Monthly Archives: June 2010

Chris Cook

The Office for Budget Responsibility is going to irritate lots of people this week. When it comes out with its assessment of the Budget, its multipliers and assumptions will come under attack. After years now (years!) of phoney arguments about the deficit, this will be A Good Thing. Indeed, all the Labour leadership candidates should embrace the new institution.

First, it should improve the credibility of the fiscal framework. No Briton can credibly claim that any fiscal rules could have any real disciplining effect: only an institution that can nip at the government can do that now. This framework offers the golden combination of clear red lines for governments and the flexibility to respond to as-yet-unforeseen economic circumstances.

Second, farming out forecasting should improve the quality of projections that inform fiscal decisions. As an excellent Social Market Foundation pamphlet puts it, an independent forecaster would help overcome some problems with internal forecasting:

  • Organisational bias in projection-making: promotion, reward and status may be linked - most likely implicitly – potentially excluding valuable contrarian opinions from influencing fiscal projections. This effect may be particularly strong if fiscal decision-makers have significant powers over the institution. Indeed, academic research has shown that in several European countries, official growth forecasts used for fiscal policymaking are biased toward being over-optimistic.
  • Policymakers risk being subject to group-think where all elements of fiscal policymaking are housed in the same institution with no institution charged with an “official challenge” role. For example a shared belief in what is actually unsustainable growth may be self-reinforcing and amplified if all the functions of a fiscal policymaking are combined in the same institution.
  • When combined with the credibility associated with longstanding institutions, such as that of HM Treasury, this can also lead to another behavioural economic phenomenon known as anchoring, whereby other, non-governmental organisations take the cue for their economic forecasts from HM Treasury. This is particularly likely to occur since no institution wishes to stand out against received wisdom: for any independent forecaster it is far less reputationally damaging to be wrong with everyone else than to be wrong on their own.

At the moment, being seen to have credible forecasts is particularly worthwhile: investors have, in recent months, fixated on suspect growth forecasts. But all of those benefits rely on the OBR actually becoming independent – something it currently is not.

The body – now established on an interim basis – is a Whitehall beast. Sir Alan Budd, OBR chief pro tem, leads a team of Treasury lifers, based in the Treasury, running Treasury models. This is all forgiveable: the apparatus was set up rapidly and has yet to find its feet.  It is important, however, that it does not become a permanent feature of the OBR.

The most important aspect of the institution’s independence is staffing. OBR staff cannot be borrowed from the chancellor, going back to the Treasury at the end of a stint at the slide-rule. Otherwise they will still be creatures of their political masters. The OBR needs its own recruitment stream. (I’m sure George Osborne will be alive to this issue: he has long had an interest in the independence of Bank of England monetary policy committee members.)

As David Miliband has written, the OBR should, moreover, answer to parliament – not to the Treasury. Furthermore, MPs and peers should be allowed to submit written questions to the institution and it should be ultra-transparent.

Chris Cook

The new UK government, which will present its first Budget next Tuesday, has pledged to learn its lessons from the retrenchment in Canada between 1994 and 2000. Good for them: Paul Martin did much right.  He realised that, if you are going to rein in a colossal structural deficit, you need a wide consensus. The Canadian regime has also recognised that consolidation requires you to cut where the fat is. It did not salami-slice every budget, but went for where there were savings to be found.

But the Ottawan lesson only goes so far. As Paul Krugman says, it doesn’t help the UK with the macroeconomics of cutting. Its retrenchment took place as the US was booming. The political pain of cutting would have been much higher, the process much more difficult and the results less successful if its giant cousin to the south hadn’t had its nose in the punchbowl.

Britain is going to cut its deficit in what will probably be a weak neighbourhood. German manufacturing has been roaring, but the eurozone is weak and vulnerable. The whole continent’s states are tightening their belts. So while the weak pound might help the UK build market share, the market might be sickly. George Osborne’s confidence that Britain can grow while consolidating looks like hubris.

So what is to be done? Well, the chancellor of the exchequer should press ahead with his ambition to rein in the structural deficit. I don’t really want the government spending more on pay and pensions to prop up output. Stimulus needs to be temporary programmes that come to a defined end. Raising structural spending, only to slash it when the economy recovers, is bonkers. So Mr Osborne should work out temporary packages to offset the deflationary effects of his structural cutting.

The FT has come to the view that Mr Osborne needs to prepare stimulus measures, and so has Martin Wolf. In his open letter to George Osborne, he asked the chancellor:

Are you going to stand by if the economy goes into a steep decline? … In such circumstances, the most effective instrument might be central bank financing of additional public spending. But your commitment to pre-programmed spending cuts would seem to rule this out. The alternative might be a temporary reduction in taxes, of the kind you condemned under the previous government. In any case, the UK should have a plan for growth of nominal demand at a rate of 6 per cent and preferably more, for some years. Who is to take responsibility for this and how?

There are major attractions to setting out plans for stimulus measures now. Moving towards a clearer rule-based system for discretionary fiscal policy would make it possible to take stimulatory action without spooking holders of gilts. You can make sure they’re ready to go where they’re needed. The Treasury should compile a list of names and addresses to which it could post cheques. In case the UK’s troubles are longer-term, the finance ministry should prepare a list of infrastructure projects it would like to build.

Setting out such contingency plans would require a bit of political bravery. Mr Osborne would be the first chancellor to admit that he is not, in fact, in charge of the economy and not its master. He would be required to admit there is uncertainty in the world and limits to his powers and foresight.

Now that would be new politics.

Ian Holdsworth

My musings last week on “peak oil” drew a fair number of comments, not least a wonderfully thought-provoking essay from “Oil Lady” arguing that energy availability controls the market – not the other way round. The post that particularly caught my eye, though, came from a bon viveur commenting on someone else’s blog: “I’m more worried about peak wine than peak oil.”

This time last week I wasn’t convinced that we face “an irrecoverable fall in global oil supply by 2015 at the latest”, which is the view of the UK’s Industry Taskforce on Peak Oil and Energy Security. So have I changed my mind?

Well, not on that precise point. But, at the risk of stating the obvious, peak oil is not the issue. The real danger is the “oil crunch” that could well happen even if the world’s oil supplies plateau in the next few years rather than fall off dramatically.

Whatever the level of global oil production, the industrialisation of China and other developing countries is likely to open up a big gap between supply and demand. A “convulsive shock in the global economy”, as Oil Lady puts it, seems entirely plausible. Is this crunch almost upon us – as she and other campaigners warn?

I’ve been running through some arguments that offer reassurance.

Here’s the first … “we’ll just move on to other energy sources”. In the same way that “the stone age didn’t end because of the end of stones, the oil age will not end because of the end of oil,” Erik Haugane, chief executive of the Norwegian oil company Det Norske, told the BBC’s Newsnight programme last week.

Second, “there is enough coal to buy us time”. Oil’s share as a percentage of total world energy consumption is in decline – and the deficit is being made up mainly by coal. It will last another 119 years, according to BP’s Statistical Review of World Energy 2010, published last week. (This assumes last year’s rate of production – which, of course, may be surpassed.)

Third, “have you heard how shale gas is about to change the world?” Technological breakthroughs mean that many of the economic and technical concerns about exploiting America’s huge shale gas reserves are being dealt with, Gideon Rachman wrote in the FT last month:

“The rise of shale gas, which can be used to produce electricity, reduces dependence on domestically produced, but dirty, coal. If cars powered by electricity or gas improve, shale gas would also reduce reliance on Middle Eastern oil.”

So nothing to worry about then? Not as such. There is inertia in the system – it takes time for fledgling technologies to take on global proportions. As analyst Gregor MacDonald puts it on

America “is still running on coal and oil. And the intractability of this infrastructure is why energy transition is so hard. It is [not] serious therefore to say that it will be easy or quick to start running it on different energy sources.” (Hat Tip: Norman Talarud-Bay)

Managing the transition to new sources of energy will require solving problems of scalability and infrastructure. But even if coal takes up some of the slack, we still might not escape an oil crunch. This is because oil is not just a fuel – it has two other important markets.

As Oil Lady points out, it is also a feedstock for the production of manufactured goods, including plastics, computer components, and exotic alloys and materials. And, the nitrogen/petroleum component of the super-fertilisers and super-pesticides used on today’s giant farm-factories:

“At the moment, oil is still plentiful enough to service all of the above roles all at the same time with no conflict, But once global oil supplies start falling even just a tiny bit short of what our planet-wide industrial machine is used to, then a convulsive see-saw effect will happen whereby oil will not be able to service all three at the same time, not in as generous portions, and not consistently. When any of those three start suffering, the other two also suffer. We can try and shore up just one of them with alternatives, but there is no way we can shore up all three at once, not with today’s skimpy menu of alternatives that are just barely at our very limited disposal, and not with such precious little time left before the systemic convulsions to the global economy begin.”

So we’re stuck on oil whether we like it or not.

I’ll be visiting friends in Dorset soon. Maybe I’ll cheer myself up with a trip to the nodding donkey at Kimmeridge Bay, close to the site of a new land-based oil strike. According to the BBC, David Brunell, who owns an exploration company, has discovered seven potential multi-million barrel oilfields at the site which he believes could be “a very, very commercial situation for all people involved”. This is what is so good about onshore, he adds. “It’s quick, it’s clean, it’s easy. There is risk, but there’s less risk.”

Ian Holdsworth

I once came across a letter to a newspaper from someone who had calculated that wind turbines and tidal power might damage global weather patterns by extracting too much energy. Another reader suggested, not without sarcasm, that he should put away his solar calculator to avoid draining the sun.

Some other energy scare stories are not so easily dismissed. “Peak oil” campaigners warn, for example, that the world’s supplies of oil are about to peak and then quickly enter an irreversible decline – causing a global oil crunch. Among their number is solar power pioneer Jeremy Leggett, who this week wrote in the FT that “premature peak oil would be quite as bad as the credit crunch”.

Mr Leggett is a member of the UK’s Industry Taskforce on Peak Oil and Energy Security, which fears “an irrecoverable fall in global oil supply by 2015 at the latest”. The taskforce fears that “if oil producers then husband resources, a global energy crisis could abruptly morph into energy famine for some oil-consuming nations,” Mr Leggett says.

There are people on YouTube who believe peak oil has already arrived. Yet, in their annual reports, many oil companies continue to state every year that they are finding at least as much oil as they are producing. If you believe such data, reserve bases aren’t shrinking and peak oil could even be receding.

Yesterday, BP published its Statistical Review of World Energy 2010. There’s a table saying that at the end of 2009 the world’s proved oil reserves totalled 1,333.1bn barrels , which should last 45.7 years if production continues at the 2009 rate.

Such figures won’t impress Mr Leggett:

“Every year, peak-oil worriers say that they doubt the Opec oil producers’ reserve statistics echoed in BP’s review, that technology can only slow depletion not reverse it, that rising oil prices do not help when it takes so many years to extract new oil from increasingly exotic locations and that global supply is heading for an imminent fall.”

I’m no energy expert, but it seems only wise to me that we should take peak oil seriously, and I’m glad that the report produced in February by Mr Leggett’s taskforce was well-received by the UK’s Department of Energy and Climate Change. Still, I don’t see how the world can be in danger by 2015.

Some of the 1,333.1bn barrels in BP’s report will be deep under the ocean, but this fact is unlikely to precipitate peak oil. Despite President Barack Obama’s moratorium on new deepwater drilling since the Gulf of Mexico disaster, such projects will eventually resume and will continue for as long as oil companies find them profitable.

The oil price will therefore be a big factor in determining when peak oil arrives. If the price goes up as supplies dwindle, then the industry will continue to explore increasingly difficult areas, and peak oil will recede. But if it goes down, then peak oil may come sooner. The only way that prices will go down if supply goes down is if demand also goes down.

This brings me back to the winds and the tides – and some wishful thinking. Leaving aside China’s growing industrialisation, a green revolution could one day cut the price of oil. With lower prices, the industry will be unable to push the boundaries of its exploration, and peak oil will be ushered in just as we drive off in our electric cars.

I’ve learnt a few things in writing this. Most notably it seems that my letter-writer may have been on the right track. Apparently wind farms can change the weather.

Chris Cook

The resignation of David Laws over his use of expenses has caused sadness among the commentariat – more than any other expenses-related casualty. This has baffled some in the blogosphere, who believe he broke the rules and so had to go.

The first reason for grief is simple: Mr Laws was an exceptionally able man with a staggering sense of public spirit. He left a serious City job to work in the Lib Dem research department. He appeared, as George Osborne put it, to have been put on Earth to take a job at the Treasury. By contrast, when Jacqui Smith was caught out, few cared enough to defend the not-very-convincing home secretary.

FT dot comment

FT dot comment is no longer updated but it remains open as an archive.

Politics, economics, high finance and morality – this blog addresses the issues being considered by the FT’s comment team, and their thoughts.

FT dot comment: a guide

Christopher Cook is an FT editorial writer. Before joining the FT in 2008 as a Peter Martin Fellow, he worked for three years for the Conservative party.

Lorien Kite is deputy comment editor, a post he took up in 2009 after four years as a commissioning editor on the analysis page. He joined the FT in 2000.

Ian Holdsworth became assistant features editor in 2009 and was previously chief production journalist for the features pages.