The Society's Annual Conference was held this at the University of St Andrews on 10-13 July to coincide with the Millennium Conference of the Scottish Economic Society. This report was compiled by Rob Stokes, Associate Business Editor of Scotland on Sunday Newspaper.

Political economy was well to the fore at the 2000 Royal Economic Society annual conference held At St Andrews university in conjunction with the Scottish Economic Society. Fittingly so, because policy implications and applications of the dismal science have long been a forte of the Scottish economics community. No-one can forget either that Adam Smith was born in the Kingdom of Fife, a short-drive from St Andrews. For most of the past two decades, speechwriters for any UK Chancellor of the Exchequer addressing an audience of economists in Scotland would have alluded religiously to Smith.

The Chancellor's speech

It was a sign of political change that the ghost of another great was invoked by Gordon Brown when he addressed the RES in what was an undoubted highlight of the week in July. The Chancellor continued the rehabilitation of the late John Maynard Keynes as a source of insights guiding UK economic policy. Keynes wrote of the 'animal spirits' that, in a world of imperfect information and incomplete markets, could produce short-termism, but he also believed investors could think long-term if they had confidence in stability and growth. He would have been intrigued by the current mix: strong growth and subdued inflation in major world economies; continuing jitters over 'irrational exuberance' in American stockmarkets; and a transformed UK approach to monetary policy making in pursuit of just that stability.

Keynesianism has been tarred with the failure of demand management strategies in the 1960s and 70s. Brown judged this to be a misunderstanding of Keynes's basic insight. Stop-go policies had reflected an approach Keynes prescribed for depression-bound economies where confidence was low. Yet governments had applied his solutions mistakenly to inflation-prone economies where the problem was not lack of demand, Keynes's so-called special case, but low productivity, inadequate investment, unreformed labour markets, and general short-termism.

Monetarists had failed by tying policy to flawed rules. In the post-monetarist era 'the answer is not no rules, but the right rules,' said Brown. The path to stability lay in the discipline of a long-term institutional framework. 'This Government, rejecting short-termism, not least crude "Keynesianism", is seeking to draw on the best of Keynes's insights and put a modern Keynesian approach into practice.'

By common consent, it was the most economically literate speech that anyone could remember a UK chancellor delivering to a RES conference.

Economists at the heart of government

There again, UK governments have developed a passion for economists. The Government Economic Service (GES) is 650-strong and has grown by 42 per cent in a decade while the civil service has shrunk. Rising demand is reflected in the starting salaries of assistant economists at The Treasury, rising by 24 per cent to £21,500 in the last five years. 'I like to think demand is high because we've been successful at getting across the need for evidence-based policy,' Gus O'Donnell, head of the GES, told a conference session on the state of academic economics.

Government ministers are now tutored in the basics of economics. Every Treasury entrant must do both macro- and microeconomics, though emphasis on raising productivity means much of the work is micro. The standing of economists is rising. The Monetary Policy Committee is
perceived to have played a key role in heading off a return to boom-bust. The auction of third generation UK mobile phone licences, devised by academic economists, raised £22bn for public coffers. Privatisations have created the need for civil servants who understand the complex economics of regulation. Tougher competition policy demands more economic literacy in the areas of competition, supply, demand and pricing. The trend towards more agencies at arm's length from government has stimulated a thirst for policy advisers. Moreover, three-year budgeting period for health, education and other government departments is ending the curse of annuality and fostering a more productive relationship between Treasury and spending departments. 'It used to be adversarial,' said O'Donnell. 'With three-year frameworks we can say, "if we give you the resources, what can you do for us?".'

O'Donnell says a central aim is to 'bridge the gap between economists and policy advisers' so economists understand the real-world implications of what they work on and advisers understand the theory underpinning their advice. The reality gap could be one reason that academic economics is facing a crisis in the UK even though its products - graduates and ideas - are in
greater demand.

Ken Clarke, the former Tory chancellor, once described academic economics as 'a strange…branch of mathematics'. Anyone stumbling upon many lectures at an RES conference would probably concur as they heard regression piled upon equation and assumption like the babbling of a stereotypical mad boffin from a 1950s B movie. 'One reason many bright young people leave economics is that they can't see beyond the emphasis on theory,' suggested Liam Halligan of Channel 4 television, one of few economics graduates employed by the UK media to explain economics and bring it alive. 'They can't see what relevance it has to the real world.'

Losing out to the private sector

We heard how academia is losing a three-way struggle with the private sector and government to capture the best graduates. There has been a steep rise since 1992 in those bound for the financial sector's highly paid posts. Some listeners took issue with the suggestion that they could not communicate their work and its relevance. 'We can't say that bright people leave economics because it's too theoretical,' said Richard Portes, RES secretary general. 'It doesn't happen in the USA. There's plenty of stuff written by good economists...good at writing columns. This stuff gets picked up. We just can't compete with what's being paid outside academia.'

In 1998, the top salary point for a senior lecturer in economics was £33,900. The average among private sector employees who were members of the Society of Business Economists was £53,000. Only 6 per cent of people doing a Masters degree in economics want to become academics, and only 47 per cent of PhD students, who have already made an additional commitment of at least three years to study for their doctorates. Economics is the only social science in which demand for PhD studentships is falling.

Salaries among UK academic economists are not 'bad' compared with other countries. The UK sits around mid-way in the international league table between the two extremes of relatively poorly paid Swedes and the doughboys in Switzerland. But the gaps with rewards available outside the ivory tower are stark.

Research funding has been slashed too as the more fashionable Business Studies has gained in popularity at the expense of economics, leaving it as the second worst-funded of all the academic disciplines despite its heavy and expensive demands on computing power, big databases and large research teams. 'We're getting to crisis levels in funding', warned David Hendry of Oxford university. 'There won't be any economics in 15 years' time. When both the chancellor and senior government officials are saying how important economists are, it would be a serious mistake for Britain not to invest in it as one of the intellectual disciplines of the future.'

Health care incentives

An excellent invited session on Incentives in Health Care underlined his point. All the papers shed light on the complex inter-relationships between, private and public providers, multi-dimensional objectives, agencies and divisions, prices, and the rules of the game. Martin Gaynor and William B Vogt, both of Carnegie-Mellon university, outlined how the dramatic consolidation in US hospital markets had created the need for a better understanding of competition and especially the role played by the dominant category, not-for-profit (NFP) hospitals.

They have built on a previous model involving price, marginal cost, objectives and consumer demand to generate coefficients varying between zero for perfect competition to one for a monopoly. Analysis of detailed data from 3.6m discharged patients weeded down to 900,000 in California, suggested that, contrary to expectation, NFPs do exercise market power, which shows through as higher implied mark-ups than in for-profit hospitals. The model is being further developed and will be used to examine charity care, quality issues and what happens in mergers.

Carol Propper and Bronwyn Croxson of Bristol university's Centre for Market and Public Organisation found that UK general practitioners who had been made fundholders under the Conservative governments had indeed used their purchasing power to buy quicker hospital treatment for their patients. Waiting times are a major way in which hospital care is rationed in the UK and are a constant and high profile source of political friction. Opponents of fundholding said it would lead to a two-tier system of treatment whole supporters expected it to raise quality all round.

While the Bristol team found shorter waits for patients of GP fundholders, this was only for procedures paid for by the GPs and not for the full range of services required by their patients. The effect was also most marked for procedures where the average waiting time was longest, and the net effect of the scheme on waits was small. The collective moral of all three papers was that designing competition in the public sector is very complicated. It was clear that any politician who pretends otherwise needs a polygraph test and an immersion course in economics.

The 'New Deal'

The value to policymakers of a close relationship with economists was demonstrated when newspapers claimed that research to be presented at the conference proved the failure of the New Deal, the UK government's welfare-to-work scheme. Rebecca Riley and Garry Young of the National Institute of Economic & Social Research were able to rebut this inaccurate spin on NIESR's study for the DfEE.

Their paper rehearsed why New Deal was an amalgam of best practice then attempted to evaluate its effectiveness. NIESR compared actual unemployment rates with those implied by forecasts and concluded that there would now be 40,000 more young people unemployed for longer than six months if it had not been for New Deal. 'It has had a significant impact,' said Young while stressing that the acid test of a scheme designed for higher unemployment will come when we see a sharp downturn again.

Britain and Europe

Political debate on the UK adopting the euro usually generates heat but not much light when protagonists compare economies. In contrast, Lucrezia Reichlin's presentation on 'Business Cycles in Large Economies' was a masterful analysis of flaws and their potential solutions involved in the standard, dynamic factor model for measuring co-movement in many time series across different economies. 'The dynamics of the UK business cycle is very different [from other European nations],' confirmed Reichlin, professor of economics at Université Libre de Bruxelles in Belgium and programme director of international macroeconomics at the Centre for Economic Policy Research. Her 'spectra' showed graphically how the UK business cycle is more like that of the USA than those of France, Germany. She found little connection between UK and European cycles and conceded reluctantly but forthrightly that her findings suggested the UK should heed advice not to join the euro in the near future.

'Nice work...but I don't like her conclusions (on the UK and the euro),' one celebrated economist and RES office bearer remarked afterwards in a private admission of how hard it can be for even seasoned sceptics to confront their own beliefs with ugly little facts.

Patterns of housing ownership and finance are often cited as a key structural difference between the UK and many continental European economies. German and French mortgages, for example, are restricted to 60 per cent of the purchase price. High home ownership and mortgages are deemed to make the UK more susceptible to interest rate shocks, an hypothesis used to justify the view that vesting control of UK interest rates in the European Central Bank would be a mistake.

Joining the single currency is likely to lead to inflationary consumer pressure in countries with high levels of owner-occupation and deregulated mortgage provision, like the UK, concluded Andrew Henley and Bruce Morley from the University of Wales at Aberystwyth. Their study suggested that UK membership could mean higher taxation, or greater regulation of personal and mortgage borrowing.

The Harry Johnson lecture

The Phillips Curve - a reliable old friend or spurious old acquaintance depending on your viewpoint - was the focus of the spellbinding Harry Johnson lecture from Greg Mankiw, professor of economics at Harvard. Mankiw has had an abiding intellectual fascination with A W Phillips' 1958 postulation of a trade-off between wage inflation and unemployment. Mankiw was prominent among the New Keynesian economists who in the 1980s tried to explain why workers and firms might behave less than fully rationally, at least in the short-term, by not cutting prices and wages in a recession. 'Sticky prices' have remained a key element of useful business cycle models ever since.

In a magisterial account of the way thinking has developed, Mankiw dissected the traditional backward-looking model, with and without hysteresis, and the New Keynesian forward-looking Phillips Curve. 'I still believe it is a tenet of economics,' he maintained, sparking a short but lively debate during which one critic contended that the model was 'not so much a workhorse as knackered'. Richard Portes said the lecture had been 'one in which the Harry Johnson tradition of breadth was very much present and beneficial for all of us'.

The' New Economy'

While attempts were being made to reinstate the old curve, Florence Hubert and Nigel Pain of the NIESR were getting to grips with aspects of the New Economy by investigating the impact of foreign direct investment (FDI) on technical progress and hence labour productivity in the UK. Judgements of the extent to which technology can raise an economy's potential for sustainable growth are assuming increasing importance in US interest rate policy. The UK Monetary Policy Committee remains largely agnostic on the New Economy. Some of its members nevertheless believe the UK is about to reap productivity dividends similar to those that the US has enjoyed from investments in technology over the latter half of the 1990s. The UK governments also pays out large sums to foreign investors, between £30,000 and £50,000 per job in the case of some large electronics plants in the mid 1990s.

Using an industry-level panel data set, Hubert and Pain's econometric approach found that foreign-owned firms have 'a significant positive effect on the level of technical efficiency in domestic firms'. There was evidence of significant intra-industry and inter-industry spillovers from inward investment, and the findings appeared robust even when other factors such as imports and domestic R&D expenditures were allowed for.

Sourafel Girma, David Greenaway and Katharine Wakelin of the Centre for Research on Globalisation and Labour Markets at Nottingham university's School of Economics also found that foreign firms have higher productivity and pay higher wages.

They estimated that the differential was around 5 per cent in terms of total factor productivity and wages once productivity differences were accounted for. But they found no evidence of intra-industry spillovers. Firms with low productivity relative to the sector average gained less from foreign firms, as did firms in sectors with low skills and low levels of foreign
competition.

Integrating old enemies

The society's internationalist outlook was well to the fore in a vigorously argued debate on a key issue facing Palestine and Israel against the backdrop of discussions at Camp David. Eli Sagi of Tel Aviv university provided comparative statistics and analysis to support his warning that a Palestinian free state would pay a high price if it closed its borders economically to Israel. 'Economic integration is crucial for rapid and stable Palestinian economic development.'

He calculated that a formal border would cost £100m, a large sum for a poor state, and would anyhow be bypassed by individuals and businesses in both Israel and in Palestine, which needed unimpeded access to the Israeli labour market and shared infrastructure to penetrate markets in the industrialised world. The trouble is that Palestinians have reason to be sceptical about promises of wealth from a better relationship with Israel. A paper by professor Fadle Naqib, of Waterloo University in Canada, showed how economic conditions in Palestine territories deteriorated after the signing of the Oslo peace accord in 1993 and a subsequent economic protocol between Israel and the Palestine Authority in 1994. Naqib's paper blamed the unequal division of power between Israel and the Palestinian Authority. 'It has enabled Israel to deny Palestinians access to their own natural resources and sustain exploitative structures imposed
during the occupation,' he said. Zionist policies over more than 25 years had bred a debilitating dependence on Israel, which six years of limited self-rule had not overcome. Israel insisted on permits for new businesses, which were often refused or delayed. Imports were restricted. Most businesses in West Bank and Gaza had no banking system available from 1967 and 1994.

Naqib reported that between 1968 and 1980, Palestinian GDP per capita rose from around 11 per cent of Israel's to 16 per cent. Yet in 1995, a year after the economic protocol, it stood at 10 per cent, and slipped further to 9 per cent two years later. Since the protocol, the Palestinian economy has been in crisis with a sharp rise in unemployment, a drastic decline in exports and widespread poverty. Naqib added that, in the West Bank and Gaza, only 68 per cent and 40 per cent of land respectively was available for Palestinians. In the West Bank, Palestinians could use only 15-20 per cent of water, and the population of new Israeli settlements was around 250,000. The Palestinian economy had effectively been 'disarticulated' through an extensive network of bypass roads that directed commercial and personal traffic away from and around non-Israeli areas. Naqib argued that if Israel had allowed a free market, the positive effects of Palestine having a more economically advanced neighbour would have outweighed the negatives over the past 30 years. 'Restrictions over the use of natural resources, a regulatory regime which inhibited business activities, and fiscal compression, served to incapacitate the normal operation of market forces.'

Arnon said that that for a while at least, economic borders would benefit both sides. He envisaged a real border but with flexible and open passage for labour and trade. 'Palestinians would benefit from being able to develop trade and customs policies and establish some sovereignty. Otherwise, they will continue to work in the Israeli labour market and the chances of the Palestinian economy developing will be harmed.'

The prize for getting it right could extend throughout the entire region. Successful Israeli-Palestinian economic relations are seen as essential to peace and prosperity in the Middle East. Before a peaceful and prosperous common market can emerge, observers believe it must first be shown that mutual benefits from free trade and co-operation are attainable on a narrower level between Palestine and Israel.

It is a shame that sessions covering issues with such far-reaching geopolitical implications can be so thinly attended as this was. Is it because people suspect that emotion and the problems of accessing reliable and valid data undermines the academic value of such sessions? If so, I would flip the argument around and say that the tenacity of economists making an honest attempt under difficult circumstances to collect data and run what they find against prevailing paradigms of interactions between unequal neighbouring economies deserves more visible support from peers.

My other quibble as a consumer of an otherwise stimulating week of relevant economics was the poor quality of presentational techniques. I am sure this was down to a combination of factors including time, money, technology and know-how. It leaves a poor impression nevertheless. The irritation of struggling to see and hear minuscule text, hastily drawn graphs on unlabelled axes, dense tabulations and unamplified voices prevents audiences engaging fully and participating in what is going on. But roll on 2001 when the show moves to Durham.