Personal Blogs

Congratulations to Laura Kuenssberg at the BBC for a powerful report on how Premier Foods treats its small suppliers: effectively making them pay protection money if they want to carry on working with them. This is important stuff, and deserves to be widely known about.

None of this comes as a surprise to me. Until recently I used to have a small business of my own, which I'd run for 15 years. It went bust this summer. There are many reasons for that of course, and one of them is no doubt that I wasn't very good at running a business, but another is definitely the attitude to small businesses that I'd found from some of our larger customers. We didn't come across anything quite so blatant as the Premier Foods example, but we did nonetheless find many of our larger customers insisting that we reduce our prices substantially if we wanted to work with them.

We couldn't afford to reduce our prices as much as was being demanded, so we lost the business. Eventually, I lost the whole business. There goes my retirement plan. Mind you, at least I found another job fairly quickly. I'd sleep a lot easier at night if everyone who used to work for me had also been so lucky.

Some may argue that what Premier Foods is doing is simply competition at work, and it benefits the consumer. They may argue that the businesses that can't compete on these terms will be the less efficient ones, and the ones that survive will be the good ones, so everyone wins.

I really don't think it's as simple as that.

Competition is a healthy thing in principle, but the problem is that when suppliers are under such relentless price pressure, it's going to be the quality that suffers. We've already seen what happens when people prioritise price over quality in the food industry: you end up with horse meat in your lasagne. So the businesses that survive may be the efficient ones, or they may just be the really dodgy ones that are prepared to cut a few corners to keep their costs down.

My own business was not in the food industry: we were in clinical research. Parts of the clinical research industry are very highly regulated, and our business held up pretty well in those parts. Clients can't afford to cut corners on quality, as they would fall foul of the regulators if they did, so mainly they were willing to pay a fair price to get the job done properly.

However, there is one large part of clinical research, which used to be a big part of my business, which is largely unregulated, namely the publication of clinical trial results in the medical literature. We took a huge battering there as clients took their business to cheaper companies in places like India. No doubt the quality was dreadful, but if it's unregulated, who cares? This stuff matters: doctors rely on the medical literature to make decisions about how to treat patients, and if research has been badly reported, maybe those decisions won't be the best ones. I don't know of any direct evidence that that is actually happening yet, though it seems plausible. I do, however, know of evidence which shows that clinical research published in low income countries is more likely to be fraudulent.

I'm not suggesting that tighter regulation is necessarily the answer. There are good reasons why clinical research is highly regulated, but those reasons don't apply to every industry. Regulation brings its own costs and inefficiencies.

It has been suggested that big businesses charging small businesses an "investment" (aka protection money) to do business with them should be outlawed. I don't think that's workable. Big businesses will simply find another way to screw small businesses, for example by demanding ever larger discounts. Unless you want to go down the road of full-blown communism, there's nothing you can do about that with legislation.

So what can we do about it?

Situations like we see with Premier Foods can arise, I think, for 2 reasons. First, there is a huge imbalance in economic power between big businesses and small businesses. I'm not sure how that can be fixed, but it really needs to be. Exempting small businesses from many of the taxes that large businesses have to pay (national insurance, business rates, corporation tax etc) would be something that government could very easily do, and I expect it would help. Though I doubt it would be enough.

The second reason is that we as consumers have become too fixated on price. If we demand the cheapest goods, then prices will come down, but we will get crap. I'm quite sure there is nothing government can do about that. It is up to consumers to think a bit more about whether they really want the cheapest things they can buy.

In the meantime, we will see good small businesses go bust, as mine did. The ones that survive may do so because they are more efficient, but I suspect that in many cases they will be the ones that are prepared to take a chance on passing off horse meat as beef, or whatever the equivalent of that is in other industries.

Is that really what we want?

The government have managed to annoy a lot of people again, this time by saying that paying people cash in hand as a way of avoiding VAT is morally wrong. To be told that by a politician who has not only claimed vast amounts of dubious expenses at taxpayers' expense to pay for his own taxes, but also been heavily involved in tax avoidance himself, is bad enough. It is worse when his boss, George Osborne, obtained his own unearned millions through a trust fund, a sneakly little ruse to avoid paying inheritance tax.

But that's not really the point I want to make here.

What I find most hypocritical about this is the way the government treat different kinds of tax transactions differently, depending on whether they're the kind that affect the rich and powerful or the ordinary citizen. We recently saw George Osborne get rid of the 50 p tax rate for the highest earners. The rationale for that was that if you set taxes too high, people just find ways to avoid them. The solution, then is to reduce the tax rate.

Guess what? That's exactly what happens with VAT. Paying 20% on top of every transaction is a lot of money, and people find ways to avoid it, like paying cash in hand. So why does the same consideration not apply? Could it be because the 50 p tax rate only affects George Osborne's chums, but struggling to find an extra 20% on top of everyday expenses affects ordinary people?

One can only speculate.

But one final thought. We are in a deep recession. We need consumers to spend money on things to recover from the recession. If everyone saves every spare penny, demand in the economy will remain depressed, and the recession will continue.

So why do we have such a high rate of tax on spending our money?

I've just renewed my annual multi-trip travel insurance policy. It was a hassle. I spent about 20 minutes on the phone to sort it out.

And this was renewing with an existing insurer, who already had most of the details they needed on file. I hate to think how long it would have taken to switch to a different insurer for whom I'd have needed to start from scratch.

No doubt I could have got a better deal by shopping around. But any better deal I got would have to have been dramatically better to compensate me for the time it would have taken to find the deal. I figured it was unlikely that such deals are available, so I didn't bother to shop around.

The ridiculous length of questions insurance companies make us go through therefore seem to be acting as a barrier to competition.

Just a thought, but I wonder if this is deliberate? Isn't it in the insurance companies' interest to make it difficult for us to compare prices?

A story in the news today has intrigued me. This is the story that 5 local councils in the north of England are launching a scheme to help first-time house buyers by loaning them money for the deposit on their house.

On one level, this sounds great. Although mortgage rates are currently low by historic standards, many first-time buyers struggle to save enough money for the deposit on a house, given that few mortgage lenders these days are prepared to loan more than about 80% of the value of a property, and some much less. It's not affording the mortgage that's the problem, it's finding a big enough pot of cash for a deposit up front. The size of the pot of cash required is outside the reach of most normal people.

We are told in the news story that the councils get a generous rate of interest on the loan. That seems entirely fair and reasonable. So in theory, this isn't costing council tax payers any money, as presumably it's being done at commercial rates of interest. I don't know what rate of interest, and when I phoned the first contact on the press release announcing the scheme, she also didn't know. Apparently it's up to Lloyds TSB, who are participating in the scheme, and I would guess that the rate of interest would vary according to the circumstances.

However, this scheme raises some interesting questions. If the loan is being given at a commercial rate of interest which is expected to cover the risk of people defaulting on their loans, then you have to ask why the banks themselves aren't providing a similar service? After all, one of the main functions of banks is to lend money, isn't it? Banks could easily make the councils' scheme unnecessary, either by offering 95% mortgages, or by offering specific loans for deposits, separately from a mortgage.

I can only think of 2 possible explanations why banks are not making these kinds of loans themselves. One is that the loans are a perfectly viable commercial proposition, and the banks are acting irrationally in not offering the service. It wouldn't be the first time that banks have acted irrationally. The second explanation is that the local councils simply haven't understood the risks of people defaulting on the loan, and are putting council tax payers' money at risk. Both explanations seem perfectly plausible. I have no idea which is correct.

It's worth noting in passing that this scheme may be an example of the "Big Society" in action, as it has been organised by Sector Treasury Services, a private company who appear to be running public finances for some local councils. I assume they are being paid for this scheme, and whether that had any bearing on encouraging councils to go down that route is something we can only speculate about. No, what am I talking about: that's totally far fetched, isn't it? Surely commercial interests would never have anything to do with important decisions about public finances made by responsible public servants, would they?

Anyway, all that aside, there is something else that worries me about this scheme. A big part of the reason why so many people struggle to buy their own home is that house prices are way too high. Housing minister Grant Shapps has recently argued, very sensibly in my view, that a period in which house prices fall in real terms would be a thoroughly good thing.

Helping a few first-time buyers by loaning a deposit will of course be a great help to those buyers who are able to take advantage of the scheme. But in the long run, I fear it will only make things worse for first-time buyers, as it will help to fuel increases in house prices. In some ways, first-time buyers being unable to afford houses could be a good thing if you take a longer-term view, as that situation is unsustainable, and will have to result in house prices stabilising or falling. That's just the sort of outcome that Grant Shapps has said he wants, and which I think most other sensible people would also want.

Surprisingly, then, we are also told in the story I linked to at the top if this article that Mr Shapps welcomes this scheme enthusiastically. That puzzles me. If he would like to see house prices stabilise, why is he supporting a scheme that is likely to contribute to their continued inexorable rise?

This week's news about the "shock" contraction in the economy is exactly the sort of thing that made me want to study economics in the first place.

I have so many questions about this sort of thing, and so few answers. Although I suspect that the "so few answers" thing may be shared by a lot of fully qualified economists as well.

So, first thing: why was the contraction a shock? Why was no-one expecting it? And was it really a shock? When it's described as a shock, is that because the government hadn't predicted it, but plenty of independent economists had? I must say I don't find it that surprising myself. You only have to look around to see that the economy isn't doing well. Case in point: I went out to the pub for lunch today with some of the folks from work. The pub was almost empty. It wasn't so long ago that the pub on a Friday lunchtime would be standing room only. Surely a sign of the times.

What's really worrying is that we are seeing a contraction in the economy at the same time that inflation figures seem to be on a relentless upward trend, so called "stagflation". Apparently the traditional remedy for this is a tightening of monetary policy (ie higher interest rates) to curb the inflation, together with a loosening of fiscal policy (ie lower taxes and higher government spending) to try to stimulate the economy.

Neither looks likely in the current climate.

With the enormous fiscal deficit, surely any loosening of fiscal policy is simply not on the cards. Some commentators say we should, but the government seem to be of the view that it's not an option, because of the risk of causing a crisis in the bond markets.

Who is right? I don't know, and sadly I have a sneaking suspicion I still won't know even when I've finished my studies, although perhaps by then I might know some better questions to ask.

One thing that strikes me about all this is that talk of simple measures such as changing interest rates is likely to be such a hugely simplified version of what's really going on that it's probably not very useful. The economy is a hugely complicated thing, and I doubt that simple interventions can ever have controlled and predictable effects.

Perhaps that's why no-one appears to really understand what's going on.

Today sees a rise in the standard rate of VAT from 17.5% to 20%. Now, as I've mentioned before, I'm not an expert in economics, I'm a beginning economics student, so my thoughts on this subject may be ill-informed or based on misunderstandings. But I'll share them with you anyway. Do feel free to point out in the comments if there's anything you think I've got wrong.

3 questions spring to my mind about this VAT increase. Is it necessary? Is it fair? And what effect will it have on the economy?

As for whether it's necessary, the first thing to say is that some kind of tax rise is surely necessary. The Labour government spent taxpayers' money like a drunken sailor and left us with such a mind-bogglingly huge budget deficit that it is inconceivable that the hole could be plugged by either budget cuts or tax rises alone. Both are necessary. But as for whether VAT is necessary, that depends on how it stacks up against possible alternatives.

So on to the next question: is it fair? There seems to be a broad consensus among politicians that progressive taxes are fair and regressive taxes are not. Progressive taxes are those paid more by the poor than by the rich, and regressive taxes are those paid disproportionately by the poor.

So is VAT progressive or regressive?

Many commentators describe VAT as a regressive tax. See here, here, and here for examples. Even David Cameron himself described it as regressive, although it should be noted that that was what he said before the election, when he also said he wasn't going to put the VAT rate up.

And we all know that what politicians say before the election doesn't count.

However, I don't think it's as simple as that. In one sense, VAT is not as progressive as putting up the basic rate of income tax. People at the bottom end of the income distribution, who don't pay income tax, are not affected by a rise in the rate of income tax, but are hurt by a rise in VAT.

However, they are not hurt very much. Remember that VAT is not charged on most essential items, most notably food and rent. If you are poor, most of your expenditure goes on food and rent. If you are rich, a much higher proportion of your expenditure goes on luxury items which attract VAT, so you probably pay more VAT. So I suspect that overall, VAT is a lot more progressive than most people give it credit for. It would be interesting to know if there are any reliable statistics on how much VAT is paid as a proportion of income by different income groups, but I don't have those to hand.

So what about the effects on the economy?

I can think of 2 ways in which it could have an effect: reducing consumer demand, and increasing inflation.

There is no doubt that increasing VAT will reduce consumer demand. If prices go up, then demand must fall. I may not be an expert in economics, but that seems pretty basic. How much demand falls is, of course a harder question to answer. Will it fall be enough to make a big dent in the economy? I doubt it, but time will tell.

But it's also worth considering whether it's a good thing if consumer demand goes down. Didn't we end up in the mess we're in partly because everybody borrowed too much and spent too much? If people are less tempted to splash out on a 56 inch plasma screen TV and pay off a bit of their mortgage instead, would that be such a bad thing?

After all, one of the first signs of the current financial crisis was the run on Northern Rock. Northern Rock's problem was that they had lent far more in mortgages than they had received from savers, and they found themselves unable to fund all those mortgages when funding from wholesale money markets became harder. So their problem was caused by people borrowing too much and saving too little.

Of course we need people to spend money, because that's what keeps the economy going. As we attempt a fragile recovery from a nasty recession, it could be argued that spending money is more important than ever. However, is the domestic market the be-all and end-all of the recovery? I suspect that the economy needs to focus more on exports than on domestic demand if we are going to see our economy recover strongly from the recession, so perhaps a small dip in domestic demand is less of a problem than it seems.

The other effect of the VAT increase is that it fuels inflation. At first sight, that seems a bit artificial: underlying prices have not increased, any jump in inflation is due to a one-off tax increase. However, it will feed through to official inflation figures, and of course it does mean that there is a very real increase in the price that ordinary people pay for things, so it could feed through into higher wage increases, which would then cause further inflation. That doesn't seem too big a danger at the moment, when many people are thankful that they have a job at all and many employers, struggling to survive the harsh economic climate, are not contemplating any wage increases at the moment.

But the cynic in me wonders whether the government are actually quite keen to see rising inflation. Our national debt is huge, and is going to take a long time to pay back. One cunning plan for making it easier to pay back would be to have a period of high inflation, which would erode the real-terms value of the national debt, thus making it easier to pay back.

I have no idea whether the government are thinking along those lines or not, but I'm sure the idea must at least have crossed their mind.

Does it even matter if we do see a period of high inflation? It probably does if you're a pensioner and reliant on the value of your savings, which would be eroded by inflation, but I suspect it may not matter so much for others, and for anyone with a mortgage, inflation also erodes the value of the mortgage. Of course high inflation tends to lead to high interest rates, which is bad news for mortgage holders.

Clearly there are winners and losers from high inflation, and I suspect that overall it's a bad thing, but it may not be quite the apocalyptic scenario that some people believe.

So, after all that, do I think that the VAT increase is a good idea? On balance, probably yes. In an ideal world, I'd rather not have to face any tax increases at all, but given that we do have to have them, VAT is probably one of the least painful. Unlike income tax, paying VAT is largely voluntary, as it's charged mostly on things that you don't absolutely have to buy (although of course there are exceptions). I certainly think it's a better option than putting up employers' national insurance: when we are faced with rising unemployment, the last thing we should be doing is increasing taxes on job creation.

As for the effects on the economy, time will tell, but my guess is a VAT increase is probably less harmful than most of the alternatives.

What do you think? Do let me know with the comments form below.

This post is largely to test whether the blog works, but is also to say that I am very excited about going back to school again.

I've been coming to realise over the last couple of years what a fascinating subject economics is, so I am thrilled to have the opportunity to be able to study it in some depth.

I have absolutely no idea whether anyone else will ever see this blog, but if you do, and there is a working comment feature, it would be great if you could leave a comment just to say hi.