Wednesday, April 27, 2011

Problems of Tackling Debt

The EU is unfortunately proving a very clear example of how difficult it is to solve a budget deficit during a recession by austerity measures.

Greece has implemented severe spending cuts, but the recent budget deficit was bigger than expected at 10.5% of GDP.

The Greek government explained the higher than anticipated debt was: "mainly the result of the deeper-than-anticipated recession of the Greek economy that affected tax revenue and social security contributions," WSJ

Bond yields on Greek debt continue to reach record levels. Two-year Greek government bonds rose Tuesday to a euro-era record of 22.48%

Ireland once held up as model of austerity is having similar problems. But, the spending cuts, haven't stopped markets pushing up interest rates to double figures.

Rates on Irish Bonds



Source: Confidence Fairy - Krugman

The Irish economy contracted 2.1% last year, shrinking 1.6% in the last three months of 2010 (Business Week)

Ireland is experiencing deflation and unemployment over 10%. Unfortunately, there is little help from the ECB, who seem still concerned about the spectre of inflation and are threatening to increase EU interest rates.

The UK has a little more room for manoeuvre, with an independent monetary policy and exchange rate. However, don't be surprised if later the government reports lower than expected tax revenues due to weaker economic growth.

The EU countries in difficulty have few options in dealing with their crisis. But, debt restructuring increasingly seems like a necessary step, despite EU promises to avoid restructuring (asking bond holders to accept a capital loss)

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Tuesday, April 26, 2011

Surplus on Current Account Balance of Payments

Readers Question: I can't seem to understand why a surplus on a BOP of an economy might be a problem ? The negative effects of a deficit on Current account BOP are obvious but why would economies be better off with a balance of zero compared to a surplus ?

A surplus on the current account component of the Balance of payments indicates that the country is exporting more goods and services than importing. This means they are gaining foreign currency they can use to buy foreign assets such as government bonds and invest in foreign factories.

It is not clear that a surplus on the current account is a bad thing. It has certain advantages such as being able to invest in foreign countries and build up foreign exchange reserves. It may also indicate that the country is quite competitive relative to other countries.

Countries with Large Current Account Surplus
  • Japan - 3.4% of GDP
  • China - 6.1% of GDP
  • Germany - 5.1% of GDP
  • Switzerland - 11.9% of GDP
However, a large current account surplus may indicate an unbalanced economy. For example, it may indicate the country is relying too heavily on exports and consumer spending is relatively too low. For example, during the lost decade of Japan in 90s and early 00s, they mainly had a large current account surplus.

I don't think economists would be concerned with a current account surplus per se. However, they may be concerned with policies which are generating such a big imbalance.

For example, in the case of China, one reason for large current account surplus is their decision to keep their currency undervalued. This makes their exports more competitive and imports more expensive, increasing domestic demand. However, this undervaluation of the currency is arguably contributing to inflation. China is at risk of allowing their economy to grow too quickly and cause a boom and bust.

If China allowed its currency to appreciate, this would slow down growth and reduce inflationary pressures. It would also help to reduce the size of their current account surplus.

(Of course, other countries like US would like a stronger Chinese currency as this would help their domestic industries be more competitive)

Another issue with China's large current account surplus is that they are using the foreign currency to buy a significant quantities of US and other securities. This is a mixed blessing. On the one hand, it is a contribution to financing the US debt and enables the US to keep interest rates lower.

However, if there are huge imbalances in the world economy, it could artificially keep interest rates too low in countries with current account deficits. For example, in the boom period the large inflow of funds from the East, kept interest rates on US securities low, contributing to a boom in lending. This boom in lending later proved unsustainable.

In summary, it is quite complicated. You can't say surplus bad, surplus good. However, there are definite advantages to avoiding imbalances which could create long term problems.

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Thursday, April 21, 2011

Stagnant Wages Delay Interest Rate Rises

One of the key issues this year has been the extent to which we should be concerned about the headline rise in inflation. CPI is at 4%, almost double the inflation target, RPI is higher. In nearly any other circumstance, this would be good reason to increase interest rates (especially when they are near rock-bottom). However, the MPC has felt other factors mean that interest rates should be put on hold, perhaps delayed until November now.

In particular a key statistic is wage growth. If wage growth takes off, this tends to cause inflation because of - higher demand pull inflation and higher cost push inflation. However, the UK is not experiencing wage inflation. As many people know we are seeing living standards squeezed by high inflation and low wage growth. Falling real wages

The MPC approach is in stark contrast to the ECB. Despite lower inflation in the Eurozone, the ECB have already stated they expect interest rates to increase in response to the rise in temporary inflation.

Amidst all the concern over inflation, I was pleased to see the OECD make a warning over a potential lost generation of unemployed workers. The ECB would benefit from weighing up costs of unemployment when worrying about a temporary blip in inflation.

Tuesday, April 19, 2011

American vs British Health Care

Impressions from America Series - I've just spent the past two weeks in New York. Despite the fact I go to America three times a year, I can't say I feel at home in America. It definitely feels like a different country to England, so if you can forgive a little parochialism, I hope to write a few essays on the comparison between the UK and US. Also, these essays are often inspired by the small group of Americans I meet in New York (not representative of all of America by any means)

Universal Care vs Insurance The first thing that stands out is that quite a few people I know in the US don't have health insurance. I ask them what happens when they are ill; they kind of shrug their shoulders as if to say, well it's a bit inconvenient. They say some hospitals have a reputation for treating the uninsured and are not too officious on chasing up the bills afterwards. But, it hardly inspires confidence that health care is based on going to a hospital and running away before anyone notices.

At least one person I know indirectly, declared bankruptcy after a serious illness. In fact, health care costs are one of the biggest reasons for bankruptcy in the US. According to a study by Steffie Woolhandler, M.D., of the Harvard Medical School, in Cambridge, Mass, health care costs accounted for 60% of bankruptcy cases in the US. (CNN, link) One note is that even those who are insured often have only limited insurance.

One thing I find undeniable is that for many Americans, health care is a real and continuous worry. My friends say that to get a serious illness can be financially damaging. In the UK we may worry about not getting the best treatment, but the idea of going bankrupt from a serious illness just isn't there. Nor is there the same level of bureaucracy in getting a private insurance company to pay.

The UK model is far from perfect, they point to the waiting lists on the NHS and also the fact in the UK, doctors make judgements about the cost-benefit of certain treatments. In the US, this weighing up of whether to offer expensive treatments for marginal improvements in life quality, would likely be referred to as the highly emotive 'death panels'. Health care is certainly an emotive issue.




% of health care spending as % of GDPGovt spending as % of total health carePer Capita expenditure 2006 (PPP)Doctors per 10,000 populationNurses / midwives per 10,000Hospital beds per 10,000Life Expectancymale obesity
UK8.287.3281523128398022%
US15.345.367192694317831%

US health care costs were 7% of GDP in 1970. UK was 4% of GDP in 1970 (Runaway health care costs)

Relative costs of Health Care

The US spends 15% of GDP on health care. Yet, from these statistics, it is not clear the US gets value for money. In terms of numbers of doctors, nurses and hospital beds, the UK seems to come out slightly better.

Where does the Money in US go?

  • Profit margin to Private Health insurance companies
  • Profit margin to Drug companies
  • US has a much greater willingness to pay for expensive treatments. In the UK, doctors facing a tight budget have to make decisions and choose most cost-effective. In the US, someone else pays (i.e the insurance company and indirectly insurance premiums). US doctors might get sued for not giving best possible treatment, they won't get sued for suggesting most expensive treatments. Therefore if in doubt, pay the money
  • US doctors / nurses are paid better.
  • US has higher level of obesity so may have more health care related issues. (though I'm sure UK is trying its best to catch up with US obesity levels?
  • Advantages of Private Health Care
  • You could argue US health care is better because private health care has that profit incentive to be more efficient and offer best possible treatment. If you have full insurance you don't have to worry about waiting lists and being given inferior treatment.
Tax and Direct Provision

Americans hate tax. But, they pay for health care indirectly. What is health insurance if not a type of tax?

It is hard to make a case for the UK to adopt the US model of health care. It would be more expensive and leave people with uncertainty. It is said that the US has no chance of adopting a Western style free at the point of use system. Presumably vested interests have too much influence. (even in UK, the great Socialist Nye Bevan claimed he had to 'stuff the doctors pockets with gold' to make them accept the NHS)

Also, health care costs in America will be difficult to control in the future. It is rising health care which poses biggest long term danger to US budget.(free market and health care by Krugman)

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Thursday, April 14, 2011

Essay on Debt

In response to a readers question. I wrote a piece in response to J.Hari's The biggest lie in UK Politics.

See: UK Debt - Biggest lie in UK politics?

I am currently travelling in New York and return next week.