 65 to provide an average income of £10,000 a year. Now the same annuity would cost £201,300. This has been driven by two causes – increasing longevity and falling yields.

So the true picture, once you adjust for spending power and buying power, is that the young are not particularly badly off – as indeed can be seen from their spending on holidays and eating and drinking out. But they are less interested in saving for their old age despite the fact that mortgage repayments are historically affordable even after allowing for higher house prices. While at the same time the old are chronically worried about whether they can make ends meet because of rising life expectancy and falling yields.

Of course there is an extent to which the conventional wisdom of expensive housing and over-wealthy pensioners based on purely cash-based calculations is true. Young people still have to raise large sums of cash to pay the deposits when they enter the housing market. This acts as a barrier to entry to those who cannot benefit from what my Cebr colleagues named The Bank of Mum and Dad (BOMAD), where middle class parents use their own housing equity to pay for the deposits on house purchases for their children.

And older people could raise cash to make their old age much more comfortable by selling their houses and downsizing. But crippling stamp duties of as much as 12 per cent make this much more difficult than it might appear. With the transactions costs of moving house running at around 9 per cent paying for movers, solicitors, estate agents and the like, much of the wealth that might be liberated by downsizing disappears in tax and moving costs. In reality one would need to move to a property worth about half the value of one’s current property before liberating a significant amount of cash. So people stay put in larger properties than they need. And their theoretical wealth is just notional – and although it would be possible to use various lending devices to borrow against their housing wealth and to finance their lifestyles, older people do not like doing this.

So, if the baby boomers did not in fact steal young people’s future, why are the young unhappy?

The biggest change in young people’s financing arrangements from when I was younger is that many more people go to university but the Treasury has funded this though the student loan scheme instead of the grants that were available in earlier years and has allowed universities to charge higher fees. The original Treasury intention was that bringing the market into academic education would lead to an improvement in courses and better value for money. It appears that the opposite has happened. There has been an explosion of courses, and though many are likely to be of economic value, many are not. While universities have grabbed the extra cash to pay their senior staff (especially the non-academic staff) significant salary increases. Vice-chancellors in particular have benefitted to the extent that the average pay for a vice-chancellor of a Russell Group university last year had reached £389,340.

Because those who don’t reach the earnings threshold don’t have to repay their loans, which eventually get written off, there is a disincentive for many students to study those courses that will lead to high levels of remuneration. My Cebr colleagues estimate that the UK may need as many as a 177,000 additional experts in Artificial Intelligence by 2031. This compares with only 355 new students enrolled in the subject at all UK universities this year. At the current rate it would take 498 years to educate those whom we need in ten years’ time. So the unintended result of the Treasury’s cunning scheme has been to leave the better off students funding unnecessary courses, overpaid vice-chancellors as well as their less successful contemporaries. This is unfair on just so many levels besides creating adverse incentives that damage the economy.

What does this mean for the funding of social care and the associated redistribution of wealth?

Any sensible reform of age care needs to factor in three things.

First, those who save to build up wealth should not be disincentivised excessively over those who do not. The UK has always had a relatively low savings ratio and with demographic trends against saving it is important not to make this problem worse.

Second, it should be made easier for older people to release cash by downsizing their housing by removing the huge and damaging stamp duty charge.

Third, the Bank of Mum and Dad needs to be made less discriminatory by being made more available to those who do not have the privilege of rich parents to pay their deposits on their houses. I suggested in my book, The Inequality Paradox, that inheritance tax could be restructured to make its effects more redistributional.

The idea that the baby boomers have stolen the young’s inheritance is, like the crocodiles breeding in the sewerage system, an urban myth.

If anyone has stolen anything from the young, it is the Treasury and the universities.

Douglas McWilliams is Deputy Chairman of the economics consultancy Cebr which he founded in 1993.

With the Chinese economy of similar order of magnitude in nominal terms to the US economy and much larger in PPP terms (and hence the dominant importer of most primary commodities), the stability of the Chinese economy is of importance not only to China.

As ever, Westerners speculate about motives. Kamikaze is not a concept generally associated with the Chinese. So what is going on?

The Cebr interpretation of this is less apocalyptic than that of some observers. We think two motives are at work, both intended to increase longer term stability. The first is a sense by the Communist Party that Chinese companies have played fast and loose with rules and have used western listings and VIE (virtual interest entity) listings to evade local laws. This both created risks and vulnerabilities which, if left unchecked, could put the whole system at risk. The second is that the scale of the borrowing that has partly fuelled Chinese growth since the 2008/09 financial crisis has its own risks and the authorities have been keen to defuse the credit bubble before it creates serious problems.

Evergrande has played an intrinsic part in the Chinese property boom. Because markets for other assets are less well established in China than in the West, many Chinese prefer to hold property as their main long term assets. In addition, it is possible to own property through nominee companies which means that undeclared sources of income (which remain considerable in China) can be laundered through the property market. 

The result is a substantial economic dependence on the property market with the average residential property worth 28 times average income (compared with an equivalent ratio of 9.5 for the UK, itself often accused of having expensive property). Combined with a standard model of housing development in the East where the development is financed by advance payments from potential purchasers, the potential for damage if the market collapses is considerable. And according to a 2016 article in Forbes magazine, 15% of Chinese residential property is fully paid for in cash, often transported in bulging suitcases.

Our guess is that the authorities are allowing a cooling of the property and other markets now as part of the price that they are prepared to pay to reduce the medium term risks to the system of a much larger collapse. And that they are trying to limit exposure to Western markets for a range of reasons, both political and economic.

While this adjustment is taking place, companies’ ability to raise capital will be more limited and bank lending more constrained. Both will reduce economic growth temporarily and we are revising down our Chinese growth forecast for 2021 and 2022 by about 1 percentage point each year. But the Chinese authorities will feel justified if a temporary dip enables them to avoid a more serious downturn, a risk that might have been reinforced if the West were to have an inflationary boom and bust at some point in the next decade.

Gordon Brown famously claimed to have ‘abolished boom and bust’ just before the evidence emerged that he had not. Might the Chinese authorities have succeeded where he failed?

Douglas McWilliams is Deputy Chairman of the Centre for Economics and Business Research (Cebr).

The worldwide recession caused by the first oil shock when the price per barrel shot up from $3 to $14 removed the shortages. But an interim effect was rising inflation. In the UK, where trade union power was at its zenith, twelve-monthly RPI inflation peaked at 26.9 per cent in June 1975. In the US, inflation peaked in the mid-1970s at 12.3 per cent but actually surpassed that peak in 1980 after the second oil price shock, reaching 14.8 per cent in March 1980. Even the countries that were considered to have handled the inflationary pressure “well” like Switzerland and Germany had annual inflation of 9.8 per cent and 7.0 per cent at their peaks in the mid-1970s.

There are eerie echoes of this today. Pictures abound of empty shelves, sometimes attributed to Brexit. There is a global shortage of electronic chips. Ironically also a shortage of French fries in the US, though the two are largely unrelated. There is a shortage of drivers of all kinds, especially of HGVs in the UK where Brexit is clearly part of the problem – though since we at Centre for Economics and Business Research (a London-based economics consultancy) wrote our first report on the coming HGV driver shortage over 15 years ago, Brexit can’t be the whole story. The May data for Japanese car production showed a 19.4 per cent fall mainly because of semiconductor shortages. The average lead time for chips is assessed at 19 to 54 weeks: these items are normally available either off the shelf or within a month. Food shortages are emerging around the world. Shipping prices have soared; the pre-pandemic cost of shipping a container from China to Ireland was €1,250. It is now €8,000.

Cebr has been relatively optimistic about the pace of the recovery this year in both the US and the UK and while there is still plenty of time to be proved wrong, the consensus forecast has gradually caught up with us. But the consensus view at the beginning of the year was for quite a subdued upturn and the scale of the recovery has taken many businesses by surprise. This is probably the biggest single reason for the shortages. Further contributing to this have been a wide range of supply problems, ranging from the blockage of the Suez Canal to shut sawmills creating shortages of lumber to petrochemical plants in the Gulf of Mexico shut by winter storms.

An underlying cause is that companies have been reducing inventory and moving to just-in-time, “lean” production for over 40 years. Inventories were clearly excessive in the 1970s – I remember one of my fellow students doing the stocktaking for tyres in the British Leyland plant in Oxford who discovered that the workers had created a “cave” within the pile of tyres and had installed beds and chairs, television sets and a card table. But I’ve always been surprised at the extent of management effort devoted to minimising inventories when the cost of holding them has been relatively low and the damage from disruption if anything runs short is high. The potential benefits have typically been more to do with financial engineering than productivity.

In the UK the problems, if not entirely attributable to Brexit, have almost certainly been exacerbated by it. The combination of COVID and Brexit is an important contributor to the HGV driver shortage. Pre-Brexit, Cebr estimated a shortage of about 60,000 drivers. The latest equivalent estimate is over 100,000. 

Some of the UK’s food shortages are also due either to Brexit or to post-Brexit customs regulations. And, although the exodus of foreign workers from the UK is at least partly due to COVID, it would also be hard not to attribute a sizable proportion to Brexit and the highly bureaucratic post-Brexit migration rules. Some of the Brexit-related problems could be reduced by UK government action – most obviously that of labour shortages where bureaucratic procedures are making it much more difficult than necessary to obtain staff, as my colleague Kay Neufeld pointed out in recently. There are also two upside Brexit impacts on shortages for the UK, though these are rather smaller than the downsides. Firstly, shortages will accelerate attempts to streamline post-Brexit processes. And secondly, products (especially food) for which exports are being frustrated post Brexit are becoming more easily available for domestic consumption.

Most industrial experts expect the impact of shortages to grow during the rest of 2021 and particularly hold back economic growth in 2022. It is possible that they could reduce GDP growth worldwide by more than 1 per cent.

But this is small beer compared to the impact shortages might have if they lead to 1970s style double digit inflation. Empirical work suggests that if inflation is running at 10 per cent, the cost of getting it back down to 2 per cent is at least 4 per cent of GDP.

The only answer to inflation caused by shortages is to reverse expansionary fiscal and monetary policies. But governments can do more to speed up the pace with which the economy returns to low inflation. In particular, they can boost competition and they can deregulate. They also need to be very tactical about policies that might raise prices such as higher indirect taxes and climate change policies. The timing of imposing restrictions to meet climate change objectives might need to be carefully aligned with macroeconomic objectives to avoid a suboptimal result.

Douglas McWilliams is Deputy Chairman of the Centre for Economics and Business Research (Cebr).