Sunday, 18 December 2016

Draft Budget 2017-18 and councils

The Scottish Government's Draft Budget for 2017-18 was presented to the Scottish Parliament on Thursday. Much of the analysis has centred on comparison with last year's budget, especially on money given to councils. In this post I'll try to take a longer term view and update figures that appear in Chapter 5 of the book.

The graph below shows the total spend* in each Scottish draft budget from 2008-09 to 2017-18 adjusted for inflation to be in real prices for the financial year 2016-17.
* I took DEL, AME & Other figures, which sum to give TME, directly from each individual Scottish Draft Budget. This history is not published in one place.  Figures comparable with later years don't seem to be available from before 2008-09. The split into DEL and AME & Other isn't of immediate concern here — see this post for more detail on what these terms mean.  As done in the Draft Budget, HM Treasury deflators are used to adjust for inflation.

The height of the bars represent Total Managed Expenditure (TME) which is the amount the Scottish Government plans to spend in a financial year. This total is set by the block grant from the UK Government plus all taxes under devolved control. Previously these taxes included some limited changes to income tax, NDR (business rates), SLfT (landfill tax), LBTT (stamp duty on property sales) and a few others. For the first time in 2017-18 the Scottish Government controls all rates and bands for income tax.

What the graph shows is that in real terms (i.e. accounting for inflation) the total budgeted spend peaked in 2009-10 then fell to reach a minimum in 2013-14. This fall was caused by austerity under the coalition UK government. Since then spending has risen slightly.

There's been much attention to the amount given to councils by the Scottish Government. This appears in the Draft Budget under a heading called "Local Government" and is analogous to the block grant that the UK Government gives to the Scottish Government. And, in a similar fashion to that, the total that councils can spend is set by this amount plus tax devolved to councils which is comprised of council tax and some other revenue (e.g. parking charges, community hall hire etc).

The amount allocated to Local Goverment in each Scottish Draft Budget is shown below as a percentage of the TME** shown in the above graph.

** "Local Government" is a level 3 heading and can be summed along with other level 3 headings to give the level 2 heading "Total Social Justice, Communities & Pensioners' Rights". The sum of all level 2 headings is equal to TME. For this reason it is appropriate to view "Local Government" as a share of TME and not just DEL.
 
It's clear from this that Local Government's share is declining. The drop in 2013-14 is because the Police and Fire Services were centralised and so its funding was removed from the Local Government heading. However, this only accounts for 3pp (percentage points) of the 9pp drop between 2008/09 and 2017/18, leaving a drop of 6pp.

This drop cannot be attributed to UK Government austerity because that would also reduce TME. If Local Government funding was changed in proportion to a change in funding to the Scottish Government then the percentage would remain constant. In fact, since 2013-14, TME has shown increases whereas the Local Government share has continued to decrease.

There have been other funds made available to councils outwith the Local Government heading which can be viewed as offsetting this drop in funding. This has animated a debate surrounding the 2017-18 Draft Budget with Finance Minister Derek Mackay claiming a £240 million rise to council funding whereas opposition parties claim a £300 million cut.

It is true that the Scottish Government has provided other funding, but it's hard to see these amounts covering the 6pp drop in the longer term. Also, even if they did, there's the question of control and centralisation. These extra amounts are not under the Local Government heading precisely because they're not really under council control: they must be spent as the Scottish Government directs.

A separate but important point is that adjusting for inflation accounts only for changing prices and not for increasing needs. The population is growing and the increasing number of school pupils likely requires a real-terms rise in school spending (largely under the Local Government total) and a growing elderly population means extra pressure on the NHS and social care budgets (with the latter also mainly coming under Local Government). If budgets aren't increased then extra efficiencies will need to be made and once those are exhausted (along with the staff that must implement them) standards of public service will surely decline.

There are ways to alleviate these problems, if the political will exists. The Scottish Government have now given councils the option to raise Council Tax by up to 3%. This can relieve some pressure on council budgets but Council Tax is based on dubious 25 year-old property valuations and is only loosely related to ability to pay. Raising money for public services centrally by raising income tax rates would not only be fairer but also avoid issues of exacerbating existing inequalities between councils.

Of course, the lack of funding for public services originates with the UK Government's nervousness in increasing public borrowing. The Scottish Government has only limited borrowing powers, but it is no longer constrained to follow the UK Government on income tax. Nevertheless it has chosen to set exactly the same income tax rates and make only a small change to the higher tax rate threshold. This now leaves any significant tax raising decision to the councils. It will take some courage to present people with the first Council Tax rise in a decade in the few months leading up to the May 2017 council elections.



This spreadsheet contains all calculations and gives all sources used in this post.

Amended at 14:30 on 18 Dec 2016 because APD was incorrectly described as a previously devolved tax. SLfT is now included as an example of such a tax instead.

Friday, 16 December 2016

Raising tax and raising income

Scotland's 2017-18 Draft Budget was presented in the Scottish Parliament today and yesterday proposals to alter taxation, specifically to raise tax rates, were voted down. In this post I'll take a look at how Scotland's unique fiscal arrangements can lead to the counter-intuitive situation where tax rates go up but cause a modest boost to collective income (i.e. GDP). Even if the effect is small, it serves to highlight the distinction between the technical, moral and electoral issues surrounding taxation.

Raising tax rates means taking a greater share of income from households and businesses — the private sector — and giving it to the public sector. Understandably, most people see this as reducing their income which is why raising taxes is a near certain way to lose votes.

But, when you consider it more carefully, especially in the context of the new tax powers wielded by the Scottish Government, it's not nearly so clear cut. Consider two facts about taxation.

Firstly, the greatest share of total tax revenue comes from the highest earners. It's not hard to see why: a) they earn the most b) tax rates increase with income.

Secondly, the higher your income, the greater the fraction of it you are likely to save. Again, it's not hard to see why. If you are on a low income, you might need to spend all your money to provide the basics of shelter, food and warmth. Those on much higher incomes have the luxury of choice, such as whether to save £10,000 per year or use it to buy a Mercedes instead of a Ford.

The decision to save or to spend has an impact on the economy. If a higher income earner decides to save by stuffing notes under their mattress, the money will leave the economy and do nothing. Even if the money is saved with a bank there's no guarantee it will be used productively. If a bank cannot see a way to make a return by lending, the money is effectively stuffed under a financial mattress. Even if such deposits do somehow cause a bank to increase its lending there's no guarantee that saving money with, say, The Royal Bank of Scotland, will lead to a loan that gets spent into the Scottish economy.

Whatever way you look at it, money that is saved is less likely to find its way into the productive economy. Much of it will pile up as wealth, probably with those who are already most wealthy.

Now consider what might happen if the Scottish Government ups tax rates as illustrated in this diagram:

The top part of the diagram shows the situation before the tax rate increase. Most of the private sector's post-tax income is spent (green) and a smaller portion is saved (red). The total spending into the economy is the private sector's spending (green) plus the government's spending (blue).

After the tax rate rise, all else being equal, the amount spent by the private sector reduces slightly but the amount saved decreases by more. This is the likely result if the tax rate rise is directed at higher earners for the two reasons given above. The blue amount of government spending is the same as before but there is also extra spending funded by the new tax take.

And here we come to what makes the Scottish Government's position unique: by law, with only a little wiggle room, the Scottish Government must draw up its budget so it spends all its revenue. As a result the total spend into the economy is larger than before the tax rise.

In other words, a portion of the money that would have otherwise been saved is now placed under the control of the Scottish Government and is almost guaranteed to be spent.

Suppose for example that the extra tax take is used to recruit and employ new teachers. People at the start of their career are more likely to spend all their income because not only are their salaries lower, but they will likely be setting up homes and starting families, all of which involves spending into the Scottish economy.

Even if the government spent the extra tax take on something daft, such as painting the Forth Bridge a different colour every six months, the money paid to the army of painters would still find its way into the Scottish economy. In fact, as long as the government doesn't splurge money on imports or direct it at the already wealthy, its spending will serve to increase everyone's collective income. That is, it will boost GDP.

There are two assumptions implicit in the above. The first is that raising tax rates raises the amount of tax revenue. This is likely but not a given. For example, raising rates of tax on high earners who can afford multiple homes and good accountants could result in them moving their incomes elsewhere, most obviously to England if tax rates are lower there. For this reason, estimating the extra tax revenue involved is not easy and a very large increase in tax rate may even lower collected tax revenue (the much contested Laffer Curve).

The other assumption is that people's desire to save does not change. Economic ill winds from abroad, or an oil price shock, or the tax rate hike itself can spook consumers so that they become nervous about the future. The usual result is that people spend less, save more and economic activity is hampered, possibly causing a recession with a drop in GDP and job losses.

External and uncontrollable influences not withstanding, both assumptions are reasonable if the tax rate change is small and targeted only at higher earners. For instance, higher earners are unlikely to incur the cost of moving home or making major changes to their tax arrangements for a small increase in tax rate that doesn't impact their current or future standard of living.

Separate to political and technical issues of tax, there are questions of morals and values. In fact, nothing written above addresses these. There is no contradiction if an individual accepts the validity of the above argument but objects to the call for tax rate rises because they believe it is best to let the private sector take decisions on spending (and saving). A contrary position would be, say, to argue that tax rises are essential to fund the NHS or else it will not have the staff needed to maintain current standards of care.

I am not saying that these two positions are equal (nor that I have no preference personally for one over the other), my intention is just to point out that they raise questions that are quite distinct in nature to what has been argued above.

Questions on whether tax changes are justified on grounds of economics or values have unfortunately been conflated in the political rhetoric. If the Scottish Government wished to mitigate UK Government austerity, which the First Minister has openly criticised, then the above argument suggests that it can do so by raising tax rates and, all else being equal, it could be done in way to give the economy a wee boost too.

However, I suspect the reasons behind the Government making only very minor tweaks to taxation in the 2017-18 budget are neither economic nor driven by values. Instead it is what might be expected from a party that is in a strong electoral position and is cautious in making changes that may lose them votes.

A more detailed version of the argument made in this post can be found in this post. But be warned, some mathematics is involved.


Thursday, 24 November 2016

ScotRail Punctuality

Disruptions to ScotRail's train service in recent weeks have had a noticeable effect on my family's daily routine. We weren't the only ones to experience this of course. Concerns spread on social and traditional media and it's now been raised in the Scottish Parliament. Not all of the discussion has been helpful. In this post I'll lay out some recent data on ScotRail's performance and try and put it in a wider context.

Background

Before getting stuck into data on performance, it's worth understanding how our rail services were split into two parts when privatised in the 1990s.

Network Rail handles infrastructure, such as the track, signals and overhead wires across Great Britain (England, Scotland and Wales but not Northern Ireland). Although Network Rail is not a private, shareholder-owned company like its predecessor, Railtrack plc, its status remained ambiguous until 2013 when the Office of National Statistics ruled that it was a government body in the public sector. As a result its debts of £34 billion were added to the UK's public debt.

The train services that run on Network Rail's infrastructure are operated by private companies. They procure and maintain rolling stock, manage staffing and are responsible for many train stations. Trains in Scotland are run by the ScotRail franchise which is awarded to private companies in a competitive tendering process. National Express won the first contract in 1997, and were followed by FirstGroup in 2007 and most recently Abellio was awarded a ten year contract starting on 1 April 2015.

Whereas Network Rail must reinvest any surplus (if it ever made one) in its infrastructure, the private companies could choose to distribute profits (if they can make any) via dividends to shareholders.

Punctuality - long view

The information presented here is mainly from the Office of Rail and Road's (ORR) Passenger and Freight Rail Performance report for 2016 Q2 published in November 2016.

First, take a look at the history of punctuality since 1998.

This graph shows PPM which stands for Public Performance Measure and is the percentage of trains that arrive at their destination on-time. On-time is defined as being within 10 minutes of the timetabled arrival time at the final destination for long distance journeys, and 5 minutes for all others. If a train fails to run its entire planned route calling at all timetabled stations it will count as a PPM failure (see end of this page for the full definition).

MAA stands for Moving Annual Average which means an average is taken over the year leading up to the stated date. This smooths out short term variations, emphasising trends and easing comparisons. Information is of course lost in doing this, most notably a 5 to 10 percentage point drop in PPM that occurs every winter (see first graph here).

With this in mind, you can see what the above graph is telling us. Train punctuality fell suddenly in the early 2000s, then had a slow recovery and since 2010 has stabilised at around 90% (except in London and the South East where a decline is evident).

The plummet in PPM in the early 2000s followed the Hatfield derailment in 2000, which killed four people and injured many more. This tragedy prompted an investigation which uncovered serious flaws in track inspection and maintenance that had developed in the years since privatisation (whether it was caused by privatisation is another matter). To prevent many potential repeats of Hatfield, an extensive programme of investment in rail infrastructure was instigated and the disruption caused by these works is why PPM suffered in the early to mid-2000s.

Punctuality - recent

The chart below shows latest PPM MAA figures for Train Operating Companies (TOC) such as ScotRail. These figures are for 2016-17Q2 (Jul to Sep) and the difference from Q2 in the previous year is also shown. Abellio has operated Scotrail during the whole of averaging period for 2016-17Q2, but FirstGroup operated ScotRail for two of the four quarters in the 2015-16Q2 average.


ScotRail sits in the middle of all GB train companies at 89.6% which is a 1.2 percentage point drop on the previous year. This drop is typical of most companies.

The situation is little changed if we look at data for 2016-17Q2 without the averaging. ScotRail's PPM was 90.2% with a drop of 2.0% from 2015-16Q2.

According to data for the latest official period (16 October to 12 November 2016), available from this Network Rail page, PPM was 87.0%, up from 84.3% for the same period in the previous year. PPM MAA for the year to 12 November 2016 was 89.8%.

The same page also gives statistics on who was responsible for any passenger train delays of 3 minutes or more. For the entire GB network in the year to 12 November 2016, 61% of delays were caused by Network Rail, 29% by the train operator itself and 10% by other operators. For ScotRail these figures are 54%, 38% and 9%. Out of the 22 train operators listed, only three others had larger self-caused delay percentages than ScotRail.

The ORR report also gives some European context. GB ranks 9th out of 22 European countries for long distance PPM, but only 18th of 23 European countries for non long distance journeys.

Conclusions

In short, ScotRail's performance has been unremarkable in PPM terms: neither particularly good nor bad relative to rail companies across GB. However, ScotRail ranks near the bottom for self-caused delays.

The numbers presented here do not show that ScotRail has a serious problem. That's not to say it doesn't though. We'll have to wait and see if data beyond 12 November will show what people have reported anecdotally. It is also possible that legitimate concerns have been amplified by both social and traditional media.

Daily PPM data is available, such as from trains.im or uktra.in, and at the time of writing (17.31 on 24-Nov-16) it showed ScotRail as having the fifth worst PPM in GB of 75%. But caution is required over short timescales for a variety of reasons. For example, in the last week it was pointed out that ScotRail's performance was amongst the best in GB, but this was while the southern part of Britain was beset by Storm Angus.

There's one point worth noting here that applies beyond just ScotRail. The most problematic part of our railway system is Network Rail; it is responsible for over half of all delays. But, the only reason train operating companies stand a chance of making a profit is because the most heavily loss making part of the railways has effectively been nationalised in Network Rail.










Wednesday, 2 November 2016

A tale of two unions

This is a short post to explain why I devoted so much attention to sector balances in the last couple of posts this one on Scotland's onshore economy, and this one extending it to include the North Sea.

Although sector balances will seem rather remote and abstract to many, they do have important implications for currency which does play a much more tangible role in our everyday lives. And it's not just that we can literally hold bank notes in our hands — it's whether our pay is in the same currency as our debts and savings, and how that affects our confidence in the future and even our outlook on life.

But there's a more fundamental reason to pay attention to how countries balance their economies against each other and one that calls for action that transcends national boundaries.

Imagine two countries that mainly trade with each other but where one is a net exporter and the other a net importer that runs a trade deficit. In time, the exporter, which runs a trade surplus, will build up a stock of the other's currency from the proceeds of selling its exports.

Clearly this trade imbalance cannot be sustained indefinitely otherwise the exporter will end up with all the money and the other none, leading to economic collapse in the importing country. Thankfully, there are a number of ways that rebalancing can occur before the situation gets too extreme.

If the countries have different currencies, the net importer can let its currency devalue which will make their exports cheaper to the other country and that should, in time, reduce the importer's deficit and balance the trade.

Flexibility with currencies helps keep trading economies in balance. But it's important to realise that a country that permits a devaluation is effectively allowing all its citizens to become poorer relative to the rest of the world. The alternative, to ask workers in certain industries to take a cut in their wages to help reduce the price of exports, may be equivalent in theory, but would cause an outcry politically.

But what if both countries use the same currency?

One option is that the exporting country with the surplus lends money to the importing country with the deficit. But this is not sustainable either because the accumulation of the net importer's currency is just replaced by a build up of debt, and the importer will face mounting interest payments which can only make the situation worse. This is essentially what has happened with Germany and southern European countries that use the Euro.

A better solution, if politically feasible, is to balance the economies with fiscal transfers. In other words, set up a common public sector that spans the countries with spending and taxation powers that can redistribute the money to where it's needed. This is the mechanism that currently operates within the UK in tandem with the Sterling monetary union, but which is absent from the EU and its Euro monetary union.

And this brings us to why sector balances and currency are not mere technical details but fundamental in understanding unions of countries.
If the EU does not put in place a surplus recycling mechanism between exporting and importing countries then it's hard to see how the Euro can survive because imbalances of trade will result in long-term, ever-increasing accumulations of debt.

If Scotland leaves the UK then the UK's fiscal recycling mechanism will need to be replaced with a solution involving currencies. As yet, it's not at all clear how this might be done.
Interesting and uncertain times are ahead for both unions. But as Bertrand Russell pointed out, uncertainty is no excuse for inaction: it is important to accept what can be known with some certainty, hold one's beliefs with a certain element of doubt, but still act with vigour.

Unfortunately, reality is somewhat backwards in this regard. What has been researched and established on evidence is often dismissed in the face of untested beliefs that are held with great certainty, and what action there is by government is diluted variously by dithering, timidity and, in the worst cases, ideology. That said, perhaps it is just as well that governmental vigour is kept in check by the electorate.

Sunday, 30 October 2016

Balances and North Sea Exports

Two things bugged me about the last post and, as with many important points made in writing, they received attention only in the two footnotes. After a bit of reading around I've managed to assemble some data on exports of oil and gas from the North Sea industry and outflows from the Scottish economy to the foreign sector. I'd recommend reading the previous post if you're not acquainted with the concept of sector balances.

About 80% of North Sea production is currently in waters that are closest to the Scottish coast and it's thought by most commentators that this geographical share would belong to Scotland if independent. So it's interesting to consider how the balances presented previously change if this geographical share is included.

With the caveat that there are significant uncertainties involved — and it could be several billion pounds either way* — here is my attempt to construct these balances.

Balances with North Sea (wNS)
To save flicking back and forth, here's the onshore version of this graph from the previous post. For brevity, I'll refer to the one above as wNS (with North Sea) and the one below as onshore.


Balances - onshore only

The two graphs are obviously quite different. The main difference is that the onshore version shows a large but fairly constant trade deficit (the blue foreign sector balance is positive), whereas the wNS one has a smaller and more volatile trade surplus. This is because North Sea exports have historically been very large and variable.

The public balances in the wNS graph are smaller than those in the onshore graph because of North Sea tax revenues which are (mostly) levied as a percentage of profits. In the boom years this led to wNS public balances being improved by £10 billion or more over onshore balances. Following the oil price drop in 2014/15, profits and so tax revenue sunk to almost zero. For 2015-16, the wNS public balance was improved by a miniscule £0.06 billion over the onshore balance.

A crucial point to appreciate is that although exports have also fallen with oil price to about half of their 2008-09 peak, they remain substantial and nowhere near zero.

The bulk of the flows into the Scottish economy from North Sea exports are into the private sector, and so the wNS private balance is large and highly variable. Note though that both graphs show the private balance expanding in response to the 2008 financial crisis due to a desire to save money when faced with an uncertain future.

The wNS private sector balance is overstated because some of it is sent to the foreign (private) sector to pay foreign employees and owners of North Sea companies (called factor income). For 2010 this amount was estimated to be £7.8 billion, of which £5.4 billion was related to North Sea activity. Unfortunately this is rather uncertain and estimates are not available for any other year.

The result of removing this from the private sector and adding it to the foreign sector balance is shown in the 2010-11* column at the right of the wNS graph. This makes the foreign sector balance zero and so according to the identity introduced in the last post, the private and public sector balances must be equal and opposite. (Another way of stating this would be to say that the current account balance of Scotland is zero.)

Although we can only correct the graph for 2010-11, we can use that correction to make a rough prediction for following years. North Sea exports have decreased since 2014 due to the fall in oil price. So if the actual wNS foreign balance was about zero a few years ago, it is almost certainly positive now, meaning that it constitutes a net outflow from the Scottish economy (i.e. a current account deficit).

In other words, in recent years, and likely for years ahead, we would see the wNS graph looking more like the onshore one with blue and green bars being positive and the red bar negative. Although the red bars would be about the same length on both graphs (North Sea revenues are near zero), the wNS graph would have shorter blue bars than the onshore graph but larger green bars meaning a larger private sector balance.

The last post concluded by pointing out that trying to reduce a fiscal deficit must entail reducing one or both of the private balance and trade deficit. This conclusion still holds true but as the trade deficit would now be relatively small (perhaps a few billion), it seems more likely that the private sector would bear the brunt.

Currency conundrum

A fascinating (and concerning) conundrum arises if Scotland were independent. It would be composed of two interlocked economies:
  • an onshore economy closely tied to rUK with a trade deficit (net importer)
  • an offshore petro-economy that's a net exporter.
And these two economies pull the currency choice in two different directions.

The onshore economy that's tied to rUK would benefit from using the pound, but an exporting oil economy would require Scotland to have its own currency that could respond to the volatile oil price and perhaps also fluctuations in the exchange rate with the US dollar in which oil is priced.

Quite how that square could be circled is a subject for another post, but if you've a thirst for more detail I recommend reading what Angus Armstrong wrote in 2013 and Ronald MacDonald's 2014 paper (full of typos I'm afraid).

Both these articles were written before the 2014/15 fall in the oil price and the Brexit vote. Rather than render their arguments out of date, these events make them seem all the more vivid as they highlight the importance of currency.

There's a fundamental reason why I think considering sector balances is important, but I'll leave that to a third and final (and shorter!) post.


*Uncertainty, complexity and technical details

The easy, or at least easier part is the net fiscal balance. Data on this including a geographic share of North Sea revenue is given in GERS.

Firstly, all the trade data, even with the onshore economy, should be regarded as quite uncertain. In the worst cases I've noticed revisions between quarterly publications of the Scottish National Accounts of as much as several billion pounds (e.g. compare imports-exports between 2015Q4 and 2016Q1 editions).

Unfortunately, the data on trade of North Sea oil and gas is both more complex and even more uncertain. In 2013, the Scottish Government published an experimental analysis of this for 2012 (though the news article about it on the Scottish Government website was deleted in the last five days for reasons unknown), and has since provided an updated report that gives data for the years 2000 to 2014. Although very interesting, it's not possible to simply add the North Sea trade data to the trade data from the onshore quarterly national accounts because the latter includes imports and exports between the North Sea region and onshore Scotland (see pages 18 and 19 of the report for more detail).

However, drawing on a graph given in Armstrong and McCarthy (2014), with a sense check against the Scottish Government updated report, I was able to estimate the trade balance as shown in the blue bars of the wNS graph. Unfortunately, this data set was by calendar year whereas the GERS net fiscal balance is by financial year. Ideally this should be corrected if quarterly data is available, but given that calendar and financial years differ by only one quarter, the error involved (about 5%) is probably dwarfed by the larger uncertainties.

The net factor income adjustment comes from the Scottish Government's attempt to estimate Scotland's Gross National Income or GNI for 2010. The GNI is similar to GDP except cash flows to foreign employees and owners are included. This work tells us that GNI is about £7.4 billion less than GDP for Scotland because that amount is flowing out as what's called a net factor outflow. Armstrong and McCarthy (2014) also estimate a further transfer overseas of £0.4 billion which gives the £7.8 billion figure mentioned above.





Sunday, 23 October 2016

Balancing national identity

There's an engineer's saying that goes "Faster. Better. Cheaper. Pick two." In politics you could say "Fiscal deficit, trade deficit, private savings. Improve two." This post takes a look at this for Scotland and offers an alternative perspective on Scotland's fiscal deficit. Data sources are given in the footnotes.

If you spend £1, someone must receive £1. Likewise, if the government spends £1, someone must receive it. The government also has an income from tax and for every £1 it received in Scotland in 2015-16, it spent £1.28. Given the total tax take was £54 billion, that means the government spent £15 billion more than it received from tax. This is known as the fiscal or budget deficit, which was discussed in previous posts

We're using the term 'government' loosely here. Strictly, we should be talking about the public sector, which is all government bodies plus public owned corporations such as Scottish Water along with a population share of UK institutions such as the Bank of England.

So if the public sector is spending £15 billion more than it pulls back in tax revenue, you might wonder who's lucky enough to be on the receiving end of that £15 billion. In other words, if the public sector's balance is minus £15 billion, who has a balance of plus £15 billion?

When a teacher, doctor or nurse is paid, that's money going from the public to private sector. Likewise, when the government makes a payment to someone for their state pension or for housing benefit, that's a transfer of money from the public to private sector. In fact virtually all public sector spending goes into the private sector.

So, would it be right to conclude that the private sector balance is about £15 billion?

The answer is no. The reason is that there's another large flow of money out of the private sector (in addition to tax) that means the private sector balance is much less than £15 billion. This flow is caused by trade (which was discussed in this post). Specifically it is the amount spent on imports less what is received from exports, which for 2015-16 amounted to £12 billion.

At this point we need to be precise about our definitions. We've defined three sectors so far:
  • Scotland's public sector  — government and public corporations — balance is minus £15 billion.
  • Scotland's private sector — households and businesses — see below for its balance.
  • Foreign sector — everything outside Scotland, including rUK — balance is plus £12 billion
By balance, we mean the income of the sector less its outgoings for a given year, which for these figures is the 2015-16 financial year. A sector with a positive balance is enjoying a rise in wealth over that year.

If you consider these definitions, you'll notice that we've divided the whole world into three sectors and, so long as we discount the possibility of secret trade with Martians, the balances of the three sectors must add to zero.

So, the balance of Scotland's private sector* must be £15 billion minus £12 billion which is £3 billion.

What we have done here is construct a well known macroeconomic identity. That is, an equation that must be true by definition.

The graph below shows the three balances for the last 18 years in nominal terms (i.e. not corrected for inflation) excluding the North Sea**. 

First, notice that the bars are symmetric about zero. This is another way of understanding the identity: the balance of all three sectors must sum to zero, that is:
public balance + foreign balance + private balance = 0
which, with a little basic algebra, can be stated in terms of the more commonly discussed deficits as follows:
fiscal deficit = trade deficit + private balance
where the fiscal deficit is just the negative of the public balance (called the net fiscal balance in GERS), and the trade deficit is the negative of the foreign balance.

The private balance is often referred to as something like 'net private sector savings' by economists but 'savings' does not have its everyday meaning, and can mean different things to different people. In macroeconomic terms it's best to think of 'savings' as meaning income that is not consumed. Consumption refers to spending on something that has no long term value, for example, buying a packet of crisps or toilet roll represents consumption spending, whereas purchase of a house or shares in a company does not.

Causal caution

Do not read any causation into the way an identity is expressed. The second word equation may tempt you into thinking the fiscal deficit is caused by the trade deficit but no such inference can be made without more information.

However, it is instructive to consider different scenarios. To provide some connection to the present reality let's keep one quantity fixed, change another and see what happens to the third.

First, if there was no trade deficit we would have:
Fiscal deficit = £0 + private balance = £3 billion
What this is telling us is that if trade were balanced and the private balance remained as it is now then most of the fiscal deficit disappears.

Quite how this might come about is not easy to imagine. The trade deficit can be reduced by increasing our exports or by reducing our imports. If you look in your fridge, wardrobe, driveway, or inspect the device you are reading this on, you will appreciate the problem with the latter. The Scottish Government is very keen on upping exports but has not had much success in recent years. In fact, most developed economies struggle to find ways to improve their trade deficit as it is asking for both the private and foreign sectors to change their behaviour.

Next. consider what would happen if, as suggested by John McLaren, the fiscal deficit is chopped down to £3 billion and the current trade deficit of £12 billion persists:
£3 billion = £12 billion + private balance
that is
private balance = - £9 billion
This cure for the fiscal deficit means that the private balance takes the hit — quite a colossal hit if the trade deficit stays the same — and this is because, as John McLaren outlines, the government raises taxes and/or cuts government spending.

Economic growth does not in itself change the argument (in fact McLaren's scenario assumes £3 billion of tax revenue growth) unless you can explain why exports or tax revenues see superior growth to imports and public spending.

So, although caution is needed in reading cause into such an identity, we can be sure that Scotland's fiscal position cannot be changed without either the closing of the trade deficit or a reduction in wealth for households and businesses, or a bit of both.


*Scotland's private sector balance as I've computed it here includes a component which goes to the foreign sector but not through trade. This is because foreign employees work and are paid in Scotland, but also because some private sector assets in Scotland are foreign owned and returns from these are sent abroad. Also, some Scottish residents receive income for working abroad and Scotland receives income for owning assets located abroad. Ideally this net income (denoted by Z in this blog post) would be separated out and added to the foreign balance as is done in computing the UK's current account balance. Unfortunately the Scottish Government doesn't publish this for Scotland. The other consequence of this is that the foreign balance here is just the trade balance. If these issues could be corrected, the foreign balance would be larger and the private balance smaller. This is considered further in the next blog post. EDIT 31/10/2016: Clarified and link to next blog post inserted.

**Data on imports and exports for the North Sea are not available for Scotland, though an experimental estimate was published for 2012 (one of the North Sea industry's best years) by the Scottish Government. To remain consistent I have kept all figures in this post to the onshore values as published by the Scottish Government in the 2016Q1 national accounts (trade deficit) and GERS 2015-16 (fiscal deficit). Due to the fall in the oil price from late 2014 onwards, North Sea revenues have dropped markedly and profits are now near zero and so for 2015-16 there was almost no difference between onshore tax revenue and tax revenue including the North Sea.
EDIT 30/10/2016: The link above to the Scottish Government experimental estimate news item disappeared in the last five days. I don't know why. The report it is based on is still there however.

Tuesday, 11 October 2016

Brexit

The Fraser of Allander Institute (FAI) published its report on how Brexit might affect Scotland this week.  There were many such assessments for the UK before the EU Referendum, but this is the first that takes a detailed look at Scotland with economic modelling.

Most economists agree that leaving the EU will hurt the UK economy because it will make selling our exports more difficult. There are of course societal issues too. To some people, EU membership is desirable as it brings with it such things as the freedom to move and work in any EU country. But others are concerned that the UK has lost sovereignty — the power to take the final decision in matters affecting its own citizens. And of course some worry that there is too much immigration. But societal and economic considerations are not entirely separate and immigration is one aspect that links them. In fact there's a surprising and important aspect in the FAI's results regarding immigration, which we'll come to later.

Firstly, let's deal with its main finding: as a result of Brexit, in 10 years time Scotland's GDP will be 2% to 5% below what it would have been if we stay in the EU.

It's worth being precise on the terms here.

Firstly, the statement is concerned with onshore GDP only, mainly because the North Sea bit of it is near impossible to predict over 10 years.

Secondly, this is real GDP, meaning that it is corrected for the effect of inflation (changing prices).

Finally, and I've seen much misunderstanding on this point, it's not saying GDP will be 2-5% lower in 10 years than it is now, nor is it saying the annual growth rate will be 2-5% lower. The statement on GDP, and all other quantities in question (wages, jobs, population), is relative to what it would be if we don't leave the EU.

The impact depends on the type of Brexit: the 2% is soft, Norway-style Brexit and the 5% is hard Brexit where we default to the World Trade Organisation (WTO) rules. At present, hard Brexit looks more likely so I'll stick to the WTO scenario here.

GDP


Consider this graph of real GDP.

This is not from the FAI report but it illustrates what their 5% reduction in GDP looks like over 10 years. The blue line uses actual figures for real GDP in 2015 prices from the latest Scottish national accounts.

The red line shows what might happen if we stay in the EU and GDP increases with a growth rate of of 1.6% per year — the average from 1998 to 2015 including the recession following the 2008 financial crisis.

The green line shows what might happen if article 50 is triggered in early 2017 and hard Brexit commences in 2019. From then onwards, GDP grows at a lower rate of 1.1% so that we arrive at a GDP of £173 billion in 2029 which is 5% lower than the red value of £182 billion.

Remember this isn't a prediction or a real run of a model — it's a plausible illustration of what the FAI's estimated 5% loss of GDP over 10 year might look like.

The difference doesn't look so dramatic on the graph and you might be tempted to think: oh, Brexit, even hard Brexit doesn't look that bad. Well, there's some truth to that, but to appreciate the impact you need to look beyond just GDP.

GDP and people


You can think of GDP as the sum of all income in the Scottish economy for newly produced goods and services. This isn't quite right due to depreciation and few other wrinkles, but it'll do for our purposes. (See this post if you'd like to know more about GDP.)

Now, if total income grows faster than the population, then people must, on average, be enjoying higher incomes. Of course, these incomes are not distributed equally, which is an important but separate point which you can read about in this post and the ones following it on Scotland's inequalities.

To account for changes in population you need to work with GDP per capita which is just GDP divided by the population. This tells you the average income per person and is related to other measures of individual income. For example, GDP per capita was £27,300 in 2015 whereas the median income before tax according to the Annual Survey of Hours and Earnings was £27,710 in Scotland.

The graph below plots GDP per capita. Each value on this graph is calculated by taking the value for that year from the previous graph and dividing it by Scotland's population.

The population figures are from the National Records of Scotland and they provide projections for 2016 onwards which I've used for the EU scenario. However, for the Brexit scenario I've only used those projections for 2016-19 and then set a population growth to match the FAI report's estimate that Scotland's population will be 3% higher in the Brexit scenario than in the EU scenario after 10 years. I'll come to why shortly.

If you compare the two graphs you'll see that the GDP per capita gap in 2029 is larger than the one for GDP; this is due to the more rapid population growth in the Brexit scenario. To put it colloquially, not only is the pie growing more slowly but there are more people wanting a slice of it.

So the slower growth of GDP and faster growth of population lead to 2029 GDP per capita being £30,100 in the Brexit case instead of £32,600 in the EU case. This is a difference of £2500 or 7.6% which chimes with the FAI report which finds a real wages difference of £2000 or 7.2%.

Scotland and rUK


The FAI model finds that Brexit will have a greater impact on the rest of the UK (rUK) than Scotland. This is because Scotland has a lower proportion of direct trade with the EU. According to the latest Scottish national accounts 16% of Scotland's total exports in 2015 went to the EU whereas 44% of all UK exports went to the EU. In fact, given that 64% of Scotland's exports go to rUK, a good part of the Brexit impact on Scotland will be from the slowing rUK economy rather than the impairment of its direct trade with the EU.

And here we come to the explanation of why the FAI's model says that Scotland's population will rise faster in the Brexit scenario. The economy in Scotland will be in better shape than rUK's, including higher real wage growth, and that will cause immigration to increase from rUK into Scotland.

There is a circular irony in the fact that concerns about immigration motivated some people to vote for Brexit and that in turn may actually cause immigration.

All else being equal


The results from the FAI model are subject to the usual qualification of all else being equal or, if you prefer latin, ceteris paribus.

For example, they assume there will be no significant fiscal intervention by the government, such as tax cuts or spending stimuli, nor any impact from new trade deals. Such factors could offset some of the loss of GDP and some proponents of Brexit, though very few economists, argue that it could boost GDP above what it would be if we remained within the EU.

And there are many factors that could make matters worse. One concern is Brexit's effect on labour productivity — the GDP produced per hour worked — which underlies real economic growth. Productivity has failed to grow since the 2008 financial crisis in the UK and there has been speculation that Brexit may result in another impediment to its growth.

There are many other imponderables. The value of the pound against the US dollar and Euro has dropped since the Brexit vote. Although this has the downside of making imports more expensive, it should also boost UK exports which will seem cheaper to foreign customers. It's too soon to conclude anything from the national accounts figures on trade as yet, but by early 2017 figures for 2016Q3 and 2016Q4 will become available.

One interesting point that's addressed in the FAI report is what will happen if the £860 million per year — Scotland's share of the UK's financial contribution to the EU — is redirected to spending into the private sector by the government. The report estimates that by 2029 this will cause Scottish GDP to be higher by 1% or £1.8 billion (although this is estimated separately from the main modelling).

The report doesn't mention it, but a significant implication of this is what might happen if, for whatever reason, the reverse happens and government spending falls. On top of likely cuts to already stressed public services — notably social care, the NHS and councils — a fall in government funding will reduce GDP and real incomes with it.

The FAI's report tells us that Brexit is going to have a significant negative effect on Scotland's economy, but it is by no means catastrophic in itself. Rather, it suggests a dimmer economic future. To my mind, the bigger concern is that it will make it more difficult to weather other economic shocks such as that due to the fall in oil price, or some kind of repeat of the financial crisis of 2008.

But of one thing we can be certain, it's highly unlikely that we'll see the nice straight lines I've sketched numerically in the graphs above.

One reality


To a scientist, comparing two future scenarios like this is unsettling because only one of them will play out in reality and, short of an alternate universe, we will never be able to compare it against the other. In other words, we can never know whether the model's results are correct.

But, that's not to say such modelling has no value. For the same reason that a journey is not just about the destination, it's not just the bottom-line results of the model that are of interest but the thinking that goes into it. Elements of that do lead to testable propositions. Here are two we can phrase as questions:
  • will Scotland see better real wage growth than rUK?
  • will Scotland's population growth rise due to immigration from rUK?
We will have to wait and see.

Sunday, 9 October 2016

Feedback and reflection

I've given this blog a wee rest over the summer not just because I was busy with other things, but also because I wanted to take a step back and reflect. As I wake it up again I thought I'd share some thoughts on feedback I've received so far. This post necessarily has a lot of first person prose, but I'll return to the more usual style in future posts.

You can read the 5 star reviews of the book over on Amazon, but most of the feedback I've received has been via Twitter because that's where I spent most time punting the book. Somewhat to my surprise the discussions have almost entirely been good natured and constructive. I've also had some feedback via email, and it's been a pleasure to meet a few folk in person who I've only previously interacted with across the internet.

As pleasing as it is to receive praise, I'm much more interested in criticism, especially of the constructive variety. So far no one has reported any factual inaccuracies but I've been very grateful to those who've reported typos and areas which could be clarified. I've updated the book a few times now in response to these.

I've been asked about my qualifications to write such a book. Well, aside from being an aspiring active citizen myself, I've spent most of my adult life explaining difficult concepts that I've managed to get my head around to people from a variety of backgrounds.

To give a few notable examples: I've explained the big bang to primary school kids; neural networks to a sheet-metal worker who was made redundant; environmental science to people I'll never meet (via OU texts); and Einstein's relativity to a person whose autism meant that he rarely spoke to anyone (though I had the advantage of not knowing that when I met him). Taking information from jargon-laden specialisms and attempting to explain it clearly to diverse and unknown audiences has occupied a lot of my working life.

One tricky issue that I've discussed with a few folk, and given much thought to myself, is my attempt to keep opinion out of the book. This presents two separate problems.


People are drawn to opinion

 

A book that's not driven by opinion is a difficult sell. The best way to get attention is to make a clear but contentious statement of opinion, especially one on a polarising issue such as the subjects of the 2014 and 2016 referendums. Indeed, the posts with most attention on this blog have been when I deliberately wrote provocative posts (at least by my standards) on Scottish independence and the fiscal deficit.

A few folk have told me, sometimes in roundabout ways, that I fail to appreciate that many people have an emotive approach to politics: they're not going to be rational or step through the facts as I try to do.

Not only am I well aware of this, but it is precisely what motivated me to write the book in the first place. Rather than just sit on my arse and despair at the level of political discourse, I decided to educate myself using public sources of information and in so doing found myself writing a blog and then a book on what I was learning. Even if there is no strong opinion present to draw in the reader, I do hope it will help readers in forming their opinions.

I know some may baulk at me saying this, but I honestly do not mind what people build on the work I have done, be it a case for an independent Scotland, an argument for staying in the UK or remaining in or leaving the EU. As long as folk engage with the facts all of these routes forward can be made to work; it's a question of weighing up the risks, rewards and sacrifices against what you want from society.

In discussing our society a clash of opinions is inevitable, but political discourse can be improved by separating the debate on what are the facts (marred by tribalism and truthiness) from the more vital debate on the core values of our society. The latter debate is of course much more difficult because "we" do not have a common "want". It can be very hard to compromise on conflicting values, but it's not impossible. In fact it seems to me that people have more difficulty in thinking about compromise than actually doing it: a communist can work for Microsoft, a capitalist can work for a government quango, an anarchist might subsist on state benefits, and some Scottish nationalists are married to unionists, and some remainers to brexiteers. In reality, most of us are not really '-ists' of any kind. If you doubt that, consider why the use of an '-ist' label is often used in derision.

So, yes, opinions do matter, and with them will come emotions that can disrupt constructive debate. But, neither the way society is now, nor the way people discuss it, is fixed. To believe these things are immune to change risks creating a self-fulfilling prophecy. We should not let our current opinions blind us to the problems and possibilities of society. Instead, if we're honest with ourselves, we can learn from the reality around us and let that shape our opinions.

Opinion free?


Have I been objective? Of course not. Although I aimed for objectivity I knew from the outset it was an unattainable goal. I have a set of values and opinions and they are both a help and hindrance. They allow me to decide what information is interesting and guide me in how best I might explain it, but equally I might unconsciously overlook data that does not fit my understanding, or give undue emphasis to facts that substantiate a prior belief. Constant policing by the conscious mind can keep the worst subjectivity at bay but I know from bitter experience that too much policing can also lead to a form of paralysing writer's block. Better to do something imperfectly than produce a perfect nothing.

So, I have to satisfy myself with being honest about subjectivity. There are two ways to approach this. The first is to take a step back, hence the reflection I mentioned at the start of this post. I'm not quite the same person I was when I wrote the book, so now I can see flaws that were previously invisible to me. But of course it's far better for me to listen to others as they have the luxury of never having been me.

Readers who have shown an interest in the book and this blog seem to come from across the political spectrum and roughly equally from either side of the Scottish constitutional question. This pleases me far more than reading a 5 star review (but please keep them coming!).

So, although I make no claim to being objective I can just about agree with one comment I received on Twitter that said I had "nae axe to grind".

Economics


A few folk have noted my interest in economics. A few days ago I was even called a "wannabe economist". It's not possible to understand society without economics, nor is it possible to separate economics cleanly from politics. Even if we could agree on our wants for society, we cannot realise it without a functioning economy. Equally, what's the point in having a well-oiled economy that supports a society we do not want? To talk of society without referring to the economy makes as much sense as trying to understand the climate without physics. Still, I've seen people do both.

But, as it happens, we live in a society that few are happy with and with an economy that's clearly been malfunctioning since 2008. In fact, it went wrong before 2008 but it escaped our notice. It has now become a right, royal question as to why economists failed to see that financial crisis coming. It's foolish to dismiss all economic theory and modelling as being worthless in light of this failure, but there's a need for some serious reflection in the economics profession. Unfortunately, this may take some time because, as the famous physicist Max Planck once said about his discipline, such change proceeds one funeral at a time. (Edit: I just checked and Planck's actual statement was in German and much less pithy).

The political response to the aftermath of the 2008 crisis kindled my interest in economics and politics, and the debates around Scotland's 2014 referendum drew me deeper into the issues of fiscal deficits and currency. As a result I have spent quite a bit of time educating myself on macroeconomics. (Macroeconomics considers the economy as a whole whereas microeconomics deals with questions of why a consumer would buy one product over another or what motivates a firm to invest.)

I was pleasantly surprised to find that there was one aspect of macroeconomics that was in robust health. Over the latter half of the 20th century, there's been a practical and useful interaction between economists and civil servants with the result that many countries have national accounts produced on a solid and comparable basis. Not only that but this rigour is reflected in the fundamentals of macroeconomics (specifically identities). So although the modelling and forecasting side of economics may be unable to properly describe our booming and busting economies we can have some confidence that we are at least doing a reasonable job of observing the macroeconomy.

Unfortunately, many, if not most politicians let short-term interests and ideologies prevent them from learning from the valuable history of economic data that their civil servants and academics have been carefully documenting. Worse still, some politicians have successfully transmitted economic mythologies to the population to win votes using what Simon Wren-Lewis has called Media Macro.

Contrary to popular belief, you don't need to have advanced maths skills to engage with a lot of economics. If you can do basic arithmetic, then you should be able to take a look behind the curtain for yourself and understand a surprising amount. The difficult bit is in approaching it with an open mind and letting go of common preconceptions. For example, what is said about time in this quote is also applicable to money and debt: in everyday life I feel I understand what time is, but when I stop to think about it I find I don't understand it very well at all. (I can't recall where I heard this, and can't find it on the web, so I'd be grateful if someone could enlighten me.)

So yes, my take on Scotland's society involves a fair bit of economics, partly because it interests me but mostly because it's necessary. Also, I'd say I'm more of a hadtobe economist than a wannabe one.

So what next?

I plan to update the book in light of a year's worth of new data being made available in many areas. But, to be honest, adding one extra data point to each graph doesn't alter any conclusions significantly. What interests me much more is finding new ways to look at the information, and I've one or two blog posts in the pipeline that will do that. Hopefully they will find their way into a future edition of the book itself.

One last thing. If there's something you'd like to suggest, contest or feel I've not explained well enough, please do get in touch with me via twitter (mcnalu), by email (twitter handle AT twitter handle DOT net) or in the comments of this blog. I will be grateful for any constructive criticism, especially if you convince me I was wrong. I'm doing this because I want to learn.

Sunday, 10 July 2016

To Vote or Not To Vote

The results of votes are usually quoted excluding those that could have voted but didn't. A common justification of this is that if people don't vote then their views cannot be registered. Some go further and say that views of non-voters do not matter.

Whatever you think about that, excluding non-voters in calculating vote shares is mathematically equivalent to assuming they would vote in the same proportions as voters. For example, if 30% of the electorate voted for the blue party, and 20% voted for the red party then the headline result would be 60%/40% to the blues. But if we supposed that the 50% that didn't vote also split 30%/20% then we would still arrive at the 60%/40% result.

Excluding non-voters can be useful for comparisons, or else if you subscribe to the belief that non-voters do not matter. But in either case you are throwing away some valuable information. Indeed, turnout is mentioned at sub-headline level in media reports precisely because it gives an indication of the strength of the result, and sometimes even as a measure of democracy's health.

The tables below offer an alternative way of viewing recent referendums and elections by quoting various vote shares as a percentage of the whole electorate, i.e. the number of people registered to vote. The idea is that instead of just comparing winner and loser percentages, as is the norm, especially in a referendum, we can assess the strength of the result's mandate amongst the various votes.

The data is from the Electoral Commission. The 2016 EU referendum and 2015 General Election percentages are for the whole UK though breakdowns for Scotland and full details are in this spreadsheet.



The Winning votes table is topped by the No vote in the 2014 independence referendum with 46.7% of the electorate. The next strongest vote is 9.3 percentage points behind this, being for Leave in the EU referendum. In contrast, both the Scottish and the UK governments hold power on the basis of votes from just under a quarter of the electorate.

The Losing votes table is topped by the non-Conservative vote in the 2015 General Election at 41.7% (the total of all votes cast for parties other than the Conservatives). It's striking that this is about 17 percentage points higher than the vote share that gave the Conservatives their majority government under the First Past the Post system. The same is also true for the SNP minority government under Scotland's PR system though the gap is smaller at 6pp.

The Did not vote table is topped by the 44% of Scotland's electorate that didn't vote in the 2016 election. One way to visualise the figures in this table is to think of picking 6 people at random from the population. On average, 1 didn't vote in the 2014 referendum, 2 didn't vote in the 2016 referendum or 2015 General Election and 3 didn't vote in the 2016 Scottish Parliament election. (Strictly, you'd need to pick 6 people from the electorate of each vote.)

The last table shows the Top 5 largest vote shares from the other three tables. Even the top result of this table — the 2014 No vote — fell short of 50%. In other words, none of our recent referendums and elections has given a majority mandate on anything from the electorate. Given the high hopes following the high turnout in 2014, it's sobering that second place in this table is the 44% of the electorate that didn't vote in the 2016 Scottish Parliament election.

It is a fact that more people did not vote than voted for the parties of government in both Scotland and the UK. This in itself is telling us something of concern about our democracy. What we cannot tell from these numbers is the enthusiasm with which voters cast their votes. Anecdotal evidence suggests that a substantial number of people feel they are voting for the least bad choice, rather than one they believe to be good.

The longer term evidence points to declining voter turnout, and declining vote share going to the traditionally dominant parties. Not only that but similar changes in voting behaviour are becoming apparent across Europe, the US and elsewhere. It seems that representative, electoral democracy is being changed by globalisation and relationships are being strained between the media, traditional politicians and the people they wish to represent.