Laissez-faire economics won't save us from COVID-2050

A laissez-faire approach to coronavirus, no matter how much we get nudged - individual responsibility to wash our hands, avoid planes and public transport, and self-isolate - will not stop the spread of the virus. What the economy needs is not words, but a strong, fiscal response to supply the physical assets that we need to push this virus back. In those terms, the recent UK budget was not ambitious enough. 

I'm not talking about the supply of toilet rolls, sanitiser and pasta, I'm talking about spending on measures to restrict the spread of the virus. I don't know much about NHS Labs, but it appears they hit a supply side constraint because, despite scaling up and there being a 10-minute test available, the UK will "stop testing members of the public who display mild symptoms". The same is true of hospital beds, where UK hospitals rank amongst the lowest in Europe; on top of an NHS staff shortage and the closure of community hospitals. I know the evidence is mixed, but providing temperature checks at stations, ports, and airports could catch just over half of coronavirus-infected passengers. 

Specific supply side constraints are not solved by lowering general interest rates, but by strong and targetted fiscal policy. Yes, there has been some money for the NHS, but it has been constrained by ten years of austerity. From this weakened base, the cautious UK response could include more incentives for people to do the right thing and stay at home if they are sick, including the self-employed and low-waged. Given the low NHS base, the UK needs more stringent controls on the movement of people than our European and Asian neighbours, not less.

Chart from my live on #Newsnight just now. Right or wrong, there’s no doubt the UK is increasingly an outlier in our Covid response. pic.twitter.com/ZczXx8M48c

— Lewis Goodall (@lewis_goodall) March 12, 2020

Where to start? As a climate activist, I would have no qualms about grounding flights for a few weeks.  Why not push harder on that net zero by 2050 door at the same time? After all, as my 13-yr old son joked last night, we don't yet know how bad the COVID-2050 strain will be. 

Indeed, our service industries depend upon the UK being a safe place to visit. Imagine if there was no yellow fever vaccine - with a fatality rate of about 5% - few people 'at risk' would travel to areas where yellow fever is endemic. Whether the case fatality rate for COVID-19 is similar or turns out to be less because of undiagnosed cases, there are around 1 billion 'at risk' over 60s today, forecast to double by 2050. Prepare for the worst, and hope for the best.

What does more stringent controls on movement mean? Ensure people can work from home for the same pay; cancel large gatherings and move to virtual events; use video calling in at risk settings, GP surgeries and care homes; offer online exams and tutorials at Universities; encourage less (and longer) overseas and other trips; help elderly neighbours get their groceries. These are familiar themes to climate activists - live locally and act globally.

Achieving net zero creates both supply and demand side problems, but the UK government should have few qualms about letting CO2-intensive companies fail under 'tooth and claw' capitalism if they are not going to meet those 2050 climate goals - this is not a time to spend £27bn on motorways and roads. Given the laisser-faire response of the UK and other governments it may be too late to hold back COVID-19. But it is not too late to plan for COVID-2050.

Using Bloomberg From R and Excel

Bloomberg from R

First, you need to be logged on to Bloomberg.

If the Bloomberg/Excel add-in does not work, then:
1. Close Excel and/or R
2. Keep Bloomberg running
3. Go to Start-> Bloomberg -> API Environment Diagnostics
4. Click Start when the Bloomberg API Diagnostics window has loaded
5. If a “Login to wintrv…” message below then pops up, this occurs when Bloomberg isn’t open – it is highly recommended that you have Bloomberg running; you can proceed without it, but you may not be able to resolve some errors if you do so
6. Once the check is finished, you will get a 'Diagnostics completed' message
7. If the Repair button is available to press on the Bloomberg API Diagnostics window, it means it needs to run the repair and you should do so by clicking Repair (it should take a couple of minutes)
8. Once the check is done, and repair if necessary, the ideal state is all green ticks except for 2 yellow “!” for Dotnet Installation and Excel Throttle Interval only. Else, you can still run Excel or R-Studio and see if the Bloomberg-associated functionality is working.

# install the Bloomberg package, and connect
install.packages("Rblpapi")
library (Rblpapi)
blpConnect()

# get the Bloomberg data history for SPY US Equity - last 100 days - and plot it
x <-  bdh("SPY US Equity", "PX_LAST", start.date=Sys.Date()-100)
plot(x)

# find out what other fields are available for prices
res <- fieldSearch("price")
res

# get the Bloomberg data history for SPY US Equity - last 100 days - and plot it
x <-  bdh("SPY US Equity", "OPEN", start.date=Sys.Date()-100)
plot(x)

Bloomberg from Excel

As above, if the Bloomberg/Excel add-in does not work, then repair (Steps 1-8).

Open an Excel Sheet, and type the following into a cell:

Historical prices: BDH("F US Equity", "PX_LAST", “16/11/2000”, “15/11/2016”)
This will give you the last traded price (PX_LAST) for 'F US Equity (Ford Motor  Company) from 16/11/2000 to 15/11/2016. The first parameter must be the Bloomberg stock code.

For DMU students, this URL shows how to get data from Bloomberg into Excel.
Also for DMU students, this URL shows how to use Bloomberg.

Ukraine's path to prosperity

You can get an Uber in Ukraine. Investment is more difficult, because borrowing in local currency (Hryvnia) is expensive. The official interest rate is 12.5%, local currency mortgages cost around 20% and credit cards cost around 40%. To borrow more cheaply, many households took out USD mortgages prior to the Global Financial Crisis but, when the Hryvnia collapsed, these became unmanageable. Subsequently, the parliament (Rada) banned foreign currency mortgages and imposed a moratorium on the confiscation of property by the banks. The government finds it equally difficult to borrow cheaply, with the most recent sovereign Eurobond issue at 7.375%. The cheapest borrowing is reserved for privatised companies that export commodities: for example, LSE listed Ferrexpo, which is 51% owned by Rada member Kostyantyn Zhevago and exports iron ore pellets, has bond yields as low as 3.7%.  

Unsurprisingly, Ukranian public opinion is that the financial system is loaded against them. Two-thirds of sovereign bonds are issued in foreign currency, which means that Ukraine must have a constant stream of foreign currency to meet its payment schedules. When Ukraine does well, the Hryvina strengthens and foreign currency is easy to get. When Ukraine does badly, as it did after the conflict in the East, the Hryvina devalues and there is a scrabble for foreign exchange to satisfy creditors. Official statistics suggest that the central bank has enough foreign exchange reserves for about 3.5 months of exports, at $18 billion, but there is another $90 billion held privately by individuals. 

The conditionality attached to foreign loans is depressingly familiar, with the IMF requiring a maximum 3% public deficit, and the World Bank calling for sustainable public pensions. This, at a time when the minimum pension is little more than $2 per day.

And therein lies the trap. Public borrowing is heavily constrained, and private borrowing is too expensive. Notionally, the primary target of the central bank is inflation, and they have implemented tough measures to stabilise the foreign exchange rate. But lowering the interest rate requires reforms to reduce the cost of borrowing from local banks: better regulation, banking competition, less corruption, enforceable contracts, recognised accounting standards and clear accountability. Without deeper reforms, the risk is that the Rada will continue to make the same mistakes: hasty privatisations and sales of public land to ease the budget pressures but, in the process, creating the conditions for a new class of wealthy elites. Part of the problem is the Rada itself, which is unicameral (one legislative chamber) with code-based law. Here, the outlook for reform is less clear.

What’s to be done? At the Ukrfinforum last week (21/9/2017), Yanis Varoufakis called for a new Bretton Woods agreement. The World Bank and IMF could acknowledge that the financial system is heavily loaded against ordinary people, accept the need for International reforms, and back off on the conditionality around sequencing: they could support any measures that reduce the cost of borrowing, including an end to the war. The economy will turn round when Ukranians are confident and able to borrow and invest locally, which in turn will reduce Ukraine’s dependency on foreign exchange being earned by a small number of commodity exporters.

Infrastructure activism

The highlight of the inaugral NEKS conference was to hear Sir Vince Cable talking about Theresa May's industrial strategy, which he describe as a 'rebranding [of the 2011 strategy] with some good new features'. He reminded us that the UK abandoned interventionist policies in 1979, a state that remained until Mandelson's car scrappage scheme in April 2009, followed by support for the UK aerospace sector.

Sir Vince told us that he concocted a letter with Michael Heseltine, who had an adjacent office, asking David Cameron to be more strategic about UK government procurement. Two big ideas followed. The first was to encourage long-term, strategic thinking by government, leading to such things as the recently launched National Infrastructure Commission; the second was to directly support key sectors such as aerospace, cars, textiles, apprenticeships and University Innovation Centres. Sir Vince reminded us that we should also question economic wisdoms: in terms of revealed comparative advantage, the UK is supposed to put all its eggs in one basket and concentrate on financial services. BREXIT poses a new question for industrial strategy: do we 'take back control' and become more interventionist, or do we relinquish control to the markets?

In explaining how the UK handles infrastructure today, Bridget Roswell told us about the National Infrastructure Commission (NIC), an Executive Agency that reports to HM Treasury. The NIC is designed to circumvent short-term electoral cycles by developing long-term infrastructure plans for transport, energy, water, sewerage and telecoms. At the conference, I heard several different approaches to long-term planning, but the problems were the same: how do you measure success, which criteria do you use? Francesca Medda (UCL) described a portfolio structuring approach, designed to optimise a portfolio of projects combining negative NPV/high social value projects with positive NPV/lower social value projects. Others, such as Tim Foxon (SPRU), outlined ways to involve the local community in the appraisal and selection of suitable projects.

It is always difficult squaring the circle between objective and subjective approaches to project appraisal. I was reminded of the solution adopted for the schools' funding formula: central government sets the boundaries within which each local authority must work. On the one hand, there is an objective framework that is the equivalent of UCL's social value optimisation. On the other hand, local authorities tweak the formula to meet local needs. However, the option to consider non-financial measures barely features in the infrastructure regulation. Chris Green (SQW) and Nicholas Miles bemoaned that the majority of transport projects look only at 'time saved', which an optimiser would rapidly transform into something akin to Le Corbusier's Plan Voisin:

Several conference participants came up with alternative factors that local communities might want to consider: health, productivity, distributional effects, ecological value, direct consumption value, and so on. Goodhart's Law is clearly at play here: 'when a measure (journey time saved) becomes a target, it ceases to be a good measure'.

In several breakout sessions, we discussed how we might persuade private investors to look beyond short-term financial gain. Steve Keen berated economists for narrow-thinking, as did Sir Vince who plugged the 'brilliant book written by Manchester students'. But there was also room for optimism. Sir Vince highlighted the alternative business model of The People's Trust whose objective is to 'achieve sustainable, long-term growth' via an alternative investment fund 'owned 100% by our members'. This is not investment advice, but a £20 bet, to help them launch, seems worth it to ensure an alternative to non-interventionist pension funds.

To sum up: I took away two strategies if we are going to 'take back control'. First, put public funds to better use through localism, or social value index optimisation, or both. Second, reinvigorate private investor activism.

Pluralism since the ‘1992 Plea’ in the AER

First published on the Rethinking Economics Blog, March 12th 2014

In May 1992, a ‘Plea for a Pluralistic and Rigorous Economics’ was published in the American Economic Review (Vol 82 No. 2). It was signed by Harcourt, Galbraith, Goodwin, Kindelberger, Minsky, Pasinetti and other eminent economists. The Plea was funded by FEED who launched a second ‘Plea’ in 2009 and support the 2012 ‘Manifesto for Economic Sense’.  Geoffrey Hodgson, Research Professor in Business Studies at the University of Hertfordshire and one of the co-organisers of the ‘1992 Plea’, is interviewed here about the history of economic pluralism, and the challenges facing economics today.

NL: Twenty two years after the ‘1992 Plea’, do you think the mainstream has changed?

GH: I think things have changed in economics, to some degree. It’s not entirely positive, but in some senses economics is more diverse now that it was twenty two years ago… for example, new areas like experimental economics and behavioural economics have gained respectability. The main problem now with economics is not so much its diversity, or its insufficient internal pluralism, but the way that technique dominates and gets in the way of substance. Economists are engaged with mathematical puzzle solving rather than real-world problems…

NL: By that you mean things like regression analysis and theoretical model building?

GH: Theoretical model building and econometrics … that is all that now seems to matter in terms of publication in top journals or academic promotion. The whole discipline has become dominated by people who are very clever in technique but innocent of many important aspects of the real world and the history of their own discipline.

NL: In that 1992 Edition of the AER there were some pluralist surveys of economists, do you think the AER would publish that kind of qualitative research today?

GH: Generally it is very difficult to publish anything like that, and not just in the AER. I include other leading journals, like the Quarterly Journal of Economics or the Economic Journal in the UK… although occasionally they publish qualitative pieces, to spice up interest in their journal.

NL: What successes have you seen in the campaign for pluralism?

GH: The ‘1992 Plea’ was an early ringing of alarm bells about the nature of the discipline and the way it had been developing. It may have stimulated further similar complaints, such as from the French student movement… and dispersed attempts in Cambridge and also in the US… but the real change came with the 2008 crash. This provoked a much larger tide of complaint among students and others about the alleged inadequacies of mainstream economics.

NL: Was there a pluralist movement prior to the ‘1992 Plea’?

GH: Several prominent economists had made complaints. The petition was preceded by an important 1988 report by a commission of the American Economics Association, called ‘Report by the Commission on Graduate Education’ (Krueger et al, 1991), which complained about the dominance of technique in the discipline. A number of leading individuals, including Milton Friedman, also complained about the subject turning into advanced mathematics.  The most important event was the 1988 commission and its critical and scathing report.

NL: Did it have any success at the time?

GH: No.

NL: So why do you think the profession keeps coming back to these very inward-looking methods?

GH: The economics profession has an internal reward system that gets reinforced and replicated. Someone once compared it to the peacock’s tail. Once this positive feedback loop gets established, then people look for the glorious tail feathers despite their questionable usefulness. Fancy mathematics gets economists published and gets them promoted. As those people rise in the profession they will recruit people who perform similarly and the same kind of behaviour gets replicated. Other people, who think more widely or philosophically, or are more interested in the history of the subject or how it has changed, or who look more deeply at the conceptual assumptions, don’t get considered for influential positions in the discipline.

NL: What advice would you give Rethinking Economics?

GH: I hate to be pessimistic, because I don’t want to dampen the enthusiasm of those people committed to this, but unless you get some of the top universities appointing professors who are more broad-minded, who are not dominated by technique, who have influence, and some of the top journals consider more conceptual, historical material rather than simply technique-driven material,  then it will fail. Mark Blaug, who was a friend of mine who died a couple of years ago, got very pessimistic about this, and so did Ronald Coase who died last year. Another problem is that American economics is now overwhelmingly dominant. I often ask people… can you name a living British economist…  and they really have difficulty thinking of anybody. When mainstream economists took over the Cambridge department in the 1980s, after the era of Robinson and Kaldor, their explicit aim was to make Cambridge a rival to the top American Universities In other words, they aimed not to develop Cambridge’s own niche, but simply to follow what America was doing. You are inevitably 5 years behind if you are lucky, and that US emulation has led to the near-destruction of British economics… with this subservient mentality it is very difficult to change things in the UK.

NL: Can we talk about your hope for the future?

You may have heard of a new association called WINIR: the World Interdisciplinary Network for Institutional Research. What we are trying to do is create a new field for study. It’s not just about economics, but institutional economics is a part. I think that this is a more productive strategy than trying to change economics…  but the problem with WINIR is it doesn’t cover everything. At the moment, it omits crucial areas like finance… we can’t do everything. We are hoping to find new ways of promoting realist approaches and developing new ideas

NL: When you look at Blanchard’s work at the IMF…  is there at least a sense that more reflective research is coming out, even on the finance side?

GH: That’s right, and there are other good examples, like Thomas Piketty’s work on capital and inequality…. but these are the exceptions. All the incentives, all the ways that you get promoted in the system are not by thinking outside of the box. When I gave a talk to the Post-Crash group in Manchester, I said you have to take the institutions of science seriously. One of the problems with heterodox criticism is that it’s a fragmented growth of people who can’t agree amongst themselves on much, except that they are opposed to the mainstream: that will never generate cumulative knowledge. We actually need an alternative centre of orthodoxy. Science cannot progress by questioning everything, all the time….  some assumptions or knowledge has to be taken for granted. These assumptions may need to be changed later, but we need consensus as much as pluralism. Hence I’m against organising opposition to mainstream economics on the basis of a ‘heterodox’ label…  in fact there are many good and interesting things going on in the mainstream.  Heterodox organisations and leading figures who work under that label often overlook potential allies in the mainstream…

NL: One of the things we are struggling with in the UK curriculum review is the word ‘CORE’… this Popperian idea of a heuristic around which everything else revolves…  is the idea of a ‘CORE’ something the profession can escape?

GH: I think the CORE idea is important: the problem with things at the moment is that the core is defined in terms of technical skills. An undergraduate doing an economics degree has to understand key aspects of game theory, to understand key certain econometric techniques, and these take up the time of teaching and testing for the student… and as the bar is always being lifted… because the complexities of game theory and econometrics are always increasing…  so it’s not so much changing the subject matter of the core, it’s changing the preoccupation of the core. We need to establish that the first and foremost job of an economist is to understand the economy…  all other things are subservient to that.

Many heterodox economists blame Marshall, among others, for what went wrong. He was part of the neoclassical revolution of the 1870s and 1880s. But if you actually look at how Marshall wrote and how he behaved he was extremely tolerant and open minded…  he wrote in his Principles and also in his letters that economic theory is not a mathematical toy. He argued that we have to understand the real world. For him, mathematics was a tool, but not the main part of the subject…

NL: Several of the petitions for pluralism talk about solving climate change, global warming, inequality, wealth accumulation, capital flight, all of these issues. Do you agree that economics is that broad? Can economics solve all of these problems or is that too grand a claim?

GH: Marshall’s definition of economics was the study mankind in the ordinary business of life: by that he meant processes concerning the generation of wealth and its distribution, which include problems like the impact of climate change…  we need to develop economic policies to deal with climate change in some way.

NL: Which includes solving these issues…

GH:  Yes.

NL: Could you recommend three pieces of your work to a student interested in pluralism?

GH:  My 2004 book on institutional economics; my 2013 book on evolutionary economics; and my book on capitalism that is coming out this year. Each book addresses the issue of pluralism and challenges mainstream assumptions.

NL: Thank you very much.

References

Hodgson, Geoffrey M. (2004) The Evolution of Institutional Economics: Agency, Structure and Darwinism in American Institutionalism (London and New York: Routledge).

Hodgson, Geoffrey M. (2013) From Pleasure Machines to Moral Communities: An Evolutionary Economics without Homo Economicus (Chicago: University of Chicago Press).

Hodgson, Geoffrey M. (forthcoming) Conceptualizing Capitalism: Institutions, Evolution, Future (Chicago: University of Chicago Press).

Krueger, A.O. Arrow, K.J. et al (1991). Report of the commission on graduate education in economics.  Journal of Economic Literature. 29(3):1035-1053

Various (1992). A Plea for a Pluralistic and Rigorous Economics”, American Economic Review, 82(2):25

Black holes and free lunches

This is a response to a blog post and Twitter chat about the persistence of UK and US current accounts deficits. It's a hot topic: see Frances Coppola. The worst case scenario is generally assumed to be capital flight and devaluation: a return to the summer of 1976 when Callaghan went to the IMF for a loan. This post is an attempt to dig a little deeper, and address the politics and ethics: whose free lunch is it anyway?

The biggest problem for any researcher is the poor quality of the balance sheet data. In theory, if you knew the gross position on the financial and capital account, you could run various stress tests on sustainability: currency and asset price shocks; illiquidity; loan defaults; and so on. I can imagine there are wannabe financial stability super-regulators salivating at the thought of this kind of real-time, country-level portfolio analytics. However, the data are poor and the time series are incomplete.

I know of two major efforts to improve the balance sheet data: the External Wealth of Nations dataset from Lane and Milesi-Ferretti, and the Hidden Wealth of Nations dataset by Gabriel Zucman. Having tried, and failed, to work with the underlying datasets, I consider both these efforts akin to the story of David vs Goliath: heroically correcting the data errors that accumulated in international financial statistics under the laisser-faire stewardship of the IMF and UN.

I'm not very familiar with Zucman but, from what I can see (Table T1) he agrees with Lane and Milesi-Ferretti that the official US external position is, effectively, bankruptcy: assets-liabilities net at around -35% of GDP in 2012. However, both Zucman and Lane/Milesi-Ferrretti argue that this is due to the under-reporting of foreign assets. The most plausible explanations for this are tax avoidance (the purchase of domestic assets by non-residents, who are nonetheless UK residents but moving domestic assets offshore) and capital gains on foreign assets (favourable yields, foreign exchange gains and asset price rises). This somewhat out-of-date graph from Lane and  Milesi-Ferretti (2007, p.232, below) shows the world's aggregate current account deficit disappearing into an offshore 'black hole':

At a first order approximation, Lane and Milesi-Ferretti agree with Zucman's estimate that ~8% of World GDP (or $7.6 trillion) that is being held offshore in tax havens: a 'black hole'.

So far, so good. However, the problem with other parts of the 'dark matter' theory is that it has a poor track record for prediction. Consider Hausmann and Sturzenegger (2006) who, just before the GFC, cast 'doubts on the need for a major adjustment of the dollar or a large rebalancing of the global economy'. I suspect that this poor prediction is partly due to methodology: Hausmann and Sturzenegger inferred the size of the 'assets from their returns... (which) is just like valuing a company by calculating its earnings and multiplying by some price-earnings ratio, or valuing a property based on its rental value ' (p.5-6): akin to driving by only using the rear view mirror.

However, Hausmann and Sturzenegger are also naive in their theoretical framework. They think about 'dark matter' not as the offshore spoils of tax avoidance, but as embedded financial services that the US and UK provide to the rest of the world: 'surprises, risk premia and embedded services [insurance and liquidity]' (page 6). Longeran says something similar in his blog: 'the US has an edge in trading assets and making superior foreign direct investments...trading assets and selling financial “insurance” is a core US competitive advantage'.

There are well-rehearsed heterodox theories that explain an edge in financial trading, where developed countries exploit their information advantages. If financial markets are rigged ('markets for lemons') then the rest of the world will demand reform: Bretton Woods II might be vetoed by the UK and US, but other players can demand centralised clearing, alternative forms of collateral, breaking up trading cartels; and so on.

What about other embedded services: insurance and liquidity? Does the rest of the world pay a fair price for these? According to Godley and Lavoie (2007), provided UK and US trading partners accept IOUs, they can always issue new IOUs in return for goods and services. There is no need for a Walrasian auctioneer, or equilibrium. If the UK or US issue securities at a higher yield, such as an expensive nuclear power stations or high yield sub-prime/PFI debt, then they only hasten their demise. There is some evidence, at least for the UK, that an obsession with issuing higher yield private debt is doing exactly that, with direct investment income accounting 'for more than 80% of the increase in the (UK current account) deficit since 2011' (Hamroush et al, 2016).

We can also use exchange rate movements to estimate, in part, the historical insurance premium payable on 'safe haven' assets. The following graph takes the known reserves of major exporters (China, Germany and Japan) and estimates foreign exchange losses (the currency composition of reserves is taken from COFER). For China, these unrealised exchange losses approached $1 trillion during the period of USD and GBP weakness after the GFC:

A similar exercise, using Japan's trade surplus as a proxy for Japanese private holdings of US T Bills (not shown) suggests that private Japanese citizens paid out a similar insurance premium. From 1975 to 2013, the YENUSD exchange rate fell from around 300 to around 90. In simple terms, imagine a Japanese exporter in 1979 who had accepted USD in exchange for a Sony Walkman. After 30 years of low returns, they finally decide to convert back to YEN and spend it: their YEN buying power has fallen by about two-thirds.

The foreign exchange losses are consistent with superior trading by the UK and US, but we come full circle: the Walrasian auctioneer is sluggish, unpredictable, greedy and avoiding tax. The insurance premia for safe havens are expensive, and the auctioneer is constantly demanding privatisations to satiate foreign demand and to feed the 'black hole'. The sustainability question is reduced to something simpler: are the insurance premiums too high, and are offshore 'black holes' desirable or sustainable?

References

Godley, W. and Lavoie, M. (2007). Monetary Economics: an integrated approach to credit, money, income, production and wealth. Palgrave MacMillan. Basingstoke, Hampshire, UK.

Hamroush, S., Luff, M., Banks, A. and Hardie, M. (2016). An analysis of the drivers behind the fall in direct investment earnings and their impact on the UK's current account deficit. Office for National Statistics. Available from: 

https://www.ons.gov.uk/economy/nationalaccounts/balanceofpayments/articles/ananalysisofthedriversbehindthefallindirectinvestmentearningsandtheirimpactontheukscurrentaccountdeficit/2016-03-31

Hausmann, R. and Sturzenegger, F. (2006). Global imbalances or bad accounting? The missing dark matter in the wealth of nations ( No. 124). Centre for International Development at Harvard University, Centre for International Development. Cambridge, Mass. Available from: http://www.hks.harvard.edu/var/ezp_site/storage/fckeditor/file/pdfs/centers-programs/centers/cid/publications/faculty/wp/124.pdf.

Lane, P. and Milesi-Ferretti, G. (2007). The external wealth of nations mark II: revised and extended estimates of foreign assets and liabilities, 1970-2004. Journal of International Economics. 73(2007): pp223-250.

Hinkley Point C: who benefits?

Since mid-2013 I have made about ninety edits to the Wikipedia page for Hinkley Point C. It's personal: I was born in Taunton and my parents live about ten miles from the site. Most edits relate to the economics of the project. I also use Hinkley Point C in my corporate finance lectures to discuss uncertainty, discounting and risk.

The figures below use discounting* to estimate different scenarios for the project. The project is very difficult to estimate without knowing the operating profits - in this case, the estimate is from from Peter Atherton at Liberium Capital. I am in favour of renewable energy and the benefits of trade. However, the project appears expensive for consumers from every angle taken.

'Best case' scenario

i) Construction costs** of £18bn from EDF ii) operating profits at £5bn/year iii) decommissioning costs at the lower end of the range of estimates for a similar sized Magnox reactor and iv) a 2.2% discount rate, as used by the UK's Nuclear Decommissioning Authority (NDA) (p. 17) to represent the cost of government borrowing. Remarkably, the NDA now uses negative medium-term discount rates, on the basis these "represent the real-term cost of government borrowing which at the present time, creates a negative rate because the interest payable on UK gilts is less than the rate of inflation – typically in the past the rate was higher than inflation which produced a ‘positive’ discount rate". 

This 'best case' scenario at a 2.2% discount rate has lifetime profits of around £100bn, but if Hinkley Point C were funded by the UK government at lower discount rates the 'best case' would be even more profitable for the producer.

'Worst case' scenario
i) Construction cost estimate of £18bn from EDF  ii) operating profits at £2bn/year, which is 40% of the estimate from Peter Atherton iii) decommissioning costs at the higher end of the range of estimates for a similar sized Magnox reactor*** and iv) a 13% discount rate, as used in Green and Staffall (p.38) for the no support scenario. High discount rates mean higher subsidies because the project is considered more risky. Disappointingly, the authors distance themselves from their assumptions, saying that "Commission staff specified the WACC [discount rate] values that they wished us to use for nuclear stations and the policy scenarios that we are testing" (p.3). Even with these pessimistic assumptions, the 'no support' scenario only just fails to break even: 

Alternative discount rates
Assuming financial support, i.e.: less risk, a 10% discount rate was proposed by Green and Staffall. Now, all scenarios are profitable, with the 'best case', as above, showing lifetime profits for the producer of around £100bn:

Taken together, it is difficult to imagine this project as anything other than an expensive burden for consumers: with government support from the UK and France, the project is more likely to be financed at lower discount rates. Alternatives, given the falling costs of wind and solar technologies, would be less of a burden on the consumer. If these predictions are even approximately right, other renewables will continue to fall in price but consumers will be locked into a 35-year contract for difference at £92.50/MWh plus inflation.

The tragedy here is that HM Treasury have failed to publish their cost-benefit analyses and justify their use of such high discount rates and pessimistic assumption regarding other technology costs. If they had, the project would have had greater public scrutiny. Instead, the estimated costs to consumers, and returns to investors, remain shrouded in unnecessary secrecy****.

Calculations are available here.

*  For these estimates, the project is assumed to have a 35-year lifetime and steady cash flows, hence the discounting formula used is PV=C*1/r(1-1/(1+r)^n). For decommissioning, the discount formula is C/(1+r)^n).   

** Compared with Taishan NPP (China), Flamanville (France) and Olkiluoto (Finland), Hinkley Point C is the most expensive.  

*** Estimated as 43% of the costs to decommission Magnox reactors (p.14). Hinkley Point C will generate 3200MWh, compared with 7405MWh for the ten Magnox reactors. Because of the effects of discounting over 35 years, the decommissioning costs are relatively low, from £0.1bn (best case) to £5.7bn (worst case). The best and worst case scenario are based on the range used by the NDA (p. 12) using the discount rates above. 

**** There is some good news, in that the European Commission adjusted the 'gain-share mechanism'. Rather than a 50-50 profit share if the project returned above 15%, the revised mechanism will see the UK taxpayer get 60 per cent of any profits above a 13.5% return. However, from the figures above, it appears this is above the project's expected return and the bulk of the profit goes to the producer. There are measures to claw back profits if the construction costs are lower that expected (p. 66), i.e.: EDF will bear the bulk of the construction risk.