Merryn Somerset Webb talks to economist and author Roger Bootle about Europe’s economic disaster zone, and the advantages to Britain in pulling out.
• If you missed any of Merryn’s past interviews, you can see them all here.
Merryn: I’m here today with Roger Bootle; he is the founder of Capital Economics and the author of many excellent books including the just released The Trouble with Europe, which we are going to talk about among other things today. So Roger, can we just start by talking about the premise of this book, what was it that prompted you to write it?
Roger: Well, I think I write books as a sort of public service, for a start; I don’t write them to make money. I also write them to try and get my ideas straight. I find I can’t usually think very clearly unless I’m writing about things, and this idea, writing the book, really grew out of the fact that I wasn’t sure what I really felt about this European issue.
Merryn: OK, so just to stop you there, you didn’t start writing this book as a Eurosceptic, because you are known to be pretty sceptical about the eurozone, so, but you started it, you feel, with a pretty open mind?
Roger: I wouldn’t quite say that. I’ve rarely been accused of that. I’ve always been Eurosceptic in the sense of being sceptical about the euro as a currency and there are a lot of things about the European Union that I, for ages, haven’t liked. But I hadn’t sat down and worked out fully what the costs and benefits would be of leaving the European Union. I hadn’t really got stuck into the arguments. So, in that sense I was open minded.
Merryn: OK. Right, so, started with an open mind and it ended with..?
Roger: Well it’s still open but it’s more decided in the sense that I find it extraordinary that all sorts of people on both sides of the debate are convinced that this is of major importance for the British economy in the sense that if we stay in or go out it’s going to cost us squillions and squillions and squillions and either wipe off or add 5%, 10% to our GDP. Yet there are so many studies of the issue that show actually the net balance of advantages and disadvantages is fairly small.
I think it’s in many of the less tangible things that the most important aspects of this issue are to be found and with regard to how things develop in the future. That’s to say: if you think for political and other reasons it would be a good thing for Britain not to be in the EU then I think one of the consequences of reading my book would be that you’d come away from my book thinking well actually there isn’t an economic case to say that that should be overruled. We can do it.
If Britain were outside the European Union, it could could deregulate quite a lot; that would bring a lot of advantages
Merryn: OK, so economically being in or out is marginal over the medium to long-term? Upheaval in the short term, obviously, but marginal over the medium to long term?
Roger: No, I think probably in the long term it’s not marginal. I think it could then be significant, because I see Europe going largely the wrong way: over-regulation, over-integration. I think the costs of that are going to grow over time; and similarly, Europe is fading in relative importance in the world. I think if Britain were outside the European Union it could take another direction. It could deregulate quite a lot, and, I think, bring quite a lot of advantages. So, I think it’s complex. Short-term: disruption, difficult. Medium-term, however long that is, I think the net balance is fairly marginal. Looking out longer-term, it could be substantially positive to be out.
Merryn: OK, interesting. So, the main economic negative as you see it now to being in the Eurozone is that we’ve essentially hitched ourselves to the wrong part of the world? The wrong horse, geographically?
Roger: I think that’s a substantial factor, but the really important thing, of course it’s so difficult to pin down how much this costs us, is the wave of regulation coming from Brussels. Now, the reason it’s so difficult to assess, is we don’t know what we would do in the absence of these regulations. We might impose the same regulations ourselves.
Merryn: We’re quite keen on regulation on in the UK, aren’t we?
Roger: We are, absolutely.
Merryn: We have a great tendency to put it in place.
Roger: You’re absolutely right. Of course it depends partly on who is in power, but you could imagine a scenario in which we could come out of the European Union, partly thinking we’re going to benefit from not having all these regulations and, let’s say, we’ve got a Labour government and it’s now got the power to rescind these European regulations but actually looks at this and says, “Funnily enough, we quite like all these, we’re not going to change them.” In which case one of the big positives simply doesn’t happen.
Merryn: And would it not be the case that in order to keep trading with Europe anyway we’d have to put a lot of the same regulations in place to maintain free trade agreements?
Roger: This is a tricky issue. I think one of the most important points in the case against staying in is that yes we have to have certain regulations in place if we’re trading with Europe but if we weren’t in the EU we’d only have to have those in place in those industries and businesses which were exporting to the EU. Of course, that’s a tiny minority in relation to the system as a whole. If you’re in the EU then you have to impose those regulations across the whole economy. So, little sandwich sellers in Dagenham have to comply with the regulations about working hours and all these other things, whereas if we weren’t in the EU that wouldn’t apply.
I think the eurozone is a complete disaster, and I’m not a Johnny-come-lately on this subject, I was saying it right from the beginning
Merryn: OK. Let’s look at the economic stagnation of Europe; the idea that we are hitched to the wrong horse. Is there any way that can end while the eurozone stands?
Roger: I think the eurozone is a complete disaster and I’m not a Johnny-come-lately on this subject I was saying it right from the beginning. The problem is really two-fold: firstly, you’ve got these countries on the southern periphery: Greece, of course, the most intense example, but also Italy, Spain and Portugal, which are uncompetitive. In the past, they would have depreciated their exchange rates and that would have kept them in the game. They can’t do that, so they are mired in a dreadful situation: low GDP, huge unemployment. Greece has lost 25% of its GDP during the last six or seven years. I mean horrendous, really horrendous. That’s problem number one.
But the second aspect which is not fully appreciated, and it is, I think, at least as important, and that is the tendency for Germany and The Netherlands and some other countries, but mainly those two, to do too much saving. They run their policies too tightly. The German companies sell all sorts of wonderful stuff across Europe and across the world, and then the income from that is not fully spent. Now, in the days – this is vital to the euro, it’s right at the centre of the euro question – in the days before the euro when the deutsche mark was in existence, the Germans were just as German then. They were wonderful at engineering and exporting and making things; they worked jolly hard; all that stuff. They had a natural tendency to run up surpluses, to save too much then. But the currency stopped that tendency from being fully realised.
They would do all this non-spending and working and up would go the deutsche mark and that would attenuate these tendencies to be able to export a lot. So, it’s the combination of those two things. So, what the euro has done is it’s locked together these two groups of countries that behave fundamentally differently. In the old days the exchange rate acted as a flex, a hinge, enabling those two sorts of countries to work together. Without out it well you’ve got this ghastly stagnation.
Merryn: So, without the common currency, if we just had a European Union without a common currency could that have lasted? Could that have worked better?
Roger: Oh, I think it would have worked much better. Most of what is wrong now in the European Union at the moment is, I think, the euro. But if you look at historical record it’s quite clear that Europe was not doing that well before the euro came into existence. I mean the gaps aren’t huge but they are there. Go back far enough, of course, right from the beginning and the European Union was very successful, which is the real reason why Britain joined. Those countries from the late 50s into the 60s and early 70s were growing very fast. We thought this was a miracle economic area and we’d better hitch ourselves to that wagon.
Then, more or less as soon as we joined, funnily enough, the relative growth performance started to deteriorate. Of course, the 70s were grim for Britain. Come the 80s we started to improve. The continent started to do a bit worse and then we got the emerging markets growing very strongly, and throughout the last 20 or 30 years the performance of the eurozone, compared to other countries around the world, has been deteriorating.
For Greece to leave the euro would be a good thing. If I were advising the Greek government, I would advise them to do precisely that
Merryn: In terms of countries possibly leaving the euro, you’re not particularly concerned about Greece are you? But you’re rather concerned about some of the other peripheral nations.
Roger: Well, I think for Greece to leave, it’s a huge step of course, I think it would be a good thing for Greece. If I were advising the Greek government I would advise them to do precisely that.
Merryn: Yes, you have to wonder who is advising them not to?
Roger: I think this is actually largely political, really. Very often, people say to me, “Why is it that the Greek government or the Greek people don’t want to leave the euro?” And I say to them, I think this is a bit like the economical equivalent of Stockholm syndrome. In the world of psychology, apparently, there’s this phenomenon where if someone is held captive in a cave, as it were, or a cage, they strike up a relationship with their captor and after so many months of all this when the door is opened they don’t want to leave.
I think this is a bit like that. If you go back in history you hardly ever find a case where a country locked in an unfavourable exchange-rate regime wants to leave: Britain 1992, forced out of the ERM. What happens, I mean the newsreaders that night, September 16th 1992, they were practically wearing black armbands! “Business survey… business optimism collapses, consumers are depressed. People are putting keys through the letterboxes.” You know, it was all falling apart. In fact, of course, we now know that was the beginning of our escape from recession.
In 1931, Britain came off the gold standard. Were there people clamouring to come off? No, on the contrary, they were stuck there desperately trying to stay in, and only after they’d been forced out did they realise this was their salvation. So, I think Greece is similar.
Merryn: OK, and Italy?
Roger: Well, I think it’s intriguing. I think Italy is lucky to have Greece in the system in a way, because it’s deflected all the attention. The Greek case is more serious. It’s more extreme. The management of the public finances is terrible. In some ways almost primitive. It’s like third-world in the way that Greece has run its public finances.
But the fundamentals in Italy are not that much better actually. The debt ratio is above 130% nearly 140% of GDP, whereas Greece is pushing 180%. But not that far behind. The key thing about Italy is it’s had next to no growth since the euro began. Virtually none. When some countries had a boom – Spain and Ireland, you know, got into trouble but they had boom years. Italy didn’t have a boom year. That’s because the economy is essentially sclerotic. I think it massively needs reform. So, I would be worried about Italy actually. It’s not an immediate candidate for departure.
Merryn: Italy does have, at least, a good manufacturing base in the north, doesn’t it?
Roger: Absolutely. I think if Italy came out of the euro and the new currency, the new lira, or whatever fell 30% or 40%, I think you wouldn’t see Italian industry for dust. It would be shooting away: exports would soar; the economy would take off. Why aren’t they doing it?
Merryn: Have you told them this?
Merryn: Hopefully they’ll read the book.
Roger: Well, hopefully they’ll read the book, but this is the sense in which a Greek departure I think is really, really important and most people taking part in this debate still haven’t got this quite right. They think the issue is about contagion from the Greek exit in terms of loss of confidence in the markets and all that sort of stuff. I think that’s completely wrong. I mean Greece is now so far on an extreme, if Greece were to leave I don’t think there would be any contagion in the markets really.
No, the real issue is whether the Greeks can make a success of it. If the sign – you know it would take about a year to tell – but if it looks as though Greece is making a success of it that’s the real danger to the eurozone. At that point the politics in Italy, Spain and Portugal will get to be really interesting. Then the people will turn round and say, “You know what you’ve been telling us to take Mrs Merkel’s medicine and if we don’t we’ll end up like Greece. Well looking over there I think actually we’d rather like to end up like Greece. Look they’re growing. You know, growing strongly.”
There are several countries that’ve experienced this: Argentina, beginning of the noughties. Iceland – no country was in a worse mess than Iceland. She zoomed back: strong exports, strong GDP performance, largely helped by a competitive exchange rate.
Merryn: Can I ask you about the politics of the EU? You know there is a view that the financial crisis has been one of the causes of the rise of nationalist politics across the EU including, of course, in Scotland. That one of the things that has driven that is the idea among local populations that they are being pushed around by the elites at the top and this has driven them to pull themselves inwards back to nationalist parties?
A more relaxed fiscal stance by Germany, and a lot more QE and activism by the ECB might hold the eurozone together
Roger: I think there is something in that. But this is a complex issue really. Those sorts of feelings and support for, let’s say, fringe parties, non-consensus parties, does tend to rise in weaker…
Merryn: I don’t think we can call the SNP fringe anymore, can we? (Laughter)
Roger: …in weaker economic times. So, I think yes the recession rather than the financial crisis itself has had that effect I think. But that’s not the only reason. I think a large part of people’s anxieties across Europe is now about the movement of labour. That’s only really become an issue after the admission to the EU of members of the former eastern bloc. While we were stuck with pretty much with the old Western European club, it wasn’t a big issue. But as soon as you open up to the Polands, Hungaries, Czech Republics of this world you then get this issue of large flows of labour. Again, concern about that tends to be strongest when unemployment is high, and that’s been the position over the last few years.
Merryn: Interesting. Is there a possible programme of reform that you can see that would allow the eurozone to survive long-term and the EU?
Roger: Well the eurozone, yes, I suspect some countries like Greece have got to leave it. But the really big change I think that might save it would be the adoption by Germany of much more expansionary policies. So, a more relaxed fiscal stance by Germany and some of the other countries like Netherlands and I guess a lot more QE and activism by the ECB; that might hold that together.
As far as the EU is concerned there are a whole host of things that could be done to make things a lot better. But fundamentally, to try and narrow them down to a fundamental principle, which I talk about a lot in the book, it’s the principle of ever-closer union. When you look at the Treaty of Rome there’s no doubt what this game was about from the beginning. It was about the construction of a political union in Europe essentially putting the national divisions of Europe behind us all and uniting, if you like, in a United States of Europe.
That’s been the principle driving everything. I don’t think that’s a desirable principle to adopt. I don’t think it can work. I think it’s a political recipe for a political nightmare I think in Europe. It hasn’t worked economically. So, the main thing to get Europe working is to draw back from that and accept that what this is an association of similar countries who are getting together for trade and friendship. If you adopt that principle then I think so many of these detailed reforms will simply fall into place.
Merryn: I think that if you entered writing the book not convinced how you felt about it you’ve come out at the end pretty clear, haven’t you?
Roger: I have, yes. I have.
Merryn: Can I ask you a little about possibly more UK economics, and where we stand today? The recovery, the GDP numbers out this week have suggested what recovery we do have is slowing slightly. Where do you think we are on our cycle?
Roger: Well, for a start these GDP figures, on a quarter-by-quarter basis just you know they are pretty loopy. The longer I go on in this subject the more suspicious I become I’m afraid about national stats. Let me give you one little homespun example. Capital Economics, my company that I founded 16 years ago, still a small company but we’ve got over 100 employees. We export 75% of our output around the world. I’ve never been asked to fill in a single form about my output or my economic activities in here, Capital Economics. I suspect in London in particular, but in Britain in general, this is not unusual. The economy has gone through massive changes. We know that the small business sector has been very important that things have been turned upside down. I wonder how many other businesses there are like this.
Merryn: You know that’s very interesting because since we launched MoneyWeek about 15 years ago. I, too, have never even seen one of those forms, let alone been asked to fill one in.
Roger: Is that right? Yes, well this is the point. So, you know these official GDP numbers are produced by a bunch of, I’m sure they’re very admirable people, but essentially the intellectual model behind the whole process just sounds like, sort of, widget counting really.
Merryn: OK, well skip the numbers then. Skip the numbers.
Roger: Skip the numbers.
Merryn: What is your feeling? Are we still in a semi-recessionary deflationary environment?
Fundamentally, the UK economy is in reasonable shape. The key development is the fact that real earnings are now rising
Roger: No. I think fundamentally the UK economy is in reasonable shape. The key development is the fact that real earnings are now rising. I mean for the last several years the average bod’s real income has been going down.
Merryn: Although I’m always slightly suspicious of those numbers because if you saw the numbers that the ONS threw out a few months ago about anyone who’s been in full time employment since the beginning of the crisis has seen their real wages rise by 4%. So, it depends where you look. So, these average numbers are sort of slightly suspicious and of course they don’t take into account all of the redistribution.
Roger: Yes, don’t try and blind me with science!
Yes, I mean there are different ways of looking at this. I mean it’s quite clear that what’s been going on in the last several years is a squeeze on real earnings. Whether the fairest way of saying it is that people’s earnings have gone up, but not by very much, or they’ve fallen, that’s like a detailed issue. The key thing is there’s been a lot of pressure on people’s real earnings and we know why. Principally because of the increase in tax; the rise in oil prices – since reversed – and the sharp fall of the exchange rate a few years ago has meant that there’s been a real squeeze on people’s earnings. That is now changing and this is I think is a very important factor. As long as energy prices stay pretty low over the next few years I think it’s right to assume that people are going to get steadily better off.
Merryn: Does that mean we have to start worrying about inflation?
Roger: No. I don’t think we need to worry about inflation for years still.
Merryn: How many years?
Roger: I don’t know that.
Merryn: But you’ve written books! You must know the answer to these questions!
Roger: No, come on! Writing that book 20 years ago, The Death of Inflation. That was a pretty call I got that right, just about. Actually, it’s very amusing I get hate mail from some readers of my Telegraph column who say, “You wrote that book, Death of Inflation, what a load of rubbish. Last month inflation was 0.1% it hasn’t died at all.”
I’ve said for a long time that I think the key issue with regard to inflation is whether and when the authorities, that’s to say central banks and governments, come actually to want inflation. They are not there yet.
Merryn: Don’t they want inflation now with these enormous debt burdens? If you were in government wouldn’t you be hoping for 3%, 4% 5% help you out with that a little?
Roger: Well that’s the point. Policy is not being operated that way at the moment. The Bank of England is essentially aiming at, essentially, 2% inflation and plenty of distinguished economists are now saying, “Look, the problem is you are aiming at too low a rate of inflation. Aim for 3%, 4%, 5%.” And if we get to that point then I start to get worried about inflation.
Merryn: Then you start to worry that once you get to 5% it’s hard to stop at 5%.
Roger: Exactly. Yes. Yes.
Merryn: Yes. On the subject of inflation, can I move you, just briefly, over onto UK house prices? In the run up to this election we’ve see pretty much every headline policy that comes out is designed to help house buyers, ie push house prices up further than they are already. You famously, for a long time, were very bearish on house prices as of course were we at MoneyWeek and now I know that Capital Economics certainly has changed its view and is looking for house prices this year to go, oh, 5%, 6% or something. Is this about lack of supply? Is it about very low interest rates? What’s your feeling on what’s driving this change?
Roger: Well, first of all both Capital Economics and MoneyWeek were right about house prices.
Merryn: Absolutely, I keep telling readers that! We were right!
Roger: This is not recognised. We were right. Prices did fall. Actually fell very substantially and of course-
Merryn: And in real terms up in the north they fell by 14% plus in some places.
Roger: Absolutely. So, that forecast was right. The timing wasn’t wonderful but the forecast was right. This is a difficult issue. Can I confess to feeling rather depressed about this?
When interest rates go up, there are going to be some serious, serious problems in the housing market
Roger: I’m not depressed about the forecast. I’m depressed about the politicians because it’s so obvious that this is a problem about lack of supply on the one hand meeting artificially boosted demand on the other. If you want people to find it easier to get the right sort of accommodation you’ve just got to build the stuff. This is all about the restrictions on the supply. What the politicians do of course, all the time, they are doing it is fiddling with it and making the problem worse by shoving a bit of money here and bit of money there and a bit of restriction here and a bit of restriction there. Not helping the problem at all.
Now at some stage or other I think there has got to be a change and the really interesting thing about the UK, interesting in the Chinese sense that is, is when interest rates go up I think there’s going to be some serious, serious problems in the housing market because there are lots of people struggling to make their payments even now with very low rates. Now I’m not forecasting interest rates going up soon, but at some point or other they are going to go up,
Merryn: I’m going to have to ask you for a definition of soon?
Roger: Well I think they’ll start to go up probably next year but not by very much.
Merryn: Yes, but then, of course, they don’t have to go up by very much to double, do they?
Roger: That’s absolutely right. But once we start getting bank rate, base rate, call it what you will, at 2% or 3%, which of course is very low by historical standards, I think there’s going to be mayhem in the mortgage market. And if ever we get back to 5% or 6%, which I think we will, well it doesn’t look good. What I would say, I do say to people, who ask me this, and I say it to my children because housing has been a fantastic investment in the last 20, 25 years, don’t assume that it’s going to be that over the next 20 years or ten years. You know, we’ve all got to live somewhere, and of course living in your own home is far nicer in all sorts of ways than living somewhere owned by someone else. But don’t do it because you think you’re going to make a lot of money, because I think housing is a pretty lousy investment starting from where we are now.
Merryn: I take it you’re not investing your pension in a buy-to-let portfolio?
Roger: I’m certainly not, no. Economists don’t have much by way of pensions anyway.
Merryn: Where would you invest your money now?
Roger: Well, I’ve got a most peculiar portfolio really. It’s very odd.
Merryn: Tell us about it?
Roger: It’s odd simply because I own still a very substantial part of this company, Capital Economics, which is after all an equity investment. That’s always made me, with regard to the bit of my money I manage myself, as it were, pretty cautious and risk averse. So, historically I’ve tended to own a lot of bonds, government bonds and I’ve still got a substantial dollop in short government bonds because I want these things to be absolutely and completely safe. Having said that, for my discretionary investment I have been piling money into large-cap equities. Which I think…
Merryn: Which are really expensive in quite a lot of places?
Roger: …well, it depends on what you buy. But the historical records I look at suggest they’re not that expensive actually. I think they’re offering a reasonable return. Not that I think they’re going to be a bonanza.
Merryn: What sort of equities? I’ll squeeze an example out of you here.
Roger: I’m loath to give away the state secrets of my own portfolio but…
Merryn: Oh, go on, just the one state secret?
Roger: …I own a few of all the usual names. I’ve owned some Tesco, unfortunately.
Merryn: You mean, Nestle, that kind of thing?
Roger: BG, the big pharmaceutical stocks, and actually because of my long-term views about the pound, for British stocks, I’ve tended to go for some that have a heavy export content because I think they’ll do a lot better.
Merryn: So, not so keen on the pound then?
Roger: I’m not keen on the pound, no. I think it’s much too high.
Merryn: On what basis?
Roger: On its trade-weighted index basis. On its average value. It just looks extremely high and, of course, Britain’s international trading performance is pretty poor, suggesting that the currency is too high. But in answer to the question about, “What would I invest in?” I wanted to give a warning in that I wasn’t suggesting that my portfolio was the best portfolio for other people.
Merryn: Absolutely not.
Roger: Because my own position is very individual.
Merryn: Of course. Of course. Of course. But in a nutshell, own lots of the company that you founded, don’t have any houses, and large cap equities in the UK that are export orientated?
Roger: That’s about right.
Merryn: Thank you very much.