Monthly Archives: December 2015

The British state is not being shrunk beyond Thatcher’s dreams

In the Guardian recently, Polly Toynbee claimed that the current British government was “driving the state below the size of anything attempted by Margaret Thatcher”. The truth is that it isn’t.

Chart 1 shows British government total managed expenditure since Margaret Thatcher took office in 1979. It shows it in real prices, ie, corrected for inflation so the numbers across years are comparable.

Chart 1

Picture2

Source: Office for Budget Responsibility

What it shows is that in real terms, on official projections, British government spending in 2020-2021 will be 81% above even the highest figure of Margaret Thatcher’s time in office (1984-1985).

It is difficult to believe that Ms Toynbee is unaware of this. What we appear to have here, then, is another, particularly glaring example, of someone saying something that isn’t true in the hope that nobody will actually check whether it is or isn’t. Sadly, much of what passes for public discourse these days is made up of statements like this.

 

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Wages and immigration in the short run

The Bank of England has a new paper out titled The impact of immigration on occupational wages: evidence from Britain. Its key finding is that “the immigrant to native ratio has a small negative impact on average British wages…Our results also reveal that the biggest impact of immigration on wages is within the semi/unskilled services occupational group.”

Why, then, does the Bank of England correctly state that “There seems to be a broad consensus among academics that the share of immigrants in the workforce has little or no effect on native wages”? The reason is that “These studies typically have not refined their analysis by breaking it down into different occupational groups”, which the Bank’s paper does.

To de-jargon this, studies which find no effect of immigration on wages make no distinction between the wages and workers they are examining; they lump the falling wages of nine road sweepers in with the rising wage of one City banker and say that, on averages, the ten workers wages haven’t fallen. A paper from Oxford University which also dug down into the averages found similar results to the Bank of England; immigration disproportionately reduces wages at the bottom end of the labour market.

In the short run at least, this is what economic theory would lead you to expect. If you increase the supply of anything relative to the demand for it, ceteris paribus, the price of that thing, whether it is shoes or labour, will fall.

But that, too, is to fall into the trap of looking at ‘the average’. There is no labour market in which we are all willing sellers of homogeneous labour. I am not offering the same skills on the job market as Sergio Aguero or Stephen Hawking. The market for the labour of economists and the market for the labour of footballers are different markets, they are not part of ‘the’ labour market. Labour, like capital, is heterogeneous.

To simplify, consider an economy with two types of worker, highly skilled and lower skilled. The markets for each are shown below, for highly skilled labour in chart a and lower skilled labour in chart b.

wages

Immigration of  lower skilled workers increases the supply of lower skilled labour – the rightward shift of the supply curve on chart b from S1 to S2. Ceteris paribus, this pushes wages for lower skilled workers down from P1 to P2. But, and this is the point the Bank of England paper makes empirically, this has no effect on the wages of highly skilled workers, as shown on chart a.

If the immigrants were skilled then the opposite would be the case. The wages of highly skilled workers would fall and those of lower skilled workers would be unaffected. It is doubtful, however, that this is currently the case, at least in Britain.

This debate over the effects of immigration on wages, in the short run it should be stressed, is another example of the difficulties economists can find themselves in when thinking of lumpy, homogeneous aggregates. Lumping all labour together for anayltical purposes makes no more sense than, for example, lumping all capital goods together. The Bank of England’s new paper is a welcome step towards greater acknowledgment of the heterogeneity of economic variables.

Has monetary policy been ‘loose’ or ‘tight’ in recent years?

One of the policy responses to the economic crisis of 2008 and comparatively subdued economic recovery, was the use of monetary policy.

Central bank policy rates were slashed to the point where the European Central Bank got a reputation for monetary rectitude for having a policy rate higher higher than 0.5%. On top of this, and less conventionally, there was Quantitative Easing, in which central banks printed up new money and used it to buy assets from the financial sector.

Despite this apparent monetary activism, there are some who think that monetary policy was too ‘tight’ – that central bankers were not getting newly printed money out of the door fast enough. Many economists, probably most in fact, think that monetary policy over the period has, by complete contrast, been unprecedentedly loose, for better or worse.

Where does the truth lie? A first step would be to determine what we mean by ‘loose’ or ‘tight’ monetary policy.

I asked this question a while ago. An economist I know told me that monetary looseness could be defined as a situation where MS > MD (money supply, MS, is greater than money demand, MD). It follows from this that monetary tightness would be where MS < MD, and the sweet spot of equilibrium would be where MS = MD. This seems a good place to start.

Well, how do you know whether MS > MD? How do we know when the S of anything is > than the D for it? By a fall in its price.

So what is the price of money? It is the inverse of the price level. To clarify that bit of jargon, think of a DVD that costs £10. That is its price. The inverse of that is that £10 costs one DVD. The DVD buyer gives up £10 to get a DVD, the DVD seller gives up a DVD to get £10.

So, a fall in the price of money would mean that more money could be bought with one DVD. Lets say that the price of money falls so that now the DVD seller only has to give up half of a DVD to get £10. For the buyer, the price of the DVD has risen to £20. In other words, a fall in price of money is better known as inflation.

The same works in reverse. If a DVD seller has to give up two DVDs to get £10, the price of money has risen, in other words, then each DVD will now only cost the buyer £5. As generally understood, prices have fallen and we have deflation.

So if we see inflation we are seeing monetary looseness and if we see deflation we are seeing monetary tightness. What have we seen in recent years?

Consumer Price Indices – RPI indices: 2008 to 2015: September 2008=100

Picture1

Source: Office for National Statistics

The chart above shows a dip from the September 2008 pre-crash peak on an index of prices of 3.8% until January 2009. In the nearly six years since then, the index has risen to 23% above that trough and 19% above the pre-crash peak. This steady, but by historic standards modest, inflation, which equals a fall in the price of money, suggests a degree of monetary looseness, which equals MS > MD.

In short, by analysing money as thought it was like any other good or service, monetary policy in recent years has been loose, but not very.