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The purpose of this blogs is to give my opinions on events in the news based on ideas developed in my book Wealth Creation and Wealth Destruction.

17th March 2014

A real recovery?

With the adjustment of economic figures the UK's recovery has been underway for some 15 months however to many it does not feel that way. On one level this is not surprising as employment is always a lagging indicator of economic health but what has got even the traditional economist a little concerned is the stagnation of wages. The standard response is that wages will rise once growth and productivity improve. This comes from the standard economic argument that growth leads to inflation which is the result of higher wages. This is what happened in the past but it may not necessarily be the case this time round.  There are many features of this recession and it associated recovery that have defied expectations; the time to recover, low inflation and relatively low unemployment. This should not come as to much of a surprise as the initial response to the crisis differed from previous recessions. Reducing the interest rate and flooding the financial markets with cheap money through quantitate easing. By the same logic we can expect a different type recovery.

There is also a myth to be bust; that improved productivity and growth always lead to wage growth. A long standing complaint of the American middle class over the last twenty years has been how purchasing power has diminished and no doubt their British counterparts would agree, let alone the poor. I would argue that the disconnection between growth and wages is a result of the low inflation policies followed by governments and central bankers. As these policies are set to continue through low interest rates then we can expect more of the same.

Then there is the recovery itself. Services, which primarily form the wealth destruction part of the economy, have climbed back to their pre-recession levels but manufacturing and construction, the creative part, are still subdued. This further hollowing out of the economy does not bode well for the economy in the longer term but even in the short term it is unlikely to raise wages. By their nature these newly created jobs are ones where the skill sets are not particularly specialised and with a wide pool of unemployed there is to draw on there is no incentive for employers to raise wages.

Whilst the economy is large enough to sustain these jobs it will not lead to further growth. As for anecdotal evidence on the state of the economy, there was Saturday afternoon congestion on the drive to my nearest town centre for much of January but it has returned to its new norm.

The British establishment has said that it has no intention of sharing the Bank of England and Alex Salmon has called it a bluff but there are many legitimate reasons why the rest of the UK would want to avoid such an arrangement which are outlined here along with their legal justification here. Another reason that that has not been mention is Salmon's proposal to offer companies a lower corporation tax. Whilst many companies have moved their headquarters to Ireland to take advantage of their lower corporation tax the Euro does provide d a small obstacle. It is unlikely that the British government would welcome such a move from a Scotland within a Sterling zone. It would undermine their ability to independently set taxes or an invitation for virtually every company to move their registration to Scotland.

It is for these reasons and perhaps a few more that it is very unlikely that the remaining UK government's 'bluff' will be called. However there is nothing to stop Scotland from using the pound without any formal agreement. In this case it would be in the interests of the rest of the UK to facilitate such an arrangement. Otherwise the lack of sterling would inhibit all the British economies. Nevertheless it would quickly prove problematic. Not only would there be no direct input into it regulation there would be no obligation to meet Scotland's individual needs. Without the powers to set interest rates that determine growth and inflation or the right to create money the economy would soon become a satellite; independent in name only. In all likelihood the first crises, whatever that is, will probably lead to successful calls for a new currency.

A new currency does not come without its problems. The pro-independence lobby point to Ireland and Norway as models of success; countries that are similar in size and tradition but the conditions that make them successful may not be directly applicable to Scotland. Norway is outside the EU with large oil reserves and a large sovereign wealth fund. On the down side the oil income has pushed up its exchange rate. It is likely that a Scottish currency based on oil would also be highly valued and the size of the financial sector is likely to reinforce this. In the short term this will provide an uplift to living standards but it will come with a cost competitiveness for any industry not associated with oil become. No doubt any surplus will lead to rising house prices. If an example of the impact of newly found oil is required one only has to look back at the UK economy during the 1980's. These were attributed to Thatcher's policies but the cause was oil and without it those policies would not have been funded. The effect will be much more pronounced for a smaller economy where oil makes up a much larger piece of the GDP pie. I have heard it said that Scots are somehow financially different and would not let such events to happen but this is nativity at its worst.  Over time the oil money will hollow out the economy and when the income does decline it will more likely resemble Venezuela than Norway. See my previous post.

The exact detail will depend on the nature of the proposed sovereign fund. If it is used to build a post oil economy then it may mitigate this reaction, if however it is invested in stock markets and alike it can most probably be written off as having any long-term value to the general population. Then there is the size of this sovereign fund. Firstly like a pension pot the earlier one gets in the larger the final pay out. Norway started its fund at the beginning of the boom and has been helped by the explosion of global growth. Scotland's fund will be starting will oil production declining. Secondly how much of the income will go into such a fund as there are also calls to fund social expenditure. I have nothing against this but this is likely to increase with unemployment benefit as parts of the economy become uncompetitive. With an expensive currency the route Ireland has taken will be ruled out.

It is for the Scottish people to decide and I do not have a say. There are other reasons for independence but regarding the economy it is likely to create as many new ones as it solves. These will not be insurmountable but the reality may not match the dream.

A warning I am gifted with dyslexia, which among other thing allows me to think outside the box, however the downside for you the reader is that my spelling is not that great and I also have a habit of skipping words. The spell and grammar checker can remove the more horrendous examples but some will get through and it creates another problem that of selecting the wrong word or meaning when the spellchecker offers a list. For the book friends and family tirelessly weeded out these mistakes but the nature of a blog means I do not have this luxury. So fill in the missing or wrong words and if this is too much for you, then any corrections will be gratefully received.