One of the announcements in the recent UK Budget was the ending of the Private Finance Initiative (PFI), including its revised form, PF2. PFI was introduced by the Conservative government in 1992. Subsequently, it was to become central to the Labour government’s ‘Third-way’ approach of using the private sector to deliver public projects and services.
PFI involves a public–private partnership (PPP). The private sector builds and/or runs public projects, such as new schools, hospitals, roads, bridges, student accommodation, and so on. The public sector, in the form of government departments, NHS foundation trusts, local authorities, etc., then pays the private sector company a rent for the infrastructure or pays the company to provide services. The benefit of PFI is that it allows private-sector capital to be used for new projects and thus reduces the need for government to borrow; the disadvantage is that it commits the public-sector body to payments over the long-term to the company involved.
As the chart shows, PFI became an important means of funding public service provision during the 2000s. In the 10-year period up to financial year 2007/08, more than 50 new projects were being signed each year.
As the number of projects grew and with them the long-term financial commitments of the public sector, so criticisms mounted. These included:
- Quality and cost. It was claimed that PFI projects were resulting in poorer quality of provision and that cost control was often poor, resulting in a higher burden for the taxpayer in the long term.
- Credit availability. PFI projects are typically dependent on the private partner using debt finance to acquire the necessary funds. Therefore, credit conditions affect the ability of PFI to fund the delivery of public services. With the credit crunch of 2008/9, many firms operating PFI projects found it difficult to raise finance.
- The financial health of the private partner. What happens if the private company runs into financial difficulties. In 2005, the engineering company Jarvis only just managed to avoid bankruptcy by securing refinancing on all 14 of its PFI deals.
Recognising these problems, in 2011 the government set up a review of PFI. The result was a revised form of PFI, known as ‘PF2’. PF2 projects involved tighter financial control, with the government acting as a minority co-investor; more robust tendering processes, with bidders required to develop a long-term financing solution, where bank debt does not form the majority of the financing of the project; the removal of cleaning, catering and other ‘soft services’.
Despite the government’s intention that PPPs remain an important plank of its funding of public services, the number of new PFI/PF2 projects has nonetheless declined sharply during the 2010s as the chart shows. Of the 715 PPP projects as of 31 March 2017, 631 had been signed before May 2010. Indeed, in 2016/17 only 1 new project was signed.
The collapse of Carillion
Concerns over PPPs remained despite the reforms under PF2. These were brought dramatically into focus with the collapse of Carillion plc (see the blog, Outsourcing, PFI and the demise of Carillion). Carillion was a British company focused on construction and facilities management (i.e. support services for organisations). It was a significant private-sector partner in PPP projects. By 2014 it had won 60 PPP projects in the UK and Canada, including hospitals, schools, university buildings, prisons, roads and railways.
However, Carillion had increasing burdens of debt, caused, in part, by various major acquisitions, including McAlpine in 2008. Events came to a head when, on 15 January 2018, an application was made to the High Court for a compulsory liquidation of the company.
A subsequent report for the House of Commons Public Administration and Constitutional Affairs Committee in light of the collapse of Carillion found that procurement procedures were fundamentally flawed. It found that contracts were awarded based on cost rather than quality. This meant that some contracts were not sustainable. Between 2016 and the collapse of Carillion the government had been forced to renegotiate more than £120m of contracts so that public services could continue.
The ending of PPPs?
On 18 January 2018, the National Audit Office published an assessment of PFI and PF2. The report stated that there were 716 PFI and PF2 projects at the time, either under construction or in operation, with a total capital value of £59.4 billion. In recent years, however, ‘the government’s use of the PFI and PF2 models had slowed significantly, reducing from, on average, 55 deals each year in the five years to 2007/8 to only one in 2016/17.’
At its conference in September 2018, the Labour shadow chancellor, John McDonnell, said that, if elected, a Labour government would not award any new PFI/PF2 contracts. He claimed that PFI/PF2 contracts were set to cost the taxpayer £200bn over the coming decade. Labour policy would be to review all existing PFI/PF2 contracts and bring the bulk of them fully back into the public sector.
Then in the Budget of 29 October 2018, the Chancellor announced that no further PFI/PF2 projects would be awarded, although existing ones would continue.
I have never signed off a PFI contract as chancellor, and I can confirm today that I never will. I can announce that the government will abolish the use of PFI and PF2 for future projects.
We will honour existing contracts. But the days of the public sector being a pushover, must end. We will establish a centre of excellence to actively manage these contracts in the taxpayers’ interest, starting in the health sector.
But does this mean that there will be no more public-private partnerships, of which PFI is just one example? The answer is no. As the Chancellor stated:
And in financing public infrastructure, I remain committed to the use of public-private partnership where it delivers value for the taxpayer and genuinely transfers risk to the private sector.
But just what form future PPPs will take is unclear. Clearly, the government will want to get value for money, but that depends on the mechanisms used to ensure efficient and high-quality projects. What is more, there is still the danger that the companies involved could end up with unsustainable levels of debt if economic circumstances change and it will still involve a burden on the taxpayer for the future.
- Find out how PF2 differs from PFI and assess the extent to which it overcame the problems identified with PFI.
- The government is not bringing back existing PFI contracts into the public sector, whereas the Labour Party would do so – at least with some of them. Assess the arguments for and against bringing PFI contracts ‘in-house’.
- Find out why Carillion collapsed. To what extent was this due to its taking on PFI contracts?
- What were the main findings of the National Audit Office’s assessment of PFI and PF2?
- The government still supports the use of public-private partnerships (PPPs). What form could these take other than as PFI/PF2 contracts? Would the problems associated with PFI/PF2 also apply to PPPs in general?
The Winter Olympics are full on as athletes from all over the world compete against each other, hoping to set new world records, win medals and be known as Olympians. Pyeongchang, the South Korean county that hosts the 2018 Winter games, enjoys a large influx of tourists – estimated at 80,000 people a day. This is certainly an unusually large number of tourists for a region that has a regular winter-time population of no more than 45,000 people.
Having such a high number of visitors to the Winter Olympics, and even more to the larger Summer Olympics, is not an unusual occurrence, however, and it is often mentioned as one of the benefits of being a host to the Olympic Games.
Baade and Matheson (see link below) distinguish between three key benefits of hosting the Olympic Games: “the short-run benefits of tourist spending during the Games; the long-run benefits or the ‘Olympic legacy’, which might include improvements in infrastructure and increased trade, foreign investment, or tourism after the Games; and intangible benefits such as the ‘feel-good effect’ or civic pride”.
On these grounds, a number of studies have been authored, attempting to analyse some or all of these benefits, distinguishing between short-term and long-term effects. Müller (see link below), uses data from the 2014 Oympic Games in Sochi, Russia, to assess the net economic outcome for the host region. He concludes that any short-term economic benefits caused by the investment influx (before and during the games) could not offset the long-term costs, leading to an estimated net loss of $1.2 billion per year.
Zimbalist (2015) and Szymanski (2011) report similar results when analysing data from the London Games (2012) and past major sporting events (Games and FIFA World Cup). Kasimati (2003) points out the significant economic benefits that host regions tend to enjoy for years after hosting the games, but argues that the overall effect depends on a number of factors (including pre-existing infrastructure and location).
The jury is, therefore, still out on what is the overall economic effect of being host to this ancient institution. But I must now dash as women’s hockey is soon to start. “Let everyone shine”.
For the sake of the games, South Korea needs to show hosting an Olympics can be economically viable CNBC, Yen Nee Lee (15/2/18)
South Korea’s Olympic bet is unlikely to pay off, economics professor says CNBC, Andrew Wong and Andrew Zimbalist (12/2/18)
Going for the Gold: The Economics of the Olympics Journal of Economic Perspectives, Robert A. Baade and Victor A. Matheson (Spring 2016)
After Sochi 2014: Costs and Impacts of Russia’s Olympic Games Eurasian Geography and Economics, Martin Müller (9/4/15)
Circus Maximus: The Economic Gamble Behind Hosting the Olympics and the World Cup The Brookings Institution, Andrew Zimbalist (14/1/15)
About Winning: The Political Economy of Awarding the World Cup and the Olympic Games SAIS Review of International Affairs, Stefan Szymanski (Winter/Spring 2011)
Economic aspects and the Summer Olympics: a review of related research International Journal of Tourism Research, Evangelia Kasimati (4/11/03)
“Let Everyone Shine”: the song for the PyeongChang 2018 Torch Relay unveiled with 200 days to go Olympic Committee (24/7/17)
The Olympic Winter Games PyeongChang 2018 Torch Relay Official Song PyeongChang 2018
- Using supply and demand diagrams, explain whether you would expect hotel room prices to change during the hosting of a major sports event, such as the Winter Olympics.
- List three economic (or economics-related) arguments in favour of and against the hosting of the Olympic games. Relate your answer to the empirical evidence presented in the literature.
- Why is it so difficult to estimate with accuracy the net economic effect of the Olympic Games?
Thirty years ago, on Monday 19 October 1987, stock markets around the world tumbled. The day has been dubbed ‘Black Monday’. Wall Street fell by 22% – its biggest ever one-day fall. The FTSE 100 fell by 10.8% and by a further 12.2% the next day.
The crash caught most people totally by surprise and has never been fully explained. The most likely cause was an excessive rise in the previous three years, when share prices more than doubled. This was combined with the lack of ‘circuit breakers’, which today would prevent excessive selling, and a ‘herd’ effect as people rushed to get out of shares before they fell any further, creating a massive wave of destabilising speculation.
Within a few weeks, share prices started rising again and within three years shares were once again trading at levels before Black Monday.
Looking back to the events of 30 years ago, the question many fund managers and others are asking is whether global stock markets are in for another dramatic downward correction. But there is no consensus of opinion about the answer.
Those predicting a downward correction – possibly dramatic – point to the fact that stock markets, apart from a dip in mid-2016, have experienced several years of growth, with yields now similar to those in 1987. Price/earnings ratios, at around 18, are high relative to historical averages.
What is more, the huge increases in money supply from quantitative easing, which helped to inflate share prices, are coming to an end. The USA ceased its programme three years ago and the ECB is considering winding down its programme.
Also, once a downward correction starts, destabilising speculation is likely to kick in, with people selling shares before they go any lower. This could be significantly aggravated by the rise of electronic markets with computerised high-frequency trading.
However, people predicting that there will be little or no downward correction, and even a continuing bull market, point to differences between now and 1987. First, the alternatives to shares look much less attractive than then. Bond yields and interest rates in banks (at close to zero), unlike in 1987, are much lower than the dividend yields on shares (at around 4%). Second, there are circuit breakers in stock markets that suspend dealing in cases of large falls.
But even if there is a downward correction, it will probably be relatively short-lived, with the upward trend in share prices continuing over the long term. If you look at the chart above, you can see this trend, but you can also see periods of falling share prices in the late 1990s/early 2000s and in the financial crisis of 2008–9. Looking back to 1987, it seems like a mere blip from the perspective of 30 years – but it certainly didn’t at the time.
Three decades since Black Monday – are markets on the verge of another tumble? The Telegraph, Lucy Burton (19/10/17)
Black Monday: 30 years on from the 1987 crash Citywire, Michelle McGagh (19/10/17)
30 Years Ago: Lessons From the 1987 Market Crash U.S.News, Debbie Carlson (12/10/17)
Black Monday: Can a 1987-style stock market crash happen again? USA Today, Adam Shell (19/10/17)
Black Monday anniversary: How the 2017 stock market compares with 1987 MarketWatch, William Watts (19/10/17)
30 years after Black Monday, could stock market crash again? MarketWatch, William Watts (19/10/17)
The Crash of ’87, From the Wall Street Players Who Lived It Bloomberg, Richard Dewey (19/10/17)
- Explain what are meant by ‘bull markets’ and ‘bear markets’.
- Share prices are determined by demand and supply. Identify the various demand- and supply-side factors that have led to the current long bull-market run.
- What caused the Black Monday crash in 1987?
- For what reasons may global stock markets soon (a) experience, (b) not experience a downward correction?
- Distinguish between stabilising speculation and destabilising speculation on stock markets.
- What determines when a downward correction on stock markets bottoms out?
- Explain how stock market circuit breakers work. Can they prevent a fundamental correction?
- Does the rise in computerised trading make a stock market crash more or less likely?
In various blogs, we’ve looked at the UK’s low productivity growth, both relative to other countries and relative to the pre-1998 financial crisis (see, for example, The UK productivity puzzle and Productivity should we be optimistic?). Productivity is what drives long-term economic growth as it determines potential GDP. If long-term growth is seen as desirable, then a fall in productivity represents a serious economic problem.
Recent data suggest that the problem, if anything, is worse than previously thought and does not seem to be getting better. Productivity is now some 21% below what it would have been had productivity growth continued at the rate experienced in the years before the financial crisis (see second chart below).
In its latest productivity statistics, the ONS reports that labour productivity (in terms of output per hour worked) fell by 0.1% in the second quarter of 2017. This follows a fall of 0.5% in quarter 1. Over the whole year to 2017 Q2, productivity fell by 0.3%.
Most other major developed countries have much higher productivity than the UK. In 2016, Italy’s productivity was 9.9% higher than the UK’s; the USA’s was 27.9%, France’s was 28.7% and Germany’s was 34.5% higher. What is more, their productivity has grown faster (see chart).
But what of the future? The Office for Budget responsibility publishes forecasts for productivity growth, but has consistently overestimated it. After predicting several times in the past that UK productivity growth would rise towards its pre-financial crisis trend of around 2% per year, in its October 2017 Forecast evaluation Report it recognises that this was too optimisitic and revises downwards its forecasts for productivity growth for 2017 and beyond.
As the period of historically weak productivity growth lengthens, it seems less plausible to assume that potential and actual productivity growth will recover over the medium term to the extent assumed in our most recent forecasts. Over the past five years, growth in output per hour has averaged 0.2 per cent. This looks set to be a better guide to productivity growth in 2017 than our March forecast of 1.6 per cent.
Looking further ahead, it no longer seems central to assume that productivity growth will recover to the 1.8 per cent we assumed in March 2017 within five years.
But why has productivity growth not returned to pre-crisis levels? There are five possible explanations.
The first is that there has been labour hoarding. But with companies hiring more workers, this is unlikely still to be true for most employers.
The second is that very low interest rates have allowed some low-productivity companies to survive, which might otherwise have been driven out of business.
The third is a reluctance of banks to lend for investment. After the financial crisis this was driven by the need for them to repair their balance sheets. Today, it may simply be greater risk aversion than before the financial crisis, especially with the uncertainties surrounding Brexit.
The fourth is a fall in firms’ desire to invest. Although investment has recovered somewhat from the years directly following the financial crisis, it is still lower than might be expected in an economy that is no longer is recession. Indeed, there has been a much slower investment recovery than occurred after previous recessions.
The fifth is greater flexibility in the labour market, which has subdued wages and has allowed firms to respond to higher demand by taking on more relatively low-productivity workers rather than having to invest in human capital or technology.
Whatever the explanation, the solution is for more investment in both technology and in physical and human capital, whether by the private or the public sector. The question is how to stimulate such investment.
UK productivity lagging well behind G7 peers – ONS Financial Times, Katie Martin (6/10/17)
UK productivity sees further fall BBC News (6/10/17)
UK resigned to endless productivity gloom The Telegraph, Tim Wallace (10/10/17)
UK productivity estimates must be ‘significantly’ lowered, admits OBR The Guardian, Richard Partington and Phillip Inman (10/10/17)
UK productivity growth to remain sluggish, says OBR BBC News (10/10/17)
Official Treasury forecaster slashes UK productivity growth forecast, signalling hole in public finances for November Budget Independent, Ben Chu (10/10/17)
The Guardian view on Britain’s productive forces: they are not working The Guardian, Editorial (10/10/17)
Mind the productivity gap: the story behind sluggish earnings The Telegraph, Anna Isaac (26/10/17)
Data and statistical analysis
Labour productivity: April to June 2017 ONS Statistical Bulletin (6/10/17)
International comparisons of productivity ONS Dataset (6/10/17)
Forecast evaluation report OBR (October 2017)
- Explain the relationship between labour productivity and potential GDP.
- What is the relationship between actual growth in GDP and labour productivity?
- Why does the UK lag France and Germany more in output per hour than in output per worker, but the USA more in output per worker than in output per hour?
- Is there anything about the UK system of financing investment that results in lower investment than in other developed countries?
- Why are firms reluctant to invest?
- In what ways could public investment increase productivity?
- What measures would you recommend to encourage greater investment and why?
- How do expectations affect the growth in labour productivity?
In two recent speeches, the Governor of the Bank of England, Mark Carney, and the Bank’s Chief Economist, Andy Haldane, have reflected on the growing inequality in the UK and other countries. They have also answered criticisms that monetary policy has exacerbated the problem. As, Andy Haldane puts it:
It is clear monetary policy has played a material role in lifting all boats since the financial crisis broke. …[But] even if monetary policy has lifted all boats, and could plausibly do so again if needed, that does not mean it has done so equally. In particular, concerns have been expressed about the potential distributional effects of monetary policy.
Jan Vlieghe [member of the Monetary Policy Committee] has recently looked at how monetary policy may have affected the fortunes of, among others, savers, pension funds and pensioners. The empirical evidence does not suggest these cohorts have been disadvantaged to any significant degree by the monetary policy stance. For most members in each cohort, the boost to their asset portfolios and the improved wages and profits due to a stronger economy more than offset the direct loss of income from lower rates [of interest on savings accounts].
Andy Haldane’s speech focused largely on regional inequality. He argued that productivity has grown much more rapidly in the more prosperous regions, such as London and the South East. This has resulted in rising inequality in wages between different parts of the UK. Policies that focus on raising productivity in the less prosperous regions could play a major role in reducing income inequality.
Mark Carney’s speech echoed a lot of what Andy Haldane was saying. He argued that expansionary monetary policy has, according to Bank of England modelling, “raised the level of GDP by around 8% relative to trend and lowered unemployment by 4 percentage points at their peak”. And the benefits have been felt by virtually everyone. Even savers have generally gained:
That’s in part because, to a large extent, the thrifty saver and the rich asset holder are often one and the same. Just 2% of households have deposit holdings in excess of £5000, few other financial assets and don’t own a home.
But some people still gained more from monetary policy than others – enough to contribute to widening inequality.
Losers from the lost decade
Mark Carney looked beyond monetary policy and argued that the UK has experienced a ‘lost decade’, where real incomes today are little higher than 10 years ago – the first time this has happened for 150 years. This stalling of average real incomes has been accompanied by widening inequality between various groups, where a few have got a lot richer, especially the top 1%, and many have got poorer. Although the Gini coefficient has remained relatively constant in recent years, there has been a widening gap between the generations.
For both income and wealth, some of the most significant shifts have happened across generations. A typical millennial earned £8000 less during their twenties than their predecessors. Since 2007, those over 60 have seen their incomes rise at five times the rate of the population as a whole. Moreover, rising real house prices between the mid-1990s and the late 2000s have created a growing disparity between older home owners and younger renters.
This pattern has been repeated around the developed world and has led to disillusionment with globalisation and a rise in populism. Globalisation has been “associated with low wages, insecure employment, stateless corporations and striking inequalities”. (Click here for a PowerPoint of the chart.)
And populism has been reflected in the crisis in Greece, the Brexit vote, Donald Trump’s election, the rise of the National Front in France, the No vote in the Italian referendum on reforming the constitution and the rise in anti-establishment parties and sentiment generally. Mainstream parties are beginning to realise that concerns over globalisation, inequality and a sense of disempowerment must be addressed.
Solutions to inequality
As far as solutions are concerned, central must be a rise in general productivity that increases potential real income.
Boosting the determinants of long-run prosperity is the job of government’s structural, or supply-side policies. These government policies influence the economy’s investment in education and skills; its capacity for research and development; the quality of its core institutions, such as the rule of law; the effectiveness of its regulatory environment; the flexibility of its labour market; the intensity of competition; and its openness to trade and investment.
But will this supply-side approach be enough to bring both greater prosperity and greater equality? Will an openness to trade be accepted by populist politicians who blame globalisation and the unequal gains from international trade for the plight of the poor? Carney recognises the problem and argues that:
For the societies of free-trading, networked countries to prosper, they must first re-distribute some of the gains from trade and technology, and then re-skill and reconnect all of their citizens. By doing so, they can put individuals back in control.
For free trade to benefit all requires some redistribution. There are limits, of course, because of fiscal constraints at the macro level and the need to maintain incentives at the micro level. Fostering dependency on the state is no way to increase human agency, even though a safety net is needed to cushion shocks and smooth adjustment.
Redistribution and fairness also means turning back the tide of stateless corporations.
… Because technology and trade are constantly evolving and can lead to rapid shifts in production, the commitment to reskilling all workers must be continual.
In a job market subject to frequent, radical changes, people’s prospects depend on direct and creative engagement with global markets. Lifelong learning, ever-greening skills and cooperative training will become more important than ever.
But whether these prescriptions will be accepted by people across the developed world who feel that the capitalist system has failed them and who look to more radical solutions, whether from the left or the right, remains to be seen. And whether they will be adopted by governments is another question!
Roscoe Lecture Bank of England on YouTube, Mark Carney (5/12/16)
One Car, Two Car, Red Car, Blue Car Bank of England, Andrew Haldane (2/12/16)
The Spectre of Monetarism: Roscoe Lecture, Liverpool John Moores University Bank of England, Mark Carney (5/12/16)
Articles: Andrew Haldane speech
Bank of England chief economist says monetary stimulus stopped ‘left behind’ from drowning Independent, Ben Chu (2/12/16)
BoE’s Andrew Haldane warns of regional growth inequality BBC News (2/12/16)
‘Regions would have faced contraction’ without rate cuts and money printing Belfast Telegraph (2/12/16)
Bank of England chief: UK can be transformed if it copies progress on Teesside Gazette Live, Mike Hughes (2/12/16)
Articles: Mark Carney speech
Governor’s ‘dynamite’ warning on wages and globalisation Sky News, Ed Conway (6/12/16)
Mark Carney warns Britain is suffering first lost decade since 1860 as people across Europe lose trust in globalisation The Telegraph, Szu Ping Chan and Peter Foster (5/12/16)
Mark Carney: we must tackle isolation and detachment caused by globalisation The Guardian, Katie Allen (6/12/16)
Bank of England’s Carney warns of strains from globalization Reuters, William Schomberg and David Milliken (6/12/16)
CARNEY: Britain is in ‘the first lost decade since the 1860s’ Business Insider UK, Oscar Williams-Grut (7/12/16)
Carney warns about popular disillusion with capitalism BBC News (5/12/16)
Some fresh ideas to tackle social insecurity Guardian letters (7/12/16)
Monitoring poverty and social exclusion 2016 (MPSE) Joseph Rowntree Foundation, Adam Tinson, Carla Ayrton, Karen Barker, Theo Barry Born, Hannah Aldridge and Peter Kenway (7/12/16)
OECD Income Distribution Database (IDD): Gini, poverty, income, Methods and Concepts OECD
The effects of taxes and benefits on household income Statistical bulletins ONS
- Has monetary policy aggravated the problem of inequality? Explain.
- Comment on Charts 11a and 11b on page 19 of the Haldane speech.
- Does the process of globalisation help to reduce inequality or does it make it worse?
- If countries specialise in the production of goods in which they have a comparative advantage, does this encourage them to use more or less of relatively cheap factors of production? How does this impact on factor prices? How does this affect income distribution?
- How might smaller-scale firms “by-pass big corporates and engage in a form of artisanal globalisation; a revolution that could bring cottage industry full circle”?
- Why has regional inequality increased in the UK?
- What types of supply-side policy would help to reduce inequality?
- Explain the following statement from Mark Carney’s speech: “For free trade to benefit all requires some redistribution. There are limits, of course, because of fiscal constraints at the macro level and the need to maintain incentives at the micro level”.
- Mark Carney stated that “redistribution and fairness also means turning back the tide of stateless corporations”. How might this be done?