The fiscal-devolution deal to Scotland is very generous
Apr 20th 2016, 10:09 BY C.W. | EDINBURGH
IT HAS now been two weeks since Scotland got control over income tax, the so-called Scottish Rate of Income Tax (or SRIT). Under this deal, Scotland has put in its own 10p rate of tax, and Westminster has reduced what it takes from Scotland by 10p. Also, Westminster has cut its funding for Scotland (the “block grant”) accordingly, given that more money is now raised locally. Ultimately, Scotland’s tax situation is thus exactly the same as it was more than a fortnight ago. Unsurprisingly, then, there has been little commentary about the SRIT since it was introduced.
However, the lack of coverage of the SRIT means that an important point about Scottish fiscal devolution is being lost. It is highly beneficial for Scotland.
You would be forgiven for thinking that Scotland was taking on a big fiscal risk by adopting its own income tax. But this is not the case. The reason lies in the arcane way in which Scotland’s block grant has been reduced to account for the fact that more cash is now raised locally. The upshot is that Scotland’s block grant will be reduced by an amount equivalent to the amount of tax raised in this financial year.
The consequences of this for Scotland’s fiscal risk should be fairly obvious. Were SRIT to generate precisely £0 this year, the block grant from Westminister would not be reduced. In other words, Scotland has been insulated from a poor income-tax performance. This is great news right now, given that the Scottish economy is in a tight spot. Some Scottish economists reckon that the country is nearing recession. Certainly, its GDP growth is way below Britain’s. This is probably down to the spillover effects of the fall in the oil price.
(Of course, the converse of this is that Scotland would not benefit if its economy performs really well this year, but the economic risks in Scotland this year are very much to the downside.)
So Scotland will do pretty well out of devolution this year. It will also do well in subsequent years, though through a different mechanism.
This seems confusing when you recall that from 2017 onwards, Scotland will get full control over income tax. There will be another reduction in the block grant from Westminster, to account for these new powers. The size of that reduction will be dependent on how Scottish income tax performs in this coming financial year, and that initial adjustment will be fixed thereafter. So from 2017 onwards, Scotland does not have an advantage in the same way that it has an advantage under SRIT.
But it has an advantage in another way. During the negotiations over the fiscal-devolution deal, something called “no detriment” kept coming up. Now, generally this is a very poorly defined term. Essentially it means that neither Scotland nor the rest of Britain should suffer directly as a result of the decision to devolve income-tax powers. The problem was that the Scottish and British governments interpreted “no detriment” differently. The most important disagreement centred on population growth.
Population is growing more slowly in Scotland than in the rest of Britain. Under the deal proposed by the Treasury, this would have meant that Scotland’s overall tax revenues probably grew more slowly than Britain's. To many that seems perfectly reasonable—after all, if Scotland’s population is growing slowly, its demand for public services will also grow slowly.
However, the Scottish government saw it in a different way—that their budget would “lose out” compared to what happened elsewhere in Britain. As a result, under the deal Scotland’s overall tax revenues will be dependent on what happens to Scotland’s per-person tax revenues, not the overall ones. The result, probably, is that per-person public spending in Scotland may increase further (it is already more than 10% higher than in the rest of the country).
In sum, the SNP got exactly what they wanted from the devolution deal. Income-tax revenue from the rest of Britain will be diverted to fund Scottish public services, even though Scotland is supposed to have complete control over income tax.
The wrong kind of savings
The economic equivalent of St Augustine’s plea
Apr 23rd 2016 |
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NEGATIVE interest rates are surely a sign that something is wrong with an economy. Normally, people have to be rewarded if they are to be induced to postpone consumption. Penalising them for doing so seems perverse.
Admittedly, negative nominal rates apply mostly to commercial-bank reserves held at the central bank. But many savers in the developed world are suffering negative returns in real, after-tax, terms. Larry Fink, the chairman of BlackRock, a fund-management group, recently argued that low rates may not work as central bankers intend: those planning for retirement will need to save more, not less, to generate a given income. By the same token, low rates explain why lots of companies’ pension funds are in deficit.
Many economists argue that low interest rates are the result of too much saving, rather than too little. A “savings glut” means that the returns from investing have inevitably fallen. Unfortunately, the savings aren’t really accumulating in the right places. The ageing citizens of the rich world should be putting lots of money aside for their old age, but personal savings rates are generally low.
Britain’s household-savings ratio perked up after the 2008 crisis, without ever reaching the 16.5% recorded in the last quarter of 1992. In the fourth quarter of 2015 it was 3.8%, well below the average level since 1963, of 10%. The American savings ratio is 5.4%; between 1963 and 1985, it often exceeded 10% (see chart).
In economic textbooks, companies use the savings of households to finance their expansion. But for much of this century companies in the developed world have been net savers. In Japan this has been going on even longer.
Given the ultra-low interest rates available on cash, and with investment-grade corporate bonds yielding just 3%, you might think there would be lots of profitable projects for companies to invest in. Although corporate investment has picked up since the 2008 crisis, it is hardly booming. Perhaps companies are cautious about the outlook for demand; perhaps competitive pressures are not what they were; perhaps they are simply using their cash to buy back shares. Whatever the reason, their behaviour has changed.
In theory, a financially strong corporate sector is good news for workers. Their employers could be putting aside a lot of money to meet their future pension commitments. In practice, however, the switch from final-salary pension schemes to defined-contribution (DC) plans means that employers’ pension contributions are lower than before. The average American employer ponied up just 4.5% of pay in 2013. Many people are going to depend on the state in their old age. As it is, more than a third of retired Americans get more than 90% of their income from Social Security.
If a country’s private sector has net savings, then mathematically the government must be running a deficit or the country must be exporting the excess, generating a current-account surplus. Deficit financing by governments makes sense as a way of stimulating demand in the short term. But it could be argued that rich countries with ageing populations should be running current-account surpluses and investing in faster-growing emerging markets. The euro area, in aggregate, does follow this approach (although Germany, its biggest economy, is often criticised for doing so), but Britain and America run persistent current-account deficits. Instead many countries in the emerging world, including China and Taiwan, are investing huge surpluses abroad. Although very low or negative rates in the developed world should discourage this, they seem to be having little effect.
Meanwhile, governments in the developed world face big long-term financial challenges. A recent report from Moody’s detailed the unfunded liabilities facing the American taxpayer: 75% of GDP for Social Security, 18% for Medicare, 20% for the cost of pensions for federal employees and another 20% for pensions in state and local government. Britain has unfunded pension liabilities (for government employees) of around 66% of GDP.
Perhaps governments will deal with those challenges by cutting benefits or raising taxes. But if workers think that will happen, they should be saving more now in order to compensate for that future hit to their incomes. There is no sign that they are doing so. Indeed, governments don’t want to see a huge rise in household saving in the short term because of the impact on demand. It’s the equivalent of St Augustine’s plea, “Lord, make me chaste, but not yet”. And it is another sign that economies are in a mess.
Romance of the three quarters
If the recent pattern holds, China’s latest upturn will be short-lived
Apr 23rd 2016 | SHANGHAI |
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“THE empire, long divided, must unite; long united, must divide.” This famous opening from “Romance of the Three Kingdoms”, a classic Chinese novel, refers to the inevitable ebb and flow of dynasties over the centuries. The same principle, in less dramatic fashion, applies to the ups and downs of the economy. But in the past couple of years, the rhythm in China has been unusually fast: the economy, stumbling for a few quarters, must strengthen; strengthening for a few quarters, must stumble.
For now, China’s economy appears to be strengthening again. Real growth edged down to 6.7% year on year in the first quarter, but that figure, subject to fiddling by the authorities, is treated with scepticism by analysts. Instead, they pay more attention to a range of indicators that tell a different story. First, nominal growth—to which corporate earnings are more closely tied—jumped to 7.2% year on year, up from 6% in the final quarter of 2015. Second, the revival of the property sector—the most important part of the economy—gathered pace: the prices of new homes increased by 3.1% in March from a year earlier, the fastest growth since mid-2014. Third, industrial output rose by 6.8% year on year in March, compared with a subdued 5.4% average over the previous two months.
All this is far from the double-digit growth that once seemed so effortless in China, but it is nevertheless striking given investors’ gloomy outlook at the start of this year. Then concerns focused on surging capital outflows, the depreciating yuan and a swooning stockmarket. Now, all three are in much better shape. Foreign-exchange reserves increased in March, for the first time in half a year. The yuan has risen by nearly 2% against the dollar over the past three months, and the CSI 300, an index of Chinese blue-chip stocks, has climbed by 7% since the end of January.
Yet anyone counting on a sustained upturn in the economy would do well to examine the pattern of the past few years. Since early 2012 Chinese growth has been trending downward despite a rapid sequence of ups and downs (see chart). The force behind these fluctuations is on-again-off-again policy support from the government. Determined to keep the economy growing in line with its annual GDP targets, officials have turned to fiscal and monetary stimulus when growth has faltered. Wary of overdoing it, they have pulled back when the economy has picked up.
That might seem to be a feat of fearsomely effective central planning, but, worryingly, each leg-up in the mini-cycle has required a bigger push. The current rebound follows a boom in lending as well as a series of policy incentives that have fuelled a mammoth property rally in the biggest cities. Total new credit rose by 42% in the first quarter compared with a year earlier, the biggest increase in three years. New home prices in Shenzhen, a southern metropolis, soared by 62.5% year on year in March, while those in Shanghai rose 30.5%. When growth flags again, as many expect will happen later this year, the government will have less scope to boost it without raising an already towering debt load.
In the meantime, regulators are trying to undo some of the excesses. They have started to crack down on leverage in the bond market, one of the main channels for new financing in recent months. Officials in big cities have also made it harder for speculators to buy homes. But appetite for the tougher reforms needed to energise China’s economy in the long term—deleveraging the financial system, breaking up state-owned monopolies and eliminating excess capacity in industry—is still wanting. Shen Jianguang, an economist with Mizuho Securities, believes the government will focus on reforms that support growth, such as providing more financing for business startups. It is reluctant to pursue the more difficult reforms, for fear of undermining growth. That means the next downshift in the mini-cycle is, like the current upturn, only likely to go so far.
Some factors are beyond China’s control, however. A big question stemming from its rebound is how that will influence monetary policy in America. The Federal Reserve has refrained from increasing interest rates after an initial rise in December, with Janet Yellen, the Fed’s chair, highlighting risks from China as a prime reason for caution. Now that China is faring better, the path to a second rate increase in America ought to be clearer. But that might lead the dollar to rise and place renewed pressure on the yuan, which would risk stoking capital outflows and, in turn, fresh concerns about the health of the Chinese economy. If it all sounds a bit dreary, one should at least be grateful that the mini-cycle features none of the death and carnage so prominent in “Romance of the Three Kingdoms”.
Drill will
America, not OPEC, decides the fate of global oil markets
Apr 23rd 2016 |
Where the action really is
“WE DON’T care about oil prices,” Muhammad bin Salman, Saudi Arabia’s deputy crown prince, recently told Bloomberg, a news agency: “$30 or $70, they are all the same to us.” Such comments by the man calling the shots in the world’s biggest oil power should be taken with a pinch of salt. Low oil prices cost the country billions, threaten its credit rating and are turning it from creditor to debtor: this week it set out to raise $10 billion from global banks. Yet the claim is not entirely hollow, either. Saudi Arabia is determined not to give any succour to higher-cost producers, despite the damage the low price does to its own finances.
At a meeting in Doha, the Qatari capital, on April 17th Saudi Arabia blocked an agreement between OPEC and non-OPEC producers, such as Russia, to shore up global oil prices by freezing production at January’s level. The idea that such a deal could have been enforced was fantasy anyway. As Carole Nakhle of Crystol Energy, a consultancy, points out, Russia is pumping at record levels and there was no way to police its compliance with a freeze. Iran, which is vowing to raise output to pre-sanctions levels, had dismissed the notion that it would take part as “ridiculous”.
Prince Muhammad apparently forced his negotiators to shun a deal just as they were about to sign it, insisting that the kingdom would only freeze production if Iran were prepared to do likewise. Some participants were furious at his behaviour. The Saudi delegation “had no authority to decide on anything”, fumed Eulogio del Pino, Venezuela’s oil minister.
For decades Saudi policy has been steered by deft negotiators such as Ali al-Naimi, the kingdom’s oil minister. Now it is under the thumb of the 30-year-old prince, who believes low oil prices will help his drive for economic reform at home and weaken Iran, Saudi Arabia’s arch-rival. “For years we’ve been told that Saudi oil policy is driven by commercial and economic considerations,” says Jason Bordoff of Columbia University’s Centre on Global Energy Policy. “Yet what happened in Doha seems to have had a big geopolitical dimension to apply pressure on Iran.”
Fortuitously for oil prices, the Doha debacle coincided with the start of a three-day strike in Kuwait that temporarily dented the emirate’s crude production. Yet that underscored how daft the effort to impose a freeze was in the first place: low oil prices are already dampening global supply. The strike in Kuwait was the result of public-sector pay cuts brought on by lean oil revenues. Schlumberger, an oil-services firm, says it is reducing activity in Venezuela because the cash-strapped state oil firm there has not paid its fees. Oil traders say they can no longer get letters of credit to trade with Venezuela. They also worry about the counterparty risk of dealing with oil-dependent countries like Nigeria.
The real freeze, says John Castellano of Alix Partners, a debt consultancy, is taking place in America. Shale producers that borrowed heavily to increase production in the boom years are likely to flock to bankruptcy court this year in even greater numbers than in 2015, he predicts. On April 14th and 15th respectively two such firms, Energy XXI and Goodrich Petroleum, filed for Chapter 11 protection. Even those that are still going concerns have no money to invest in maintaining production. As a result, shale production has fallen by 600,000 barrels a day since its peak last year, according to the Energy Information Administration, an official body. That, more than any OPEC posturing, is what is underpinning oil prices.
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