Inflation isn't the problem. Stagflation could be.

We are about to see an example of how psychologically influential inflation is in the UK. There can be no other reason why the Bank of England could even be considering raising interest rates right now.

Recently (10th March 2011), the Bank of England Monetary Policy Committee (MPC) voted to leave its Base Rate at 0.5%. This means the rate has been at an all-time low for 2 years now. But, like a swan, the serenity on the surface belies a lot of action underneath, and it is almost certain that this vote was very close and we're about to see some real action in the form of a rise in interest rates. But the fact that this might happen when we are possibly in the midst of a double-dip recession (should April's growth figure be negative then we are officially back in recession) shows the problem with the Bank of England's sole objective, to target inflation.

When teaching macro-economics, I am at pains to point out to students that when faced with an essay on policies to deal with a problem they must consider openly the cause of that problem. So, should they be asked to discuss policy options available in the event of rising inflation, they would struggle to get near top marks should they not point out the dependence of the corrective policy on what caused the inflation in the first place.

My view on this is that the causes of this inflationary spike cannot be remedied by raising interest rates. Therefore doing so could cause worsening unemployment and confirm the journey back into recession. I also suggest that the only reasons why interest rates would rise is because the Bank of England is too focussed on its primary aim (inflation stability) at the expense of its secondary aim - to support the government in meeting their targets for growth and employment. This may be because of the hold that inflation has on economic fears. Maybe the MPC thinks Britain needs inflation credibility more than anything. Well, I would like to control inflation too, but not at the expense of growth and employment at a time when we don't have enough of either. It's frustrating enough waiting for the Coalition government to come up with a strategy for growth without the MPC making it even more unlikely.

Anyway, back to causes. In this case, inflation is now consistently running at and over double the Bank of England's target - which is 2% (plus or minus 1% let's not forget) - for three main reasons:

1) The rising oil price
2) The rise in VAT from 17.5% to 20%
3) The rise in food prices

The rising oil price

The rising oil price is a particular problem for the UK. It pushes up inflation because we import so much oil so business costs rise, pushing up prices and consumers spend more on the petrol made with it. It also can cause unemployment because as it pushes up business costs rational employers may look for other ways to cut costs, through firing or not hiring people. It can also cause a slowdown in economic growth and possibly cause a recession. Inflation is often caused by rampant economic growth, with a concurrent growth in employment. This time, we have inflation accompanied by negative economic growth and high unemployment. That is called 'stagflation' and the problem is that it's more or less here. Raising interest rates will do nothing to stop the rising oil price. The Government can reduce fuel duty on it - BUT they have to reduce the deficit, so they are stuck in a bind too.

The rise in VAT from 17.5% to 20%

This automatically put prices up. Remember, inflation is measured using a basket of goods, weighted for the importance of the items within it. Many of those items have just seen their prices go up by the amount of the rise in VAT.  This was done by the Coalition government, again because of the need to raise tax revenue to deal with the deficit. An economist from afar who didn't know this happened might think that consumption had gone up, raising aggregate demand and so raising interest rates would help, but the VAT rise makes that connection different. Raising interest rates will do nothing to deal with the impact of this rise.

The rise in food prices

This has mainly been caused by extreme weather events in the major food producing countries. It has been exacerbated by speculators but they are not really to blame. The problem again here is that the rising cost of food imports  pushed up the costs of many businesses who then pass those onto customers in the form of higher prices, causing inflation. Again, rising interest rates will not stop this happening.

It would be nice to think that there was a simple answer to the economic ills of the UK. We have a massive deficit, massive debts, huge unemployment, a government without a recognisable growth strategy and now inflation. We need to deal with all of those problems and a rise in interest rates will probably make them worse.

For instance, the upcoming job losses in the public sector are supposed to be offset by job gains in the private sector. But the investment needed in the private sector for that to happen would need to be funded from somewhere, and a rise in interest rates will make that more expensive, and therefore less likely.

Many commentators feel that in the medium term there is more of a danger from deflation, in which case nothing should be done now to hurt growth.  I'm going to add my name to them.

You can't avoid tax avoidance

UK Uncut occupying Top Shop on Oxford Street

There's more than one way to skin a cat, and more than one way to correct a budget deficit. Given it's when tax revenue is dwarfed by government spending you can therefore manage both. The coalition argue that cuts in spending should bear the bulk of the deficit-cutting burden, others argue that there should be more tax rises instead. Both of these methods will, in the short-term, reduce aggregate demand and thus economic growth. But
A new pressure group - UK Uncut, has been bringing attention to a third way to do it. Don't raise tax, just stop people avoiding paying it.

UK Uncut are a rather loose coalition of left-wing groups, and their main aim is to fight the cuts in government spending announced over the past 6 months by the current UK government. The difference between them and many others is that they are combining a call to stop the cuts whilst offering an actual way to cut the deficit (take note Labour Party) by finding a solution to what they say is £25 billion of tax being avoided each year by, say UK Uncut, rich and wealthy individuals and companies. If this got paid, they argue, there would be less need for the cuts, which are mainly affecting the poor. Makes sense doesn't it?

They give the example of Philip Green, who owns Arcadia, the shopping group. Actually he doesn't own it. He runs it. His wife, who has never worked for it and lives tax free in Monaco, actually owns Arcadia. This allowed Green to channel a £1.2 billion dividend to her in 2005, avoiding paying around £300million in income tax - enough to pay the salaries of 20,000 NHS nurses or the £9,000 tuition fees of almost 32,000 students.

They also give the example of Vodafone managing to avoid £6 billion in tax recently, that they needed to pay after their purchase of Mannesmann in 2000. They lost a court case to the HMRC, but were eventually let off with a bill of £1.2billion instead. That's £4.8billion not paid. A lot of nurses, and a lot of students.

Some interesting points can be made here:

1) Everybody avoids tax, both consciously and unconsciously. The other day I was going to buy a new kettle and some food. On the way to the shop I realised I only had enough money to buy the kettle OR the food. I chose the food and avoided paying VAT. Will UK Uncut come and occupy my home in protest? Unlikely, because as you can imagine, this is a rather unavoidable avoidance!

2) There are a lot of people working hard to avoid inheritance tax. Inheritance tax is also called "death duties" and is an example of "triple taxation" in that someone is taxed on their income, taxed on interest on their savings or capital gains and then taxed again on any left over over a certain threshold when they die. There are, however, many ways to avoid inheritance tax, and it is so common that even famous Labour politicians have done it. Many argue that inheritance tax is fair as it one of the ultimate examples of a tax on unearned income. Others say it is a tax on success and everyone should have the right to pass on their wealth to their children, especially since much of that wealth has been taxed already.This is why none of the main political parties are comfortable properly attacking it.

3) Philip Green, on the many occasions he has been asked about his actions, argues that his success with Arcadia has rescued some major companies and created many thousands of jobs, which have taken many out of unemployment and generated tax revenue in themselves. However, is it really acceptable that the price of job creation is to let the creator off paying tax? What was certainly inadvisable was the government appointing Green to oversee the search for efficiency in public service as they did last August. There are plenty of other experienced corporate operators like Terry Leahy who could have done that without having everyone carp that it would help if he paid tax properly before advising us how to cut spending.

4) Vodafone's main obligations are to their shareholders. They say themselves,  in answer to questions on the HMRC case, that "the maximisation of shareholder value will generally involve the minimisation of taxation." The point is that it isn't the company who pays the tax, it is the shareholders. These include pension funds and small shareholders who hold a few shares or an ISA - and are likely therefore to have a tiny stake in Vodafone.

5) Ultimately, the main point which ties together the above points is that this is tax "avoidance" and is legal. It is not tax "evasion" which is illegal. Philip Green and Vodafone didn't make it legal, and they are unlikely to push for these methods to become illegal. The only organisation that can do that is the Government. So however many times UK Uncut occupy one of Philip Green's or Vodafone's shops they are actually aiming at the wrong target. Tax avoidance is allowed by the government.

So, why don't the government crack down on it? Why do so many loopholes exist? I imagine the main issue here is the need to balance the need to make sure that tax revenue is maximised without reducing the incentives to entrepreneurship and whilst also being that most normative of things..."fair".

If you raise tax on certain activities people may just stop those activities, or reduces the amount of those activities. Which means tax revenues fall. Which defeats the point.

This isn't an argument not to close some of more ridiculous loopholes. This goes to show that raising tax revenue isn't as simple as that. It's a little but like one of those games where you bash an object down and another one pops up. If the government do close one loophole, there are highly paid and trained tax accountants who will find their clients another one.

So what's the answer to the deficit then? It's hard to raise tax revenue by raising tax rates, and cutting government spending could actually increase the deficit in the future if it pushes the UK into depression.

The answer is found in an unlikely place. Tony Crosland - a former Labour Government Minister who literally wrote the book on the future of socialism - argued that economic growth is a necessary precursor to wealth redistribution. So that is where the UK Uncut should be targetting their campaign. We won't need cuts if we can grow because tax revenues should rise with that growth.

How do we get that growth? Here's an interesting thought...

Why, amongst all the protests against the cuts in Ireland, are they not complaining about the country's corporation tax rate being 12%?

World Cup 2018 and 2022 - The shifting sands of global politics

The World Cup went to Russia and Qatar for partly because it hasn't been to those areas before but there are three other reasons - each with significant repercussions for global politics and economics. The Freedom of the press, location of natural resources and the consequences of an indebted West and cash-flush 'Rest' were laid bare yesterday.

1)  The results of the bids for 2018 and 2022, and especially 2018, were in inverse correlation to press freedom in that country. I would bet quite a fair amount that for the next 8 years any Russian journalist who investigates or questions FIFA will find themselves on  'holiday' in Siberia. One of the most fascinating items I read about the problems those on the FIFA committee had with the machinations of the English Press was that they assumed the criticisms of them came directly from the UK government because in many of their countries the government IS the press. In particular, their understanding of the independence of the BBC is limited so trying to explain that it isn't merely a mouthpiece of the government would be very difficult. If the World Cup came to England, the FIFA committee would expect 8 years of extreme scrutiny, and the likelihood is that their behaviour doesn't stand up to even the smallest amount of scrutiny so going to Russia and Qatar made a lot of sense. For instance, the World Cup in England would generate a lot of profit for FIFA, but they demand that any income they make during the World Cup is tax free. In a time of cuts and deficits this would not have looked good.

2) Russia is the World's largest exporter of natural gas. Qatar is the World's third largest exporter of natural gas. The World is becoming more and more dependent on natural resources as it develops and FIFA seems to have recognised the importance of this.

3) Global political power is now officially on the move. From the heavily indebted importers of the West to the cash-rich exporters of the Near, Middle and Far East. This is the clearest sign yet that the creditor is King now.

Going back to number 1. I have no problem with the accusation that the BBC and the media "lost" us the World Cup. Good. I'd rather lose the bid honestly than win it because I offer FIFA 12 years of protection from tax and press scrutiny. If the BBC had been pressured into moving their Panorama investigation and we'd won it would have been a dirty win. At the end of the day, the UK may have had the best bid, but 'best' is just different now.

The child that benefits should need it.

Everytime I find myself wondering about universal benefits, I think of the wonderful support staff at my school, many of whom work on far lower wages than I ever have, and yet are funding the child benefit  of multi-millionaires. Is this really what William Beveridge envisaged all those years ago as what the welfare state was for? I sincerely doubt it. Did he also imagine the UK would find itself over a trillion pounds in debt? Unlikely. So we can't keep harking back to what the welfare state was created to do, the country has changed. And so, surely, must benefits.

It was fascinating to watch the new leadership of the Labour Party take the bait and fall into the trap of 'over-opposition' - where they simply oppose in a knee-jerk fashion every policy the coalition come up with. Are they, the party that calls itself the progressive option, really going to justify taking money from the public purse to give child benefit to hedge fund managers? Oh yes they were. Thankfully, it may well be that opposing every cut was just a 'holding position' and now they have their shadow cabinet together we have Douglas Alexander, with the work and pensions brief, tentatively supporting Iain Duncan-Smith's welfare reform.

But back to benefits. The idea is that from 2013 those households with one person earning the higher rate of tax (at the moment this means they earn £44,000) will not receive child benefit. There is a lot to commend in this idea, but the devil will be in its' implementation.

The main argument against it was that a couple earning £43,000 each (£86,000) would not lose their child benefit (£33 a week for 2 children) but if one person earns £44,000 they would. This seemed not to make sense at first and was highlighted as 'unfair'.

But if you think about it, a couple who are both earning £43,000 a year are most likely to both be working for a reason, but are not likely to be very "rich". These couples - who would therefore have their children in full-time childcare - which is expensive - cannot be very numerous, and also there is an argument that the government would like them both to be working as productive members of society as it helps with employment numbers.

But if you have a couple where one earns over £44,000 and the other doesn't you have a large net in which you can catch the couples consisting of one who earns hundreds of thousands, if not millions, and the other who doesn't have to work as their partner earns so much. They should not be receiving child benefit, and this way they won't. So in that way it can be seen to be a progressive policy.

When I say the devil is in the implementation, I mean that the current way child benefit is collected and administered means it is not possible to automatically stop paying it. It is paid to the mother of the child, (allegedly because the father wouldn't be trusted to spend it on the child instead of drink) and the mother does not have to tell the father they are getting it. This led to an amusing discussion on air between Radio DJ Chris Evans and his wife when the news broke which was the first time he found out she actually got child benefit.

Anyway, the only way child benefit won't be paid is if someone in the household earns over £44,000, which could be found out by the Inland Revenue through PAYE if you work full-time, or your self-assessment if you are self-employed. But if it's the man who earns over £44,000 they would have to say whether their partner receives child benefit (even if you are married you have separate tax arrangements obviously) and a man could justfiably say "I don't know" then get out of paying it. They can't legally be forced to ask their wife.

Additionally, should the mother of the children earn below the threshold they might be asked whether their partner earns over £44,000, but tax affairs are private, for data protection reasons if nothing else. So the mother could say they don't know and that's that.

David Cameron suggested that the British public could be trusted to tell the truth but how far they'll go to tell the truth, given it penalises them a considerable amount of money remains to be seen.

I have no doubt we need to do something about the transfer of money from someone earning £10,000 a year to someone earning £10,000 a day. By 2013 hopefully they'll work out what to do. Meanwhile, coffee shops must prepare for a drop in machiatto sales, ballet classes might have slightly less demand, and Gymboree may have to reconsider it's entire business model.

Next stop should be Winter Fuel payments and free London transport passes for FTSE Chief-Executives and retired barristers. Oh no, wait a minute, they are old, and they vote in their droves.................

Why Ireland's cuts are sinking them and the UK's aren't

There are many genuine, economically literate arguments against the spending cuts being imposed by the UK coalition government at the moment. Not least the issue of reducing aggregate demand through government spending and relying on the private sector to fill that gap when its' major trading partners in Europe and the USA are also struggling economically (hence the recent cap-in-hand visits by David Cameron to both India and China).

Then there some economically illiterate arguments against the spending cuts. Step forward the "look what's happening in the Republic of Ireland" brigade.

Just to fill you in, Ireland has the highest bank debt in the world of €50 billion, and a budget deficit of 32% of GNP - ten times the eurozone's deficit ceiling. More importantly for this discussion, all this has been exacerbated by the steps that the Irish government felt no choice but to make. They slashed public sector pay by 10% and are taking more than 8% of GNP out of the economy in spending cuts. The point is - the cuts seem to have made things a lot worse, ergo the argument that the UK should observe Ireland and not make similar cuts.

The reason why this is economically illiterate is because of the enormous differences between the Irish economy and the UK's.

1) The boom in Ireland was hugely accounted for by the property sector - which by the time recession hit accounted for 25% of the Irish economy, whilst it was only 10% of the UKs even after our property boom. This was unbalanced growth in the first place. Worse, it was funded by huge lending of low-interest mortgages to borrowers who required no money down. These unpaid debts are what is now holding back the banks from growing again. We don't have this in the UK, where our banks ran into problems from dud investments in dodgy derivatives.

2) Ireland is in the Euro. This means two very important things:

a) They cannot use monetary policy to reflate their economy as monetary policy is controlled by the European Central Bank, so they only have fiscal policy with which to operate their economy (hence raising taxes and cutting spending to reduce the deficit). Not being able to lower interest rates, but possibly more importantly not being able to increase the money supply through quantitative easing is an enormous restriction on the economic control of the Irish government. The irony of this is that it was the lowering of EU interest rates at the beginning of the millenium that caused the boom in Ireland - its' inflation (and that of Greece, Portugal, Italy and Spain) was already high when the ECB lowered interest rates to try and inflate the French and German economies, a good example of the problem of central monetary policy being applied without central fiscal policy

b) They cannot allow their currency to devalue in order to boost exports. Since the start of the recession, Pound Sterling has fallen in value by nearly 25% against other currencies. Ireland has seen the Euro strengthen during this time. This takes away another engine of possible economic growth which might have raised money to help with their debts.

So, the upshot of this is that the IMF has praised the actions of the UK government whilst preparations are being made for what many are seeing as an inevitable moment where Ireland will need to go cap in hand to the European Financial Stability Facility, which has already helped out Greece. Both governments have taken similar actions, but it isn't working for Ireland.

As Ed Balls has pointed out many times recently, the five tests that Gordon Brown and his team came up with that more or less ensured the UK didn't join the Euro have probably been our saving grace as we fight our way out of the mountain of debt we have.

You only have to look across the Irish Sea to see the difference that it made.

The China Conundrum

Interesting watching David Cameron attempting to negotiate his trip to China through the clarion calls for him to speak up about human rights abuses. As was rightly pointed out on 'Question Time' last night, he does have a choice between 'money' and 'human rights' in that if he wants trade deals with China right now that might lead to jobs being created in the UK through China's export demand he needs to prioritise that over the human rights issue.

There is a point to be made there that right now the priority IS jobs. We've just come out of a recession and have a large amount of unemployment and a huge deficit and we need demand to come from somewhere given the cuts in the public sector.

But actually for me this is not about David Cameron, who will probably be damned whatever he does, but about China. It is about what we in the West regard as the most important human rights, and what we in the West expect of countries who are yet to develop fully economically.

There is a lot of misunderstanding in the UK about China. First of all - they may have the World's second highest GDP but this is shared amongst such a large population that they have a GDP per capita of around $3,000 a year (World Bank estimate). Ours in the UK is over $40,000. Most of all - they have over 200 million of their population still living in absolute poverty. That means they survive on less than $1.25 a day, the amount the World Bank feels is needed to enable a person to fulfill their needs of food, water, shelter, warmth and clothing.

That is their priority. Simple as that. We can make trite comments like that of an unnamed US negotiator who returned from last year's failed Copenhagen climate conference having not achieved any kind of agreement with China and muttered that it "shows what happens when you try to negotiate with a nation of only children". Or we can understand the following:

1) China's priority needs to be developing their country to the stage where they do not have citizens in absolute poverty.

2) As part of this they need to provide jobs for their population, food for their population and energy for their population.

3) Committing to a deal to limit their carbon emissions at the expense of their development would be tantamount to a form of 'sovereignty suicide' - their first priority is the prosperity of their citizens, given they have very little security issues. Their citizens need the fruits of development and growth and need them now, far more than we do in the UK.

4) Futhermore, they may also need to import food, raw materials and energy from countries regarded by the West as 'rogue'  states. They can get those vital resources cheaply and they can provide them for a population that actually needs them to live.

5) China's idea of 'human rights' may well be the right to live. It is generally thought that democracy may not be appropriate at times of either war or where economic development needs take priority. They do take priority, so when China complain that people don't understand the concept of 'human rights' the same as they do they are probably right.

I am not an apologist for the way China treats its' citizens who ask for democracy. I am not an apologist for their actions over Tibet. I am, though, prepared to understand from an economics point of view why China acts they way it does.

Sometimes, those who complain the loudest about China  need to put themselves in the position of their leaders. Leadership is an onerous responsibility, and sometimes you have to make unpalatable choices.

Do we really have any better ideas? 200 million people would like to hear them.