Tax and ‘the rich’

One of the my favourite Spitting Image sketches features the Queen complaining about the behaviour of the rich, to which an exasperated Prince Philip replies, “You ARE the bloody rich!”

The rich are always somebody else. As Gaby Hinsliff says, there’s always someone with bigger yacht. So it was inevitable that John McDonnell would get flack for suggesting that the rich who should pay more tax are those earning over £70,000 a year. “We’re not rich,” said lots of people who live in London and see much of their income disappearing in housing costs. “Oh yes you are,” said anyone who had looked at the pay distribution and wanted to indulge in this year’s most fashionable sport, having a go at “the elite”.

Of course, a lot of this depends what you mean by rich. Is it a relative term or is there a threshold for richness that means you have to at least have a mansion and a yacht?

Whether or not £70,000 a year means you are rich, there can be no argument about where it puts you in the income distribution. According to the most recent HMRC data, someone on £70k would be at around the 95th percentile, so, at least in terms of income, richer than 95 percent of the population. The HMRC data is 2 years out of date and we have had some pay growth since 2014-15 so a £70k income might not be quite so high now. Even so, it would still put you comfortably in the top 10 percent.

Chart by Michael O’Connor

So should those on £70,000 pay more tax or should it just be the very rich who get stung?

Here’s where the problem starts. Limiting tax increases to those earning over £70k isn’t going to do much good. As luck would have it, HMRC published its estimates of tax revenues on the same day that John McDonnell made his comments.

Assuming an April 2018 implementation, here are the amounts a 1 percent increase would raise on various taxes.

The four big revenue raisers are income tax, corporation tax, national insurance and VAT. Of the rest, the largest yields come from stamp duty which is some way behind. The trouble is, the government can only get big numbers by taxing everybody. A 1 percent increase in the higher rate of income tax, those earning over £45,000, would bring in just over £1 billion a year while 1 percent on the basic rate would net £4.5 billion. A similar increase for the £150,000 plus band would only bring in £165 million.

OK, there might be some scope for hitting the rich indirectly through corporation tax and employer NI but there are ways of avoiding both. Significant increases in employer NI might just lead to more poorly paid self-employment.

According to the Office for Budget Responsibility, even if the government achieves its planned cuts to public services and social security, which is by no means certain, it will still be £21 billion adrift in 2019-20. Assuming the government does manage to close the deficit sometime early in the next decade, the OBR’s longer term projections see deficits opening up again from the middle of the 2020s as demographic and other pressures start to push up public spending. Since the recession, tax revenues have continued to disappoint, which is the main reason why the deficit is still with us. Even if the government stops trying to eliminate the deficit and adopts the more modest aim of covering day-to-day spending with revenue, it will need to find some more money from somewhere.

The trouble is, however attractive a tax-the-rich policy might sound, it won’t deliver enough. To deal with the upward pressure on public spending, without making yet more cuts in the next decade, the government will need more tax from all of us. At the last election, the Resolution Foundation came up with the term Candour Deficit to describe the reluctance of all main political parties to come clean with the voters about tax, borrowing and the feasibility of public spending cuts. Things don’t seem to have changed much. Even the chancellor’s hint that he might have to increase income tax, VAT or NI caused a fuss.

At some point, someone will have to tell those on middle incomes (rather than those who just think they are) that they will have to pay more tax. Will that happen at this election? Is somebody going to come clean or will we just have another 5 years of blather about eliminating the deficit with spending cuts, while our public finances and public services slowly deteriorate?

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Productivity: Why worry?

My post on productivity earlier this month prompted a few questions about the relationship between profit and productivity, and specifically, how a company can increase its profits while productivity is falling.

For example, one on LinkedIn remarked:

Since productivity and profit are so inextricably intertwined, eschewing one for the other would suggest a level of ignorance that will quickly kill both.

Perhaps so, but how quickly depends on all sorts of other things. It is possible to increase profits without increasing productivity. It is even possible to increase profits while productivity falls.

Here is an example which, I hope, might provide a simple explanation.

Let’s say I run a sandwich shop* in a town’s busy business district. I have 5 workers and they can each make and sell 100 sandwiches a day. I sell each sandwich for £2.50, of which 50p is profit. That brings me in £1,250 a day in revenue and £250 a day in profit. I only open on working days, as there wouldn’t be any point on other days. That amounts to around 250 days so my annual profit is £62,500.

That’s not bad, I think to myself, but I know there is more demand out there so, next year, I double the size of my premises and take on another 5 workers. My workers are still making and selling the same number of sandwiches each but the increased turnover means more profit. I have doubled my profit without increasing my productivity.

This is a trick I can only pull off once though. I know there is still more demand so the next year I move again and take on another 5 staff. Now that I have more staff I need a manager so I entrust the job to one of my most dependable workers, Big Barry.

The new workers aren’t quite as good as my long serving ones and, unfortunately, Big Barry’s approach to staff development is to let people work it out for themselves, then shout at them when they get it wrong. As a result, my workers are having to spend quite a lot of time helping the newer people. Despite my and Barry’s best efforts, we never manage to get quite the same level of productivity so we are now only managing 95 sandwiches per worker per day.

Nevertheless, I’m getting more production so I can buy my ingredients more cheaply as I’m using more of them. Consequently, despite a 5 percent increase in staff costs per unit, I can still make 49p profit per sandwich. My profit and revenue per worker has gone down, which is cause for concern but, on the whole, I’m happy. I’m still making nearly £50k more profit than I did last year.

Then I realise I have been missing a trick. I could deliver sandwiches to offices too. I take on another 8 staff to do the delivery but, having read about the gig economy, I decide to make them self-employed, thus saving me some NI and putting the responsibility for transporting the sandwiches onto the staff. Furthermore, I only need to employ them for around 5 hours a day. They come in to help make the sandwiches and they are pretty much done by early afternoon. In terms of hours worked, then, it’s only like having another 5 staff.

However, the effect on production has been catastrophic. I have left Big Barry to deal with the delivery staff, as I think they might be a bit of a handful, and I have promoted Noisy Natalie to be assistant manager. Natalie is one of those small people who fills a room with her personality. Her style is similar to Barry’s but less confrontational. Instead of yelling at people she likes to shout encouragement and play loud dance music. With 23 staff racing around, it’s mayhem. There isn’t really room for everyone and they keep getting in each other’s way. I don’t want to move premises again, though, as it would hike the rent up. It would be good if Barry or Natalie could find a way of making things work in a less frenetic way but neither seems inclined to do so. Some of my older staff mutter about how it was much more fun when there were only a few of us in a shack. A couple of them have left and their replacements are nowhere near as good. Big Barry complains that you just can’t get the staff these days and that all his time is taken up with rostering and paperwork. Sales are down to 85 sandwiches per worker. My productivity has fallen through the floor.

Still, I am paying the new workers less per hour and I haven’t moved premises so my fixed costs have stayed the same. I’m also getting more bulk discounts. Despite my staff costs per unit being around 13 percent more than they were two years ago, I’m still managing to make 48p per sandwich. And would you look at my annual profits? Well over £200k.

As long as I can keep increasing my turnover at a faster rate than I lose profit per unit through falling productivity, I’m laughing.

Rick’s Sandwich bar – revenue and profits

So here I am running a profitable business and creating jobs yet all these economists are having a go at me about productivity. Why?

One problem with my business model is that it leaves little room for giving my workers much of a pay rise. The more I rely on a plentiful supply of relatively cheap labour to grow my business, the less likely I am to be able to pay them more. Even a small pay rise for my 15 regular workers might wipe out my profit margins.

The other problem is that I am not doing anything to increase the skills of my workers. They are doing the same thing every day and I’m trusting time and experience to help them improve.

If I improved the processes in my shop and provided better equipment, I would be able to produce more sandwiches with the same amount of people. With a bit of training, my workers would improve the quality and quantity of their work more quickly. Sending Barry  and Natalie on a supervisors’ course might be a good start, for them and for the rest of the staff.

Any or all of these things would help me to sell more sandwiches without increasing the number of staff I have. This would give me more money to invest or to share with my workers.

The low-wage economy creates a Catch-22. The cheaper it is to get staff, the easier it is for me to expand my business by taking more people on and the less likely I am to worry about how much they are producing. But the longer I go on relying on cheap labour, the more difficult it becomes for me to do any of the good things the experts say I should. The less profit I am making per worker, the more it will cost me to give my staff a pay rise or to invest in their development.

Economists are worried about my business model because, although I am making a profit, I’m not doing much to increase overall per capita GDP or to improve the country’s skill base. As Paul Krugman famously put it:

Productivity isn’t everything, but in the long run it is almost everything. A country’s ability to improve its standard of living over time depends almost entirely on its ability to raise its output per worker.

Since the Second World War, the UK has experienced an unprecedented growth in living standards. Unless productivity improves, the rate of that improvement will slow down or even stop. The next generation won’t be better off and might even be worse off than their parents

Added to that, we face rising demands on public finances. Ultimately the UK’s public deficit is a productivity and labour market problem. If we are to maintain our public services in the face of increasing cost pressures we need to increase tax revenue, which means increasing per capita GDP.

Which is why economists, central bankers and treasury civil servants are so worried about flatlining productivity and why they are encouraging firms to understand and improve it. At least some of the cause of the productivity slowdown lies Britain’s workplaces and there is evidence that much of the problem lies in our small and medium-sized companies.

Research by the New Policy Institute found that, for all but the largest UK companies, turnover per worker in 2015 was less, in real terms, than it was in 2002.

Nevertheless, despite declining productivity, many of these firms will still be making profits. As Andy Haldane pointed out, not all of the long tail of poor productivity businesses are the zombie firms being kept alive by cheap interest rates. Some of them are making profits. It may even be that some firms have set themselves up to take advantage of low labour costs.

What might be good in the short-term for the individual business owner isn’t necessarily good for the wider economy in the longer term. This is what Mike Haynes called unproductive entrepreneurship and ultimately it causes a drag on the whole economy.

It may be that the increase in the minimum wage and restrictions on the number of migrant workers will force a lot of companies to reassess the way they use their people. Rising pay costs and a labour shortage might, therefore, be the catalyst for an improvement in productivity. This, though, will require significant investment both in people and technology, something for which British business has shown little enthusiasm in recent years.

Which brings me back to the question I raised in my previous post. A lot of businesses might not know they are low productivity firms. Even if they did, would it bother them if the profits were still coming in? Unless something comes along to give them an incentive to change, why worry?

 

* Some sandwich shop owners will, no doubt, look at these profit margins and say “chance would be a fine thing”. I’m also not suggesting that sandwich shops are riven with poor and exploitative managers. This is meant simply as an example to illustrate a point, therefore I have tried to keep the numbers simple.

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The ‘we’ of slavery

When British people use the word ‘we’ in the context of our nation, we don’t just mean those who are part of it now but also those who were part of it in the past. So ‘we’ stood up to Hitler, even though only a few of the people who lived through the war are still alive. ‘We’ also beat the Kaiser, led the fight against Napoleon and saw off the Spanish Armada, even though those that did so are long dead. It’s not just about being on the winning side, though. When discussing the Battle of Hastings, most English people will say ‘we’ were the people at the top of the hill who lost, not the people at the bottom of the hill who won and went on to shape the history of these islands.

And ‘we’ conquered the largest empire the world has ever seen. When pushed, some of us might admit that ‘we’ did some pretty horrible things in the course of doing so. But when it comes to the slave trade, you hear the historic ‘we’ less often. The slave trade? Nowt to do with me. My ancestors were all peasants and artisans, mate. That stuff was all done by the rich.

The fact that Britain was involved in the transatlantic slave trade comes as news to some people, although a lot more seem to know that ‘we’ abolished it. Hollywood must take some of the blame for this. The American entertainment industry achieved Abraham Lincoln’s original aim; it restricted slavery to the southern United States. In fairness, some of this is due to the importance of the civil war in America’s nation building story. It is perhaps inevitable that most of the films depicting slavery feature the cotton plantations of the antebellum period rather than the sugar, rice and tobacco farms of British colonial America. This enables us to put even more distance between ourselves and slavery. Not only was it the rich, it was colonial elites and Americans at that. Like I said, nowt to do with me.

A couple of years ago, a Labour activist made some rather silly comments about Jewish involvement in the slave trade. The row which followed is still rumbling on but the most interesting thing to come out of it was the articles debunking the hackneyed old story that it was the Jews wot done the slave trade. Academics from University College London (UCL), who have gone into this in some depth, wrote to the Guardian:

In the research we have conducted over the past 10 years into British colonial slave-ownership, there is no evidence whatsoever of a disproportionate Jewish presence among owners and mortgagees of enslaved people.

There were certainly Jewish merchants engaged in the business, but the owners and creditors spanned the spectrum of religious and cultural affiliation.

The assertion that a disproportionate number of Jews owned slaves in the southern United States goes back to some mangling of statistics in a book published in 1991. It may be true, as The Secret Relationship asserted, that a greater proportion of Jews owned slaves than the rest of the southern population. However, as history professor Winthrop D Jordan, writing in the Atlantic pointed out, white protestants owned a far greater number of slaves between them than Jewish people did. It is the reason for this that is really interesting.

Typically, most well off Jewish people in America were merchants, as they were in Europe. Merchants tended to live in towns. As Jordan explains:

The relatively high proportion of Jewish slaveholding was a function of the concentration of Jews in cities and towns, not of their descent or religion. It is also the case that urban slaveholders of whatever background owned fewer slaves on average than rural slaveholders, including those on large plantations.

The southern region of North America the Caribbean were slave-based economies. Most people in business owned slaves. If you were a wealthy farmer or landowner in Europe, you worked your land with tenanted or feudal labour. In the Americas you worked your land with slaves. If you were a merchant in Europe, you had servants working in your home and warehouse. If you were a merchant in the Americas, your home and warehouse were staffed with slaves. A wealthier European artisan would have labourers helping in his workshop. In the Americas he would have slaves. Jewish people owned slaves not because they were running the slave trade but simply because whatever business you undertook in the deep south, you did it with the help of slaves. In short, slavery was normal.

So normal, in fact, that even the Quakers were involved. These were people who would die rather than do military service when captured by the press-gang, yet they seem to have had no qualms about owning and trading in human beings. Although the Quakers became one of the first religious groups to oppose slavery, many owned slaves in the early colonial period.

The Quakers back home were also happily investing in the slave trade but here, too, they weren’t much different from anyone else. If you had any spare money in the 17th and 18th century, you invested it in the commercial activities of the time, much of which involved slavery. Even if your business was not directly involved in slavery, any international trade would almost certainly involve doing business with people who were.

It may strike us as odd that, just as European countries were throwing off feudalism, and freeing their serfs, they were also embarking on the mass enslavement of human beings. The English rebelled against their king and cut his head off, yet even the Roundheads who had opposed royal tyranny saw no irony in owning slaves. It was as though all the declarations and treatises about rights and liberty carried the caveat ‘except for Africans’. Across Europe, scholars were laying the foundations for what would become the Enlightenment, yet the creation of new slave-based economies across the Atlantic seems to have been met with a collective shrug.

Economic historians still argue about the extent to which Britain’s economy was dependent on the profits of slavery in the 18th century but there was certainly a lot of slavery derived money flowing back to the mother country from the colonies. Thanks to the UCL research, we now know that slave ownership was a more widespread than previously thought. It was not only the rich that invested in slavery, the wealthier middle-classes were involved too.

From what I know of my ancestors on both sides, most of them do seem to have been artisans. Yet if my family had done work for t’ folks at big ‘ouse they would probably have been paid with money that had, at least in part, come from the profits of the slave trade. One or two of my forebears became reasonably well off. If they had any spare cash they would probably have invested it. In the 18th century that usually meant colonial trade. So, while I don’t have any evidence that my ancestors were directly involved in the slave trade, it’s also difficult for me to claim that they didn’t profit from it at all, because slave-based money was running through the entire economy.

Every so often there is a campaign to remove the name of a benefactor from a university or public building because of a connection with the slave trade. It would be surprising, though, if universities were not tainted with slave money, given that most of the rich families who endowed them would have gained at least some of their wealth from colonial trade. Most people with any wealth were involved in the slave trade to some degree and the universities were no different. Singling out cities, like Bristol and Liverpool, or philanthropists, or politicians’ ancestors diverts our attention from the systemic nature of slavery. Everybody was at it.

David Olusoga says we need to learn more about the history of slavery. He’s right and it needs to go beyond slave ships and antebellum cotton plantations, which are the first and last chapters of a long and complex story. And, as he says, it needs to be set in a British context:

The Virginia in which Kinte is enslaved is a British colony. Which, of course, raises the obvious question: where is the British Roots?

Why can’t we – one of the most diverse nations on earth – produce a comparable series? Are there not enough epic, inter-weaving family sagas from the three centuries of Britain’s slave empire?

Of course there are. The records are in the archives, the names of those who grew rich on the backs of the slaves are methodically listed in the database of University College London’s Legacies of British Slave-Ownership project.

The financialisation of slavery and the development of slave-based securities (see previous post for longer discussion of this) enabled British people to continue to invest in slaves long after slavery itself had been banned in the British Empire. Thanks to the efforts of British banks like Barings, people throughout Europe, even in countries which had no direct involvement in the American slave trade, could continue to profit from it right up until its abolition in 1865. Even as they congratulated themselves for abolishing slavery and the transatlantic trade, the British were still channelling huge amounts of capital to America’s slave-owning states.

For the truth is that, for the British, investing in slavery was quite normal in the 17th and 18th centuries and continued by other means well into the 19th. Isolating the responsibility for slavery the planters of the deep south, or the Jews, or Bristol and Liverpool simply gets the rest of us off the hook. For, when it comes to the transatlantic slave trade, ‘we’ were in it up to our necks.

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Brexit: Britain’s Prohibition

The prohibition of alcohol in the USA was one of those occasions when a nation seemed, to the rest of the world, to have taken leave of its senses. It is one of the most draconian and long-lasting restrictions on personal liberty imposed by a major democracy in peacetime. And it was enacted in a country which has liberty and the pursuit of happiness among its founding principles.

Essentially, prohibition happened because a series of political and social factors lined up at the right time. Campaigners had been trying to get alcohol banned for years without much success. But in the early 20th century United States there were a lot of worried people. Many in rural and small town America felt uneasy about rapid industrialisation and urbanisation. The immigrants arriving to work in the new industries were seen as a threat to the American way of life. The success of campaigning organisations like the Anti-Saloon League was largely due to their ability to link their anti-alcohol aims to these wider fears about immigration and social change.

In this narrative, the cities, with their crime, low morals, drunkenness and immigrant populations contrasted sharply with the small towns with their social order, morality, temperance and Anglo-Saxon protestant populations. Drink and drunkenness were urban and foreign. It was a powerful story. The alliance between the Anti-Saloon League and the Ku Klux Klan, a far more powerful organisation in the 1920s than it is now, linked the causes of nativism and prohibition.

There were well-meaning liberals involved in the campaign against alcohol and suffragists, who thought that sobriety would stop husbands beating their wives. There were even some socialists who believed that, once the workers had sobered up, they would realise the extent of their oppression and rise up to overthrew capitalism. For the most part, though, it was a campaign led by conservatives.

The final piece to fall into place was the brewing companies’ loss of political influence during the First World War. Most of the brewers were of German descent. Anti-alcohol campaigners portrayed drinking as unpatriotic. Any counter arguments the brewers made  were drowned out by anti-German hysteria.

Opinion polling was in its infancy in 1920 so we can’t be sure how far the American public supported the ban on alcohol. The reaction when it was enacted suggests that many did not like it at all as they started trying to get around the law right from the start. Nevertheless, the noisy and hysterical campaign for prohibition convinced many in Congress that they would be unwise to oppose it. President Woodrow Wilson, who tried to veto prohibition, was scathing about the supine legislators:

These miserable hypocrites in the House and Senate . . . many with their cellars stocked with liquors and not believing in prohibition at all— jumping at the whip of the lobbyists.

Prohibition was described as a ‘noble experiment‘ but it was, by and large, a disaster for America. Not only did it enable the rise of powerful crime syndicates, it also had many unintended economic consequences. As expected, breweries closed but so did restaurants, theatres and haulage firms. Many states were heavily dependent on liquor taxes. Around 75 percent of New York’s revenue came from taxes on alcohol. According to some estimates, prohibition cost the federal government a total of $11 billion in lost tax revenue while costing over $300 million to enforce. One of the reasons for the change of heart in government was the plummeting tax revenues during the depression. In the end, Congress wanted tax revenue more than it wanted people to stop drinking. The journalist H.L. Mencken remarked that the one good outcome from prohibition was that it had completely refuted all the arguments of the prohibitionists. After 14 years, America finally gave up on one of its worst ideas and prohibition was repealed.

The parallels with Brexit are striking. As with prohibition’s advocates, the success of the Leave campaign was in linking something people didn’t much care about to something that concerned them a lot. As the Economist noted last week, before the referendum, the UK’s membership of the EU was a non-issue for most people. Immigration, though, was something a lot of people had been concerned about for a long time. The two issues became conflated during the referendum campaign and, as this chart from Migration Observatory shows, the EU shot up in importance as the campaign progressed.

As with prohibition, support for Brexit was driven, at least in part, by a reaction against a changing world and a sense of being out of step both culturally and economically with the prevailing political climate. In England and Wales, rural areas and small towns tended to vote Leave while larger cities voted Remain. Like prohibition in the 1920s, Brexit became a lightening rod for various forms of discontent. The resentment crystallised around a single issue.

And once again, legislators were bamboozled into submission by the noise. Most MPs supported Remain yet placidly voted to leave the EU without asking many questions. Labour MPs allowed themselves to be convinced, on questionable evidence, that there was a mob of angry white working class voters ready to turf them out of their seats if they opposed the triggering of Article 50 in any way. Sure, there is a noisy sub-group of Brexit voters who call for the hardest Brexit and scream about betrayal at every opportunity but they are not representative of most Leave voters.

As the negotiations drag on, the economy starts to slow down and the drain on government resources prevents it taking much action on anything else, the enthusiasm for Brexit is likely to diminish. The FT’s Janan Ganesh perhaps echoed H.L. Mencken when he said, “Brexit is an idea whose only effective rebuttal is its own implementation.” As with America and prohibition, we will have to try it before we realise just how bad an idea it is.

Prohibition didn’t alleviate any of the grievances which led to its implementation and neither will Brexit. Already, the leading Brexiters in government are backtracking on immigration. It is likely that the Leave voting areas will be hit hardest by the economic disruption that follows Britain’s withdrawal from the EU. A few opportunistic carpetbaggers might get rich but the majority of us will be worse off.

Historians will study Brexit as they study prohibition, with bemusement that a nation can do something so massively disruptive but with so few benefits. What, they will wonder, made the British do something so pointless? Like prohibition, Brexit is another ‘noble experiment’ which will one day be judged as a spectacular mistake. The Americans, though, were able to reverse their reckless decision. We will not be so fortunate.

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Productivity and bad bosses

The speech by Bank of England chief economist Andy Haldane last month was another valiant attempt to get to the bottom of the productivity puzzle. Why did productivity decline after the recession and why has that decline been particularly sharp in the UK?

While it might, he says, be convenient to blame a financial services sector for over inflating UK productivity before the recession and knocking the stuffing out of it afterwards, this is only part of the story:

It is sometimes asserted that, without the collapse in financial services output associated with the financial crisis, the UK’s productivity performance would have held up. It is certainly true that financial sector productivity was probably over-stated in the run-up to the crisis.44 Nonetheless, the subsequent sharp fall in financial services productivity is plainly not the whole story. Of the 1.7 percentage point fall in the UK’s productivity growth since 2008, less than a third can be accounted for by financial services (Table 2).

Perhaps, then, something is going on at firm level. His analysis of the productivity of thousands of UK organisations shows that, while some firms in the UK are as productive as any in the world, this country has a long tail of low productivity businesses.

These data enable us to examine the distribution of productivity across firms. Chart 16a plots this distribution in 2014, based on the ONS data. It is wide and elongated, with a long, thin upper tail of high-productivity firms and a short, fat lower tail of low-productivity firms. This shape means that modal productivity among UK companies is around 50% lower than mean productivity.

Might that simply be because some industries are less productive than others?

Up to a point, says Mr Haldane, but there are greater productivity differences between firms within the same industry than there are between sectors. Within each industry, a few firms are improving their productivity while others are being left behind.  Furthermore, that gap has been getting wider over the last decade or so.

Furthermore, this difference between the most and least productive, known as productivity dispersion, is much greater in the UK than it is in many other countries. And again, that difference has widened over the last decade.

The paper then goes on to look at other factors, like ownership. Foreign owned firms have less of a long tail of low productivity firms than UK owned ones.

Every so often, some politician or journalist comes out with the Lazy British Workers hypothesis. But somehow, foreigners seem to get better productivity out of British workers than domestically owned firms do. Our car factories, for example, once a laughingstock, are now reckoned to be among the most productive in the world.

Size is also a factor. Among small firms, those with fewer than 50 employees, the long tail of low productivity is particularly pronounced.

John Van Reenen and the World Management Survey identified a similar distribution when they looked at management practices. (For more on this see previous post.)

Cross-country differences account for less than 10% of the diverging management scores: the biggest management differences occur across firms within the same country. The distribution of scores highlights the fact that much of what drags certain countries down is a persistent ‘tail’ of underperforming firms, those that score less than a two on our five point scale. While this tail is largely absent in the United States, it is evident in the UK and especially pronounced in developing countries such as Brazil and India.

Our research shows that large and persistent gaps in management quality remain across countries, mainly driven by the tail of underperforming firms. The UK clearly has a deficit in management quality, and this deficit is likely to be a key factor explaining the persistent productivity gap with other countries such as the United States and Germany.

Could at least some of the UK’s poor productivity be down to poor management? There is strong evidence to suggest so, says Mr Haldane.

Looked at quantitatively, there is a statistically significant link between the quality of firms’ management processes and practices and their productivity. And the effect is large. A one standard deviation improvement in the quality of management raises productivity by, on average, around 10%. This suggests potentially high returns to policies which improve the quality of management within companies.

But it is also quite likely, he says, that many firms don’t even know that their productivity is poor:

The policy question is how to effect those improvements. One idea which offers real potential comes from the Productivity Commission chaired by Sir Charlie Mayfield. This starts from the assumption that not only is there a long tail of companies, but that many are unaware of that fact. For the same reason most car-owners believe they are above-average drivers, most companies might well believe they have above-average levels of productivity.

In fact, we know most companies have below-average levels of productivity and a large fraction of them have seen no productivity improvement for several decades. The Mayfield Commission aims to create an app which enables companies to measure their productivity and benchmark themselves against other companies operating in similar sectors and regions.

By shining a light on companies’ relative performance, the aim is that this would serve as a catalyst for remedial action by company management. Indeed, the aim is to provide firms not only with a means of benchmarking themselves, but with tools to improve performance along identified areas. These online tools would be a mechanism for speeding-up the process of technological diffusion to the long tail.

At the risk of sounding cynical, though, I wonder how many firms care about productivity. Gross Value Add per worker is of interest to economists and ultimately determines how far living standards increase and how much tax revenue the country gets. But whether it is of interest to people running businesses is another matter. If you can make more profit simply by throwing more poorly paid people at something then why worry?

There is some evidence to suggest that this is what has been happening in recent years. The UK has experienced the opposite of creative destruction. High productivity firms have disappeared and low productivity ones have started up. As Albert Bravo–Biosca and Stian Westlake found, the allocative efficiency of the UK economy fell during to 2000s. The net effect of new firms coming into the market was to reduce productivity. A Bank of England paper covering a slightly later period, produced similar results. (For a discussion of both see previous post.) As Mike Haynes said, the UK is suffering from unproductive entrepreneurship, the hand car wash enjoying a revival while the more efficient machines stand idle.

At an ACAS event just over a year ago, Charlie Mayfield gave an example from his own sector of how cheap labour discourages productivity investment. In many French supermarkets the prices are updated with digital displays on the shelves. There is no point, he said, in doing this in the UK as it is cheaper to pay people to go round and update the prices. In France, however, with labour costs being much higher, the investment in the computerised system pays for itself.

Don’t get me wrong, I’m not knocking the initiative. Encouraging businesses to understand productivity and to measure things like value added per worker can only be a good thing. But measuring stuff and changing the way you manage people is hard. If you are making a reasonable profit, why bother? Sure, you might make a bit more if you could do the same with fewer people, or more with the same people but getting to that point requires a bit of thought and investment. If you can solve your problem by taking on a few more people it might take less effort.

Andy Haldane’s speech and the evidence he presented is further proof that some of the cause of Britain’s chronic productivity problem lies in workplaces and the way people are managed. Whether there is enough incentive to make enough bosses change their ways is another matter.

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Brexit: Could there be a legal challenge to trade negotiations?

Sometimes the stream of  Brexit hysteria in the Daily Express yields the odd interesting nugget. Last week the paper reported that the European Commission wants to “torpedo” the Brexit negotiations by putting “a legal lock on discussions about the UK’s access to the single market, meaning that the issue cannot be brought up during the negotiations.”

The source of this story is Ryan Heath’s Politico column, in which he reports on a conversation with “a senior Commission source”:

There may be a few months where the parties are not really talking to each other. [If] the U.K. says we want to discuss tariffs and the [location of] the European Banking Authority and the space program, and what happens to [Britain’s European Commissioner Julian] King … [the EU’s Brexit negotiator Michel] Barnier will have a simple answer: ‘This is not in my mandate to negotiate with you.’

Barnier will not be legally allowed to negotiate on trade, on customs, on whether the U.K. can still participate in the Horizon 2020 research program.

In other words, there will be a legal barrier to discussing trade. The only negotiations allowed will be those about the separation agreement.

There is nothing here that the EU trade commissioner hasn’t already said. Last summer, Cecilia Malmstrom insisted that, under EU law, the EU can only negotiate trade agreements with third countries. Therefore the UK must become a third country before it can talk trade with the EU. In other words, it must leave the EU before it can do a trade deal.

She hasn’t changed her tune on this since. If the Express’s Nick Gutteridge had read one of his own articles from earlier this year, he would have found this quote from Ms Malmstrom (my emphasis):

First of all they have to formally invoke the Article 50, the letter of divorce. Then the European Council will discuss that and based on that they will give a mandate to the Commission to negotiate.

Then, if they do leave as the prime minister has said the internal market and also probably the customs union, there will have to be all the exit procedures and then there will be a trade agreement between us and the United Kingdom which would be negotiated after they have left.

When she says a deal can be negotiated in two years, she’s talking 2021, not 2019.

She said it again earlier this month:

If she is right, the triggering of Article 50 next week will take us straight to trading under WTO rules two years from now.

Luis González García of Matrix Chambers thinks she’s over-egging it though:

Can the UK negotiate a trade agreement with the EU while being a member of the EU?

According to the EU’s Trade Commissioner, Cecilia Malmström, the answer is no. In a recent interview she said, “There are actually two negotiations. First you exit, and then you negotiate the new relationship, whatever that is.” Her position seems to favour a strict interpretation of Article 50. This interpretation may be supported by the fact that a formal trade deal between the UK and the EU would be in conflict with the EU rules and practice in the negotiation and conclusion of trade agreements.

But in my opinion nothing in Article 50 prevents the EU from initiating formal trade negotiations with the UK during the withdrawal process. Article 50 (2) provides in the relevant part that

A Member State which decides to withdraw shall notify the European Council of its intention. In the light of the guidelines provided by the European Council, the Union shall negotiate and conclude an agreement with that State, setting out the arrangements for its withdrawal, taking account of the framework for its future relationship with the Union.

This formulation requires the EU to conclude a withdrawal agreement with the UK, taking into account the framework of the trading relationship between the withdrawal Member State and the EU. What could be included in the “framework” is unclear but it seems to me that the spirit of Article 50 envisages the adoption of an instrument setting out the new rules which would govern the bilateral trade relations between the UK and the EU, including the technical aspects of a future trade agreement which could only be concluded once the UK has formally exited the EU.

This paper from Sussex University comes to a similar conclusion:

Article 50(2) TEU addresses the content of the withdrawal agreement. It is open-ended, stating that ‘the Union shall negotiate and conclude an agreement with [the UK], setting out the arrangements for its withdrawal, taking account of the framework for its future relationship with the Union.’ This does not preclude trade talks forming part of the Article 50 TEU withdrawal agreement or taking place in parallel. In practice, as Article 50 TEU has never been implemented before, legal debates about whether the UK faces restrictions in pursuing trade talks are highly politicised.

In other words, there’s a bit of posturing going on here and the law isn’t really clear.

The European Parliament’s committee on constitutional affairs seems to agree, arguing that, in practice, it is very difficult to disentangle the two agreements:

The treaty provision establishing that the withdrawal treaty will be concluded in a manner “taking account” of the future relationship is also a challenge in several aspects. This implies that the content of that future relationship should be known not only at the time of the signature of the withdrawal agreement but, ideally, from start of the negotiations. The greater the level of understanding on the future relationship, the easier drafting the withdrawal agreement will be.

What seems desirable is that the withdrawing state has a clear projection of the future relationship when negotiating the withdrawal agreement, and that both agreements are negotiated in parallel. Ideally, when the rights and obligations deriving from the Treaties for the UK and its citizens extinguish, as agreed in the withdrawal agreement, the transitional provisions and/or the new partnership provide for a clear legal framework so there is as little legal vacuum as possible.

As does Steve Peers, professor of EU law at Essex University:

Since the UK is going to be in a different situation, it could be argued the normal rules can’t really apply and the UK should be able to have informal trade negotiations that could be enforced from the day it leaves.

All very sensible. It’s in all countries’ interests to reach some sort of trade deal after Brexit so why would anyone want to put a legal block on trade negotiations?

The trouble is, common sense seems to be in pretty short supply at the moment and we don’t really know what the law says because none of it has been tested. As the BBC’s fact-check concluded:

Under current EU rules, EU countries cannot make separate trade deals with individual member states or non-EU countries. However, there is no legal precedent for a country to leave the EU and renegotiate a trade agreement with the bloc. Legal experts say the UK could argue its official status has changed once it invokes Article 50, but this is largely hypothetical at the moment.

There are all sorts of competing interests in the other 27 countries. Any one of them could bring a legal challenge if they thought there might be some advantage to be gained by holding up the trade negotiations. Even if they were not successful, what would happen to the timing of the negotiations? Would it be like a rugby game where the clock stops or would the 2-years keep running down while the court case was heard?

In normal times we would assume that someone somewhere in Whitehall was looking at this, discussing it behind the scenes with EU lawyers and making a contingency plan. But when a senior government minister can come before a Commons select committee and revel in his government’s ignorance and lack of preparation, these are clearly not normal times.

There is a great quote on one of those demotivational slides which is a warning to anyone about to embark upon a major change:

When the winds of change blow hard enough, the most trivial of things can become deadly projectiles.

This may be one of those trivial things. Let’s hope it never gets much of a wind behind it.


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Brexit likely to hit Leave voting areas hardest

If people voted Leave to stick it to the metropolitan elite they might be disappointed. A piece of research published in Regional Studies journal this month found that London is a lot less dependent on EU trade than most other parts of the UK. Furthermore, the regions that voted strongly for leave tended also to be the same regions whose economies were most dependent on the EU.

The researchers used data from the World Input–Output Database to calculate the share of each NUTS-2 region’s economic activity that is dependent on trade with the rest of the EU. They then mapped this against that region’s Leave vote.

Figure 1. Relationship between the NUTS-2 regional votes for leave and the regional gross domestic product (GDP) share due to consumption and investment demand in the other European Union countries, 2010.

Note: R2 = 0.31.

 

They then did the same with the share of wages.

Figure 2. Relationship between the NUTS-2 regional votes for leave and the regional wage-income share due to consumption and investment demand in the other European Union countries, 2010.

Note: R2 = 0.23.

 

The findings suggest that the economies and wages in the high Leave voting areas are far more likely to be adversely affected by the UK’s exit from the EU. This is counterintuitive, to say the least. The dominant narrative since the referendum has it that London reaped the benefits of EU membership while the rest of the country has seen precious little.

But, as the authors of the paper point out, London is one of the few truly global cities in the world. Because of its international connections it exports goods and services all over the world. Therefore, even though it exports more to the EU than any other region, as a percentage of its total GDP, the value of those exports is much smaller than in other parts of the UK.

While London’s financial services engage with markets all over the world every day, most of the firms in the rest of the UK’s regions tend to engage with European value- chains rather than genuinely global value-chains. The share of UK domestic GDP which is accounted for by EU demand has remained remarkably stable between 1995 and 2011, although its composition has changed due to the UK’s increasingly complex integration processes with EU global value chains.

[A]lmost every part of the UK outside of London has become more, not less, integrated with the EU over recent years, with the major exception being London. On the other hand, London has benefited from inflows of human capital more than any other city in the world and the majority of these human capital injections come from Europe. Yet, these EU-dominated inflows help London compete globally rather than just across Europe. In contrast, the rest of the UK tends to compete on more of a pan-European scale.

In short, London’s economy is globalised while the economies of other regions are Europeanised.

The report’s appendix breaks down the findings by region and sector but I have summarised them and sorted them as a league table here. There are a few surprises near the top but Inner and Outer London are the least EU dependent of the lot. East Yorkshire and North Lincolnshire, one of the areas with the highest Leave voting majority, also has one of the highest dependency on EU trade.

There’s a further twist, though, because the London economy, say the report’s authors, has become detached from that of the rest of the country.

Indeed, the extent to which the London economy is largely disconnected from that of the rest of the UK is observed in the WIOD inter- regional data. Further examination of the detailed interre- gional data8 shows that for all other UK NUTS-2 regions, demand from London only accounts for between 0.7% and 4% of their local GDP.

For all non-London UK regions, the share of their local GDP which is accounted for by the EU demand is greater than the share which is accounted for by demand from London.

It is not surprising that EU markets are more important to UK regions than London markets, given that the EU markets are some 33 times larger than the London markets, and only slightly further away from most of the UK regions than London.

In other words, the economies of many regions are more dependent on trade with the EU than they are on trade with London. Therefore, London’s resilience after Brexit might not help the rest of the country much at all.

We don’t yet know how far Brexit will disrupt trade with the EU. That depends on the terms the government is able to negotiate. Whatever happens, though, there will be more friction in our trade with the EU which will increase costs and reduce the competitiveness of the UK’s exports in the EU. Those regions whose economies are most integrated with the rest of Europe and whose incomes are most dependent on it are likely to suffer disproportionately.

The trouble is, many of these areas are also more dependent on public spending than London. They are therefore likely to lose more from the deterioration in tax revenues and the resulting squeeze on public spending in the wake of Brexit. high Leave voting areas tend to receive a greater proportion of their household income from social benefits. The last thing they need is faltering business revenues.

Brexit is therefore likely to further increase the share of the country’s tax paid by London. Those advocates of devolution who say that they want their region to keep more of its money might want to think about that. Regionalisation might mean London keeping more of its money too and, unless other regions can find new sources of revenue outside the EU, they are likely to find paying for their public services gets even more difficult than it is now.

There will be hard times ahead for many parts of the UK after Brexit. How hard depends on what happens over the next two years. London is likely to fare better than most though. The London elites, by which I mean the real elites with investments and high six figure salaries, not the cycling beardy hipsters, will be just fine. Whatever else people thought they were voting for when they put their crosses in the Leave box, those who wanted to punish rich Londoners will be the first to be disappointed.

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