Conference report by Charlotte Denny, Economics Correspondent, The Guardian

Academic conferences are not the usual haunt of the news-wire journalists who provide the City with up to the minute information on market-moving events. But the presence of two members of the Bank of England’s monetary policy committee at the Royal Economic Society’s conference in March was enough to guarantee the arrival of a posse of hacks searching for a clue on which way the divided committee would jump over the question of short-term interest rates.

In the event, neither Sir Alan Budd nor Charles Goodhart chose to hit the headlines by tipping off the conference about their voting intentions. The agenda, however, was packed with topics that have occupied many inches of newsprint over the last year, an indication of how a change of government has renewed the economic policy-making agenda. From the minimum wage to central bank independence, the new government has provided economists with an interesting testbed for ideas.

Sir Alan’s talk on the second night of the conference noted how the new monetary policy arrangements reflected the prevailing consensus in the profession. ‘We now have an approach to policy which would have dealt better with past shocks’, he said. But he warned that ‘a sense of modesty’ about what can be achieved by economic policy-making was appropriate.

Reviewing three budgets - 1972, 1981 and 1992 - he described how opinions had shifted about the goals of policy-making: from demand side management in the early 1970s to the focus on fixed monetary policy rules and the supply side of the 1980s and finally to the inflation targeting approach adopted by the previous government and refined by Labour. But the consensus is never unchallenged: ‘The 1981 budget had more critics than supporters’, noted Sir Alan, referring to the famous letter to the Times from 364 economists, several of whom were in the audience. Others questioned whether the move to separate fiscal from monetary policy-making had been a wise one.

Several of the sessions during the four days of the conference examined the consequences of giving the Bank of England independence. Stephen Hall, Brian Henry and James Nixon of London Business School asked whether the loss of policy coordination was a major disadvantage. Using game theory to analyse the choices facing an independent monetary and fiscal authority, they concluded that an independent central bank had considerable advantages over a single policy-maker prepared to sacrifice controlling inflation for short-term gains in increased output. The loss from what could be gained by a single policy-maker with a long-term outlook was small.

A paper by Silvia Sgherri and Ken Wallis (Warwick) suggested that the Bank overestimates how often it will miss its target for inflation, while in a talk on the new arrangements subtitled ‘an empirical model of Alan Budd and his buddies’, Charles Bean (LSE) discussed how often the Governor of the Bank would be writing a letter to the Chancellor explaining why inflation was more than a percentage point above or below its 2.5 per cent target. The nearest analogue to the UK’s inflation targeting regime was New Zealand, he said, but while the conditions under which the Reserve Bank of New Zealand could justifiably miss its inflation target were clearly spelled out, with the UK arrangements, the Chancellor had not specified where he saw the trade-off between variable output and inflation.

The Bank of England was not the only central bank under scrutiny. Marcus Miller (Warwick) examined how the new European Central Bank will set policy. ‘Current negotiations on the future structure and policy of EMU seem to resemble a game of chicken’, he said. Uttered a month before France took the other Union members to the wire in its determination to place Jean Claude Trichet at the head of the Bank, his words have proved uncannily prophetic.

Miller’s conclusions for the future prospects of the single currency area are gloomy. Without significant labour market reform, a period of Eurosclerosis seems likely. Perhaps undertaking such reforms would have been a more appropriate target for the starting line up than the fiscal targets, which he suggests were chosen out of mutual mistrust. The painful belt tightening that many countries have undergone to meet these targets amply demonstrates their political commitment to EMU but is no indicator of the project’s long-term economic sustainability.

New policy developments were also a theme of the conference sessions on labour markets. Jonathan Thomas (UCL) suggested that requiring participants to search more intensively could enhance the effectiveness of Labour’s welfare to work policies. Using UK data from the late 1980s, he estimated that requiring claimants to spend a minimum of nine hours a week looking for work would result in a fall in male unemployment spells of 11%. For women, the result is even more dramatic: spells fall by more than a quarter.

Examining the results from Australia’s Working Nation programme, James Richardson (LSE) suggested that targeting active labour market policies exclusively on the long-term unemployed could result in fewer flows out of short-term unemployment. Active labour market policies like the New Deal and Working Nation are aimed at the long-term jobless to minimize deadweight - spending resources on those who would have got a job anyway. Those who have been out of work for a while are less likely to get a job without help than people who have just joined the dole queue. The long-term unemployed also exert little dampening influence on inflation, and so by reducing their numbers, unemployment can fall without re-igniting price pressures.

Australia’s Working Nation programme, set up in 1994, guaranteed a job placement to all those out of work for more than 18 months. The policy involved a substantial reallocation of resources from the short-term unemployed to the long-term unemployed, but one unforeseen consequence was to increase the flow from short-term into long-term unemployment, which undermined the public success of the programme.

Analysing the impact of wage subsidies on inflow and outflows from unemployment, Richardson found that targeting the long-term jobless would reduce the overall unemployment rate, but as subsidies increase it becomes more effective to target some resources towards the short-term jobless. ‘The clear policy implication is that if there is a substantial commitment to active labour market policy, some resources should be reserved for the short-term unemployed’, he concluded.

Alison Booth and Mark Taylor (Essex) along with Wiji Arulampalam (Warwick) suggested that reducing the incidence of unemployment overall could lower the trade-off between unemployment and rising inflation. Using data from the first five waves of the British Household Panel Survey, they found that even short spells of unemployment had a ‘scarring’ effect on workers - they were more likely to become unemployed in the future. The effect was more pronounced among older workers.

Other topics covered in the labour market sessions included work by Stephen Pudney and Michael Shields (Leicester), which found that differences in the speed of career progression between male and female nurses in the NHS added up to a lifetime earnings’ loss for the average woman of £50,000; Mark Taylor (Essex) on who succeeds in self employment; and an analysis of monopsonistic employment markets by Ted To and V. Bhaskar (Warwick), which suggested that under some circumstances, a minimum wage could raise employment. An intriguing contribution from Andrew Oswald (Warwick) found a direct correlation between home ownership rates and unemployment in industrialized countries.

The interaction between the profession and the policy-makers was underlined on the first night in a special session on Labour’s economic agenda - one of the liveliest events of the conference. Nick Crafts (LSE) asked whether New Labour’s economic policies were really new. The government’s enthusiasm for raising investment and productivity growth was old, he suggested, but the total repudiation of old Labour supply side remedies - protectionism, nationalization, sponsoring champions, etc. - was new.

Crafts cast doubt on whether Labour would be able to meet some of its ambitious targets for raising the long-term growth potential of the economy. The Conservatives, he argued, had succeeded in turning the UK into an average performer after decades of relative economic decline. The new government would be doing well if they succeeded in adding an extra half a per cent to the long-term trend rate of growth.

Crafts had three questions for Labour: what do they think is good for total factor productivity growth, can they learn to live with the creative destruction that technological change forces on economies, and how big do they think the government budget should be? But his biggest challenge to the new government was over their radical credentials. A government as sensitive as Labour is to public opinion risks being hamstrung by ‘status quo’ bias - reluctance to introduce new policies even if economic welfare is increased overall, for fear of alienating the losers. ‘Can New Labour adept policies it knows to be unpopular?’, Crafts asked, and speculated on whether the government would take the UK into EMU if its focus groups showed widespread public opposition.

Dan Corry, formerly chief economist at the Institute for Public Policy Research (IPPR) and now a special adviser in the Department of Trade and industry rose to Craft’s challenge. Breaking the UK’s cycle of boom and bust would in itself improve the growth rate in the economy, he argued. New Labour’s approach to industrial policy - focusing on ensuring strong competitive markets and modern companies - was a return to older Labour’s anti-trust position.

Gerry Holtham (IPPR) picked up on Craft’s scepticism that governments can do much to alter the long-term rate of growth and issued a challenge to Labour from the left. Widening income inequality was not the inevitable result of globalization, he argued, but a consequence of particular policies. The UK and New Zealand, which both had a similar agenda of deregulation, liberalization and privatization, experienced sharp increases in inequality in the 1980s while other countries had not. ‘Given the massive uncertainties about raising the trend rate of growth, governments should make sure they don’t do anything which harms the income distribution,’ he said.

The final speaker was Ed Balls, special adviser to the Chancellor, Gordon Brown. The Conservatives had stopped thinking radically about economic policy-making, he suggested: ‘Ideology got in the way’. He stressed the transparency of the new monetary policy arrangements and defended them against charges that the Bank was crushing manufacturing with the strength of sterling. ‘The pound is high at the moment because we did things too late’, he said, making it clear that interest rates should have been raised before the election.

Topics covered in the public policy sessions ranged from drugs to bus timetables. Anna Vignoles and Peter Dolton (Newcastle) wondered whether Labour’s pledge to reduce class sizes would improve academic performance. Their conclusions, based on comparing the academic performance of secondary schools from local education authorities with different spending levels and pupil teacher ratios was that cutting class sizes by one or two would make very little difference. ‘I’d be very surprised if we spent a lot of money on reducing class sizes and there was a substantial impact on pupil performance’, said Vignoles.

A fascinating insight into why buses always seem to arrive together was offered by Alison Oldale (Lexecon Ltd). When bus routes are deregulated, timetables break down because rival operators will always scoop any company sticking to a set pickup time. Once buses start arriving randomly, so do passengers. Using game theory, Oldale demonstrated that under these circumstances, buses will start arriving in clumps as each rival operator strives to be the first at the bus-stop.

‘Men behaving badly’ was the title of paper by Carol Propper and Simon Burgess (Bristol), which found that American men with a history of violence and hard drug use earned lower wages than their peers did. In contrast, smoking dope and under age drinking appeared to have no adverse effects on men’s subsequent careers. Other papers included an analysis of the Irish potato famine by Pat McGregor from the University of Ulster, which found the British could have cut death rates by 25% by increasing the wages on the public works schemes by a fifth.

One of the highlights of the economics of business sessions was a presentation on the economics of regulating the privatized utilities organised by National Economic Research Associates (NERA). Graham Shuttleworth (NERA) challenged the assumption that frequent reviews of the prices the utilities are allowed to charge their customers are in the best interests of consumers. By frequently reassessing the cost base on which the utilities’ returns are calculated, regulators have been able to force British Gas and the water companies into lowering prices.

But the cost of changing the rules is considerable uncertainty for investors, which may lead them to require a higher rate of return. ‘Regulation in consumers’ interests requires predictability and commitment’, Shuttleworth said. The danger was that unpredictable reviews would lead to underinvestment, which in the longer term is bad for consumers. While the UK has been trumpeting the virtues of the RPI-X formula around the world, Mr Shuttleworth suggested that we have more to learn from other countries than to teach. His NERA colleague, Graham Houston, estimated that rule changes had cost the utilities something like a £13 billion since the privatization of British Telecom in 1984.

Two papers in the international economics section untangled the thorny question of making aid flows and debt relief for poor countries conditional upon economic reform. Silvia Marchesi (Warwick) argued that accepting an IMF programme was an important pre-condition for debt relief because undergoing the pain of structural adjustment sent a signal to donors that a country was committed to reform.

But Paul Mosley (Reading) and John Hudson (Bath) argued that empirical evidence suggested that even conditionality does not completely overcome the problem of moral hazard. Countries would still be tempted to substitute aid for domestic investment or adjustment effort. They argued that compensating the losers from the reform process would help overcome the problem.

Others papers in the international sessions included work by Tony Venables (LSE) on the future economic geography of Europe under the single currency, and an analysis of the US advantage in manufacturing productivity by Stephen Broadberry (Warwick), which concluded that it was based on technological superiority.

Two contrasting papers examined the impact of international trade on low skilled workers. Stephen Machin (UCL), Thibaut Desjonqueres (LSE) and John Van Reenen (UCL) using international micro data for manufacturing and non-manufacturing industries, found no evidence to support the argument that international competition was the driving force behind falling wages and rising unemployment among the low skilled. Bob Anderton (National Institute of Economic and Social Research) and Paul Brenton (Centre for European Policy Studies), using evidence from the UK textiles industry over the 1970-83 period, concluded that ‘outsourcing’ to low wage countries could have accounted for about 40% of the rise in the wage bill of skilled workers and a third of the rise in their share of employment.

Paul Davidson (Tennessee) gave the Economic Issues lecture. He examined whether a Tobin tax would cut down speculation in the financial markets. Foreign exchange turmoil of the sort that rolled through the currencies of East Asian currency last autumn undoubtedly had adverse effects on the real economy, he argued, but advocates of Tobin tax were mistaken to think it would solve things by throwing ‘sand in the wheels’ of international finance.

Volatility in the financial markets was not the result of ‘noise traders’ - speculators who mistakenly believe they know how the stock market works and do not take account of underlying fundamentals. Therefore a Tobin tax was the wrong solution. Instead, Davidson argued for a system of fixed exchange rates where countries running current account surpluses were responsible for providing countries in deficit with the necessary liquidity to withstand speculative assaults.

In the Harry Johnson lecture the following morning, Barry Eichengreen (UC, Berkeley), a senior policy adviser at the IMF, advised against fixed rate regimes. Much of the crisis in Asia could been avoided if countries had exited their dollar pegs earlier. Very small countries find it hard to maintain an adjustable peg or a dirty float because of the vastly expanded flow of funds, he said.

‘Those countries not prepared to delegate monetary policy-making to a foreign bank, currency board or a transnational body like the European Central Bank are better off floating’. But exiting a fixed peg during a crisis is seldom successful. In Thailand, the banks accumulated unchecked currency exposure because the government stuck to its guns and defended the peg, thereby taking on all of the exchange rate risk itself. There were historical examples of successful exits. When Singapore unpegged its exchange rate in 1973, the currency depreciated but was back at its pegged level by the end of the year.