Health spending over time

There has been some comment on the fact that, with recent increases in spending on the NHS, the health budget is taking a growing proportion of UK state spending. I am missing Flip Chart Fairy Tales, so here is a chart heavy post to make one or two obvious points that regrettably are often missing from political reporting.

The first is that health has been taking up a growing slice of our total expenditure (i.e.GDP: expenditure on everything including investment) for a very long time. Here is a chart from a recent IFS publication which is a good source for more in depth analysis.

Note that real spending numbers can be misleading: although real spending has increased since 2010, as a share of GDP it has not, which is a reversal of previous trends. That alone does not inevitably explain recent problems in the NHS, but it certainly could do.

So why is it only recently that the growing share of public spending has been so obvious? Again the IFS have a handy chart that goes a long way to providing the answer.

In 1955/6, defence spending was over 20% of total spending, while by 2015/6 it had fallen to just 5%. This peace dividend (actually two: first a retreat from empire and then the end of the cold war) masked a steady rise in heath, which was only 7.5% of total spending in 1955/6 but was approaching 20% by 2015/6.

Many economists would simply describe this as reflecting that health was a luxury good, which means that spending as a share of income rises when income rises. Not all the evidence confirms this, e.g. the spending patterns of lottery winners. In reality I think there are various things going on. One may be that medical science has got better at prolonging life faster than it has held back the aging process. Another is that medical innovation is increasing the scope of what medicine can do. For example cancer is now increasingly survivable, but only with expensive care. While there is productivity growth in the NHS, it is below the national average and therefore fails to match increases in wages. In the document all the figures so far come from, the IFS expect these factors will require real health spending to increase by 3.3% each year over the next fifteen years.

Politicians, particularly those adverse to taxation, love to think that some kind of reorganisation will somehow change the inevitability of an increasing share of government spending and GDP. But this chart, taken from this source, suggests these trends are not some peculiarity of the way we organise things in the UK

In 1970 health spending was between 4-6% of GDP in these 5 countries, but by 2016 it was between 9-16% of GDP. (There is a definitional break in the UK series in 2013: there was no leap of spending in 2013 as earlier graphs show.) If there is any organisational lesson here, it is not to run a health service in the way they do in the US. It is indicative of the mess the world is currently in that politicians are busy trying to dismantle the positive recent reforms in the US and key politicians in the UK have once talked about making the UK health system more US like.

If the IFS is right, this inevitably means that taxes of some kind will have to rise significantly. Yet the Conservatives have repeatedly pledged not to raise any of the headline taxes, and Labour have felt compelled to match these pledges at least in part. That the budget included increases in the tax thresholds, and Labour’s internal spat over whether to vote for them, illustrates nothing has changed in this respect. This year this tax/spend dilemma was avoided by a tax windfall no one had forecast. But at some point in the near future something will have to give, and I really hope it is not once again the quality of our health services.

Real wages are mainly a macro issue

What do I mean by this? Macroeconomists have many faults, but one clear positive is that we think about systems as a whole rather than just one particular component. One area where it is important to do this is in thinking about what determines economy wide real wages. Take, for example, this recent post by the Flip Chart Rick. (His posts are brilliant and I try and read every one, but unfortunately this one is too good an illustration of the problem I have in mind.) He starts with this chart from the FT that I reproduce below.

Why is the UK unique in having a combination of negative real wage growth but positive GDP growth? Now it just so happened that I had written a post about this, explaining I thought pretty well the key reasons. But Rick mentions none of these, but writes about a whole bunch of stuff related to labour market structure and trade union power that I think are largely irrelevant. I think he is making the same mistake that people make when they say immigration reduces real wages, or that we would all be better off if only unions were more powerful.

All these things are important in influencing nominal wages, and perhaps the distribution of wages between workers. But real wages also depend on prices, which are set by domestic or overseas firms depending on where goods are made. If nominal wages go up, prices are likely to go up.

So what do I think accounts for the fall in real wages in the UK over the last decade? We need to start with GDP per head rather than GDP: growth in the latter has been boosted by immigration. Here is what has happened to GDP per head over the last ten years.

GDP per head fell in the recession, and then steadily but slowly recovered: the slowest recovery in at least a century. To see how that is related to real wages (using ONS average earnings divided by the CPI), which I call real consumer wages, we first need to look at an intermediary measure: real product wages. These are real wages divided by the price of UK output: the GDP deflator.

This is an interesting measure because its closely related to a simple identity relating GDP to labour income and profits. We can see that real product wages have not changed very much over this period: the recession mainly hit profits, or it created unemployment. (Real wages are wages divided the number of workers, GDP per head is GDP divided by the total population, which includes the unemployed.) But if we are comparing 2007 with 2015, real product wages were as stagnant as GDP per head.

So why did real consumer wages fall? That must be because consumer prices rose more than output prices. There are two reasons why this happened in this case: indirect taxes increased (remember the 2011 VAT hike), and a large sterling depreciation during the GFC worked its way into higher prices for imported goods. It is of course another depreciation after the Brexit vote that is cutting real wages once again right now. As I always try and stress, real GDP growth per head is not a good guide to real income growth if the price of imported goods rise or the price of UK goods sold overseas falls (what economists call a decline in the UK’s terms of trade).

Real wage growth in the UK has not been lousy because of lack of union power, immigrants or higher profits, but because economic growth (properly measured) has been stagnant, austerity included raising indirect taxes and we have now had two large depreciations in sterling. [1] That is not to say that these labour market factors are not important. At a macro level they are important in keeping inflation low, which should have allowed a more rapid expansion of GDP growth than we have actually had. That is where fiscal austerity and Bank of England conservatism come in. At a micro level labour market structure helps influence the distribution of earnings between different labour groups. [2]

What I say about the unimportance of profits is factually true for the UK over this period, but it is not always the case. In the US and elsewhere we have seen a gradual shift from wages to profits over the last few decades. But even here it is not obvious that weak nominal wage growth is the main cause, because in a competitive goods market lower nominal wages should get passed on as lower prices. One explanation that is attracting a lot of interest is the rise of superstar firms. These firms make unusually high profits, or equivalently have low labour costs, and if output is shifting towards these firms labour’s share will fall. What these firms do with their profits then becomes an important issue. More generally, it may be the case that governments have become too lax at breaking up monopolies, allowing a rise in the overall degree of monopoly.

The consequence of growing concentration, superstar firms and a rising share of profits is that income derived from profit grows faster than income from labour. I say derived from profit because I would include in this CEO and financial sector pay, which in effect extracts a proportion of profits from large firms. The net result is that most of the proceeds of economic growth are going to those at the top of the income distribution. But it would be good if we could change that by making the goods market more competitive and removing the incentive for CEOs to extract surplus from firms [3], rather than by making the labour market less competitive.

Technical appendix

For those who are lucky enough to have learnt economics using the Carlin and Soskice text, this is a classic application of wage and price setting curves. If workers become weaker, this shifts the wage setting curve towards the (perfect competition) labour supply curve, reducing the equilibrium real wage (unless the price setting curve is flat) but increasing the equilibrium level of employment. An increase in the degree of monopoly (the mark-up) shifts the price setting curve further away from the perfect competition labour demand curve, which reduces equilibrium employment as well as the real wage.

[1] One possible caveat here is that low wage growth may have encouraged firms to use more labour intensive production techniques, which has depressed investment and productivity. But if we want to incentivise firms to invest in more productive technology, increasing demand is a much better method than increasing nominal wages.

[2] Another caveat. I'm not sure where the real wage data in the FT chart comes from, but the fall in UK real wages there is greater than you get by using the ONS average earnings data (which I have used), so it may be a different and more specific measure of real wages. In which cases labour market structure might be relevant in explaining that number, and I apologise to Rick in advance if that is what he had in mind. 

[3] By, for example, applying much higher tax rates on high incomes, or imposing a maximum wage.  

Conservative Contradictions: the limits on Red Tories

There has been much talk of Re-leavers: those who voted to Remain but are now voting for Theresa May to get the best Brexit deal. I had talked about something similar long before the term arose (see here and the previous linked post), so I do not think this is just an artifact of particular poll questions. But I’m also sure that this is not the only reason many Remainers will vote Conservative.

Some, as Ian Dunt suggests, just believe that Brexit is inevitable (as you would based on most of the MSM [1]), and that May would be better at negotiating our exit than Corbyn. Others always vote Conservative because they belong to particular groups in society, and they are sure that party will - whatever happens - protect their interests over others. Think the typical Times reader for example. If we are talking about what you might call the affluent middle class, their assumptions have a solid empirical base.

This becomes important once you recognise the dismal economic outlook that faces the UK over the next decade. Productivity growth has virtually stopped. That means that, on current policies, growth in output per head is likely to be pretty slow. In addition, the Brexit depreciation will reduce real incomes, a process that has already begun. Finally May seems determined to reduce immigration as far as she can, which if it happens will damage the public finances.

Think of both the Conservative's core support and these dismal economic prospects in trying to decide how seriously to take the interventionist proposals in Theresa May’s first manifesto. (For good background discussion on this written before the manifesto was published, see Rick here and Geoffrey Wheatcroft here.) The words in the manifesto are certainly different: for example

"We do not believe in untrammelled free markets. We reject the cult of selfish individualism. We abhor social division, injustice, unfairness and inequality. We see rigid dogma and ideology not just as needless but dangerous."

Furthermore some of the proposals would have been condemned as socialist nonsense in certain quarters if they had been made by another party. For example a cap on energy bills, worker ‘representation’ on company boards, more council housing, a ‘modern industrial strategy’, and of course more measures to discourage (and maybe control) immigration. Now not all of these measures require serious money, but a lot of them do if they are to be meaningful. And, unlike the Labour or LibDem proposals, the Conservative’s plans are completely uncosted.

As a result, it becomes imperative to ask how much each measure will cost, and where the money comes from, because that will reveal a basic contradiction between rhetoric and reality. It is extremely difficult if not impossible to tackle social division and inequality if you want to protect your core supporters and are not increasing the size of the cake. You could find the money by raising taxes on business, but given Brexit the Conservatives are unlikely to reverse their cuts in corporation tax. (Not so much because of their economic effects, but to preserve the support of the business community which has become strained by Brexit.) You could find the money by raising taxes that largely impact on the better off, but that risks losing your core support. You could put fiscal rectitude to one side, but that would seriously tarnish the brand.

Given these contradictions, the rhetoric above is only likely to be accompanied by token gestures in reality. The most obvious thing May could have done to help the just managing family was to scrap the proposed cuts to in work benefits, and she did nothing. To be able to address inequality and social division without taking away from the better off you need a growing economy. The tragedy for Theresa May is that her insistence that Brexit means controlling immigration ensures [2] that is very unlikely to happen, and it is not clear she realises this.

But surely the change in rhetoric must mean something? The start of a Red Tory era, or the re-emergence of pre-Thatcher Conservatism, or at least the death of neoliberalism in the UK? I will start to believe those things when the IFS starts expecting falls in child poverty, rather than the - policy induced - increases they project. I will start to believe it when the pledge to introduce inequality enhancing Grammar schools is dropped. Until then, I suspect all we may be seeing is the same grasp of economics May has always displayed in government: she wants everyone to have more, while implementing policies that impede economic growth. I fear this Red Tory may be another symptom of the disease that hit the UK with Brexit. We are in the 'have your cake and eat it' era, an era that through its own contradictions cannot last.    

[1] The MSM where I fear the idea that the current fall in real wages is down to Brexit is now a ‘contested view’, thanks to recent remarks by the Prime Minister.

[2] Both directly through the impact of lower immigration on the public finances (uncontested by the Conservatives, perhaps because it comes from the OBR), and indirectly because it means we have to leave the Single Market.

Inequality or poverty

Tony Blair famously said:

“[It’s] not that I don’t care about the gap [between high and low incomes], so much as I don’t care if there are people who earn a lot of money. They’re not my concern. I do care about people who are without opportunity, disadvantaged and poor.”

Most people, including the Labour government, interpreted that as focusing on poverty rather than inequality. For an excelllent discussion of historic trends in inequality and how they were influenced, among other things, by poverty reduction programmes pushed by Labour (as well as how that may unwind in the near future) see this excellent discussion by Rick. 

I recently saw a very clear defence of the position that poverty mattered more than inequality from Miles Kimball. His argument comes from surveys that quantify a basic principle of economics, which is diminishing marginal utility. He quotes results which suggest that a dollar of income means an awful lot more to someone earning half the average wage than someone who earns double the average wage. He suggests the results come close to validating the second principle of justice suggested by John Rawls. To put the idea at its most simple, we should not worry about the rich too much because their extra money buys them very little extra happiness, but instead focus on reducing poverty.

Now of course this point is irrelevant if we are talking about reducing poverty by taxing the rich. The rich are a very good source of money, because they will not miss it very much. The importance comes if we compare two societies. One has no poverty, but a significant number of very rich people. The other has no rich people, but still has poverty. Miles’s argument is that we should prefer the society with no poverty to the one with no super-rich. In a static sense I think that is right, but I have dynamic concerns that I will now come to.

Right at the start of Miles’s discussion is an interesting paragraph:

“Before going on, let me concede first of all that the amount of wealth held by the ultra-rich is truly astonishing, and that making sure that the ultra-rich do not convert their wealth into total control of our political system is important. Documenting and studying in detail all of the ways in which the ultra-rich influence politics is crucial. But short of the ultra-rich subverting our political system, the focus of our concern about inequality should be how well we take care of the poor; whether money needed to help the poor comes from middle-income families or the rich is an important issue, but still of secondary importance to how well we take care of the poor.”

I want to explore a point that Miles does not pursue. If money matters so little to the very rich, why would they want to become ultra-rich to an astonishing degree, and go on to try and control the political system to ensure they get even more? The answer comes from exactly the same logic as Miles uses. If £1000 means nothing to you because you are very rich, if opportunities arise you put effort into making that £1000 into £10,000 or £100,000. The fact that the ultra-rich have wealth that is truly astonishing may not be an accident, but may be a result of exactly the same principle that Miles explores: diminishing marginal utility. The rich are no different from everyone else in wanting more utility, except for them it requires huge amounts of money to get it. [1]

To see why this can matter, consider an argument put forward by Piketty, Saez and Stantcheva that I discussed here. Why has pre-tax income for the 1% risen so much in the two countries, the UK and US, that in the 1980s saw large reductions in top income tax rates? The argument these authors put forward is that with punitive tax rates, there was little incentive for CEOs or finance high-flyers to use their monopoly power to extract rent (take profits away) from their firms. It would only gain you a few thousands after tax, which as they were already well paid would not increase their utility very much. However once top tax rates were cut, it now became worthwhile for these individuals to put effort into rent extraction.

As I discussed here, the bonus culture may be the means of rent extraction that was incentivised by cutting top tax rates. If you want to see the kind of thing I have in mind in action, read this article by Ben Chu on what happened to Theresa May’s wish to see annually binding votes by shareholders on executive pay. That kind of lobbying takes effort. It worked, and as a result top executives at the builder Crest Nicholson can ignore a shareholder vote against changes to their compensation rules. No wonder executive pay seems to rise even when a company’s fortunes turn sour.

So it seems to me that I could take the same basic principle that Miles explores and write a very different conclusion. Once we allow those at the top the opportunity to earn very high incomes, and the only way these individuals can see to get additional utility is to embark on rent seeking, we can at the very least divert their effort from socially enhancing activities (i.e improving the company). When those efforts extend to influencing the political system, we are in serious trouble. These activities may culminate in taking over the political system, which after all is what has happened in the US, with potentially disastrous consequences. For that reason alone, inequality matters as well as poverty.

[1] Of course status linked to competitive consumption is also important.

The Autumn Statement marks the return of austerity

One of the problems with instant responses is that you miss the big picture. And although everything I wrote immediately after the Autumn Statement was perfectly correct, I too failed to spell out the big picture. The big picture is that austerity has returned. (Credit to Rick for a much better call.)

Let me explain. Unlike some, I do not just define austerity as fiscal consolidation or government spending cuts. Instead I define it as fiscal consolidation that creates an output gap. That should normally only happen for three reasons:

1. you are part of a monetary union (or fixed rate regime) and the rest of the union is not doing fiscal consolidation (as much).
   
   
2. if interest rates are stuck at their lower bound.
   
   
3. If the monetary authority is incompetent.

I believe it makes sense to define austerity that way, because only then does fiscal consolidation lead to a waste of aggregate resources.

A competent central bankers’ tell (as in poker) for being at the zero lower bound is that they embark on new Quantitative Easing (QE). Central bankers know that interest rates are a much more reliable instrument than QE, so expanding QE tells us we are at the lower bound as they see it. We also know that fiscal expansion is a more reliable instrument than QE. So if central banks are doing QE, it pretty well follows that we have austerity.

Now Hammond could have changed that on Wednesday by announcing a significant fiscal stimulus relative to previous plans. He did not. The increase in public investment, as I said in my previous post and the IFS confirms, was small, as were his other measures. This, as Martin Sandbu points out (who, naturally, also called it right), was a huge missed opportunity. Don’t get misled by actually borrowing levels to judge changes in fiscal stance: most of the additional borrowing was unintentional.

As I have tried to explain on many occasions, the nature of policy pre-Brexit was different from policy in 2010 and 2011. The later was austerity as I like to define it. The former was bad in many ways, one of which was to run the risk of more austerity if we had a negative demand shock. Brexit was a negative demand shock, and so we now have austerity, and Hammond did far too little to rectify his predecessors mistake.

So why did Hammond keep his squeeze on the public sector’s current spending largely unchanged (again, see my previous post for the relevant chart)? Why not give some money to the NHS? Perhaps he too wants to pursue deficit deceit: to shrink the state. Another possible reason is that the Treasury has persuaded him that he should not ‘take any risks’ with public debt. Let me end by saying a bit about that.

Another definition of austerity beside the two already mentioned is an economic policy that focuses above all else on the need to reduce government debt levels. That is the sense of austerity being used in this BBC piece. Needless to say I very much side with Jonathan Portes rather than Michael McMahon on this. But many journalists are puzzled nevertheless: what about all that stuff about the world falling in if debt to GDP reached 90% of GDP? At what level do those who buy UK government debt start to worry about default? I will talk about that tomorrow.

The folly of triggering Article 50

Immediately after the Brexit vote, all the analysis I saw argued that Article 50 would not be triggered for some time. They all made a simple mistake: they were thinking rationally about what would be best for the UK. Rick has an excellent analogy that elaborates on one that I and others have used, and it really would be best if you read his blog rather than for me just to repeat it. The conclusion, which this earlier analysis I mentioned had also come to, is that triggering Article 50 without any kind of idea about what any agreement would look like puts the UK in a very weak negotiating position.

This is why the EU were pressing for Article 50 to be triggered as soon as possible. Their real fear is that the prospect but not the actuality of the UK leaving would hang over them for years, and that was the UK’s strongest card. Before playing this card the UK could at least get a clear idea of what the EU might be prepared to offer, and possibly get some commitments that sketch the broad outlines of any deal. Once Article 50 is triggered, the UK will be far more desperate for a deal than the EU. It would only be a slight exaggeration to say it allows the EU to dictate terms. Triggering Article 50 was our best card, yet it is a card that Theresa May is determined to throw away.

Just to emphasise the point, this has absolutely nothing to do with whether you voted to Remain or Leave. Anyone who actually wants a good deal from the EU when we leave should realise that the UK’s negotiating position becomes instantly weaker once Article 50 is triggered. I do not know whether those who have successfully pushed for triggering Article 50 so soon simply live in a deluded state where they think that the UK will be in the stronger negotiating position, or whether they are desperately afraid that if it is not done soon people will go off the whole idea of leaving. But whichever it is, it is an act of folly, whether you want to leave or not. It substantially increases the likelihood of getting a bad deal.

As for Labour’s position, I’m afraid all I can say is you were warned. Jolyon Maugham describes Labour’s position as checkmating itself, but I strongly suspect this is a match the Labour leadership do not want to win. The fact that others in the PLP are content to go along with this does not make it any better. As I wrote at the time, all this was one very good reason for voting for Smith rather than Corbyn.

And if Labour wants to position itself as being the party that can make a success of Brexit, that road spells doom. If MPs think they can avoid losing votes to UKIP or the Conservatives in their traditional heartlands by adopting this line (or trying to be all things to everyone and therefore in reality champion of nothing), they will lose many more votes in their new heartlands than they will save in the old. Many voters feel much more attached to Europe than they do to Labour. This is something I have argued for some time, and this poll suggests I am right. If Labour backs Brexit they will get less votes than the Liberal Democrats. As I also wrote during the Labour leadership election, Brexit changes everything.

But I do not want to get distracted by that. The key point is that triggering Article 50 so soon does not make sense even if you voted Leave.

So if MPs, pro or anti leaving, had any sense at all, and any independence at all, they would vote against. Yes the right wing press will scream and brand you an ‘enemy of the people’, but if have the interests of the British people as your priority rather than your short term popularity that is what you will do. You could even get voters on your side if you explain why you are doing it. This is one of those moments, like the Iraq war vote, where it is utterly obvious what should be done. We are not yet a country that is run by the Mail and the Sun, but triggering Article 50 will make it look suspiciously like we are.