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notes_on_real_life

A Crowded Island?

Can we fit 71 million people in?

Believe the latest population projections, and we had better start preparing ourselves. On realistic assumptions, that's the population we can expect the UK to have by 2031.

Indeed, the official figures go much higher. We'll apparently be up to 84 million by 2081.

Can we take it?

My suspicion is that we can. Most people hugely underestimate the amount of "empty space" we have in our country. Fly over the UK, and you see that human settlement does not fill up the UK at all. It accounts for something of the order of 15 per cent of the landmass.

So physically, we could probably fit another ten million people in - or 16 per cent of the population - without toppling into the sea.

As it is, the UK is not the world's most crowded country. Belgium, Japan and the Netherlands are more densely populated than we are, and would remain so even if we had anther ten million people.

Indeed, if the UK had the population density of the Netherlands, it could accommodate 90 million people. And believe it or not, if the UK had the population density of the quaint island of Jersey, we would actually accommodate another 120 million people on top of the 61 million we already have.

So, yes, I suspect we could accommodate another ten million people.

But that does not mean we would want to.

The British quite reasonably like empty land, and may prefer to keep it empty rather than turn it into a country like the Netherlands.

And anyway, the population growth now being projected will not fill the empty bits of the UK (the Highlands and Islands which could arguably do with more people). It will fill yet more of the same places that are already among the world's most densely populated areas. England's population is projected to grow far faster than Scotland's.

Making that worse, the projected speed of population increase is very rapid. In the next ten years, we will grow as much as we have in the last thirty years, and will in effect absorb the equivalent of the population of Ireland.

And in twenty-five years time, we will have added the population of Belgium to the UK.

This can be done, but it won't be done very comfortably by simply squeezing more and more people into the existing infrastructure of houses, roads, shops, GP surgeries and schools. Nothing will make the country feel more crowded than an unmanaged surge in population without proper account being taken of water, energy and food security, and new infrastructure.

In short, if we are going to accommodate the population now being projected, we had better start spending some money, and building.

But before we do that though, it is worth asking how seriously we should take the projections now being made. Before we let people get too alarmed about this talk of 70 or 80 million people, and before we entice investors to buy property now, in anticpation of higher house prices as the population grows, there are a few things to bear in mind.

First, as the statisticians like to remind us, the figures published today are projections not predictions. Projections do not profess to tell us what will happen, just what would happen under various assumptions.

Secondly, the assumptions get more and more ridiculous the longer you extrapolate them. So, while it is reasonable to assume the UK population will grow 0.6 per cent a year for the next ten years, or even for the next twenty-five years, it is absurd to carry on projecting that indefinitely. (If you do, you can project the UK population reaching a billion by 2464. It's all a bit silly.)

And thirdly, the projections can be very wrong even on shorter time frames. In the 1960s, demographers thought the baby boom would be a permanent feature of life, not a temporary one. So they predicted there would be 75 million Britons by 2000. It didn't happen that way. The baby boom was just that - a boom.

You might even remember the fabulous film, , made in 1973, which depicted New York in 2022. It was so overpopulated that Charlton Heston had to step over the sleeping bodies occupying the staircase of his apartment block. There was not enough food so people had to eat Soylent Green. I won't spoil the end suffice to say it was a great film undermined by poor demographic projections.

Today's projections suffer all the problems of previous ones. In particular these ones are dependent on one assumption about migration, and annoyingly that assumption is both the most important and the least reliable.

Migration accounts for 70 per cent of the projected population growth over the next few decades (taking into account the direct inflow of people, and also the indirect fact that migrants are often of child-bearing age, so push up the number of births.)

This all means the overall projections are only as good as the assumption that net inward migration will continue at 190,000 a year, or roughly last year's level.

That might come to pass - it might be too conservative. But equally, we maybe experiencing a temporary inward wave that will soon fall back.

Or most likely of all, it may be that confronted with the prospect of such rapid population growth and an unwillingness to pay what it takes to prepare for it, the government decides to take further action to stem the inward flow.

PS: A version of this article appeared on the main 大象传媒 News website yesterday.

notes_on_real_life

Do economists do good?

Radio 4 asked me this week to summarise the contributions of in 50 seconds. It wasn't easy.

Firstly, there isn't in fact, a Nobel Prize for economics; officially, this one is called the "Sverges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel". As it takes almost 50 seconds to say that on its own, most of us refer to it as the Nobel Prize for Economics.

2007 prize winners Leonid Hurwicz, Roger Myerson and Eric Maskin (L to R)

Secondly, the economics prize-winners never seem to make contributions that can be described simply.

This year, the Nobel notes (to be found ) cite practical examples of the three winners' work, in - for example - improving the design of insurance policies.

Big deal.

They haven't invented a cure for a disease, or brought peace to a region of the world. As usual in the Nobel season, the practical applications of the economics winners sound rather small compared to the others.

But contrary to the casual impression one might pick up, economics is useful. In the social sciences, intellectual breakthroughs are a big deal. They may not cure diseases, but they can cure muddled thinking. They may not bring peace, but they can bring clarity to regions of public and private policy.

And take this year's Nobel winners as an example. Their contribution is called mechanism design theory.

A mechanism is some kind of procedure for allocating things. Like an auction, or a vote, or a market. Society uses mechanisms to allocate things all the time - lotteries are a mechanism; dictators are another. We use some kind of mechanism for making every material decision. We use markets for allocating beans, and elections to decide on defence spending.

The issue is how to design these mechanisms to make them as efficient as possible.

This already sounds as though it is getting quite abstract.

But let me take a simple example of a mechanism. You want to divide a piece of cake between your two greedy sons, with as little fuss and argument as possible.

My mum faced this issue pretty frequently, and had a solution to the problem that was tried and tested around the world with parents through the generations. She let one of us divide the cake in two, and the other have first choice over which half of the cake to have.

This works far better than alternative mechanisms. For example, cutting the slices yourself inevitably leads to arguments about who gets the bigger slice.

Letting one son cut and choose would surely be an enticement to cut the slices unequally. You might ask him to cut them as fairly as possible, but how are you to know whether he is truly doing his best or not?

The "one-divides/other chooses" rule is perfect as it is - in economics jargon - "incentive compatible". The cutter has the perfect incentive to cut as well as possible. You don't need to ask him to do so, you know that he'll give exactly the right effort to cutting, because it is him that suffers when he doesn't.

Now, my Mum doesn't have a Nobel prize. And I suspect it was not economists who first devised the divide and choose rule.

But it raises some issues that come up all over the place in life, and which academic economics has gone long way to clarifying.

All over the place, there are issues in life where you want to ensure people reveal in their behaviour what they are really thinking; whether they are cutting the cake as equally as they can.

For example, how do you design an auction? It sounds simple, but in an efficient auction, you really want sellers and bidders not to play tactical games - you want them to make offers which honestly reflect their willingness to do a deal, not ones that try to second guess other people's bids.

Or, when you design a voting system, ideally, you want people's votes to tell us what they really feel about an issue. If I ask people whether they want 拢1bn more defence spending, I'd like them to tell me how much they value defence regardless of whether they think they personally will pay more tax as a result. Otherwise, the vote probably just reveals that people who don't think they'll be paying the tax, want a lot more defence.

If you are regulating the prices or profits of a monopoly utility, you'd like to know if it is as efficient as it could possibly be. But you don't know whether it is or not. And simply asking the utility is unlikely to give a very revealing answer.

In all these cases, it is possible to design mechanisms like Mum's divide and choose rule, that do their best to frame incentives for players to reveal their true thinking. And this year's economics prize-winners between them defined the problem, laid the foundations of the science, and did quite a lot of the building work on top of that foundation.

Probably the biggest value is in spotting the similarities between splitting a piece of cake and regulating a utility. Once some of the common features have been put into formal maths, the practical applications and understanding can follow.

None of those applications on their own sounds particularly grand, but taken together they amount to something. And there is no limit to the number of future issues which might be advanced using the same body of economics.

It may not sound like saving the planet, but the Nobel laureates can be reasonably satisfied their work is useful.

notes_on_real_life

Return to normality

Among the many highlights of the Pre-Budget Report will be an update of the government鈥檚 borrowing forecasts for the next few years.

Alas, the revisions to be made may not be in the most attractive direction. So far this financial year, government borrowing has deteriorated not improved. Tax revenues are coming in below expectations.

The missing money might come in later as the figures are always volatile and were very volatile last year. But it seems that corporation tax in particular is not as lucrative as the Treasury thought it would be.

As a result the government is set to borrow about 拢5 billion this year, on its 鈥淕olden Rule鈥 measure of borrowing ie the amount it borrows in excess of the amount it invests in long term capital projects.

The economy has hitherto been strong not weak, so there is no obvious explanation for the shortage of cash.

Now there鈥檚 no need to pour blame on to the Treasury for getting it wrong this year. They are only one or 2% adrift on their revenue forecasts, and it鈥檚 hard to predict tax revenues more precisely than that at the best of times. And they may still turn out to be right 鈥 we鈥檙e not even halfway through the year.

But it does have to be said that in recent history the government鈥檚 forecasts have usually turned out to be too optimistic. And there鈥檚 quite a bit of history to this which is worth re-visiting now, as we see the borrowing problem remain as stubborn as it is.

Before the 2005 election, the government was that it was being too optimistic in its revenue forecasts; not just by oddballs and opponents but by the consensus of credible expert opinion.

Indeed, in January 2005, the Institute for Fiscal Studies (the most respected independent analysts of the public finances) published projections showing that unless the government changed policy by raising taxes or cutting spending, it would be borrowing 拢10 billion this year (on the Golden Rule measure).

Two months later, Gordon Brown published projections showing a surplus of 拢4 billion for this year. In other words, there was a 拢14 billion gap between the chancellor and the IFS.

Since those projections were made in 2005 there have been four Budgets or pre-Budgets, which have between them announced tax rises raising 拢4 billion this year.

So, if we do end up borrowing 拢5 billion this year, the IFS will be seen to have been almost bang on back in 2005, while the chancellor was overly-optimistic by about 13 billion.

Ironically, at the time the Treasury said of its forecasts 鈥淭he use of cautious assumptions audited by the National Audit Office builds a safety margin into the public finance projections to guard against unexpected events鈥. This was seen as incredible at the time, and with hindsight people were right to have viewed the use of the word 鈥渃autious鈥 with scepticism.

However, a consequence of those overly optimistic Treasury forecasts was that inadequate action was taken to sort out the borrowing problem, and the borrowing has persisted.

Of course, deficits don鈥檛 always matter. Governments expect to run surpluses in the economically buoyant years and run deficits in the downturn years. Then the two average out over the cycle as a whole.

But we have been in deficit for the last six years and these do not feel like they have been sluggish. Observing strong corporate profits, the private equity boom, the way house prices have moved and consumer spending, it doesn鈥檛 feel as though we have been in years of famine with the feast about to start and with tax revenues now just starting to ready themselves to walk through the door of the exchequer.

If anything, with the credit crunch biting in the City it feels as though the boom is coming to an end and normality is about to return. That鈥檚 why forecasters universally think growth next year will be slower than this year.

If the economy is in for a few slower years, (and that is still a big 鈥渋f鈥) the new chancellor might wish his predecessor had sorted out the borrowing earlier on.

notes_on_real_life

A quick primer

For those caught short by the possibility of an imminent major financial statement (which could even be on Monday) here鈥檚 a quick guide as to what it is and what to look out for.

What is it?

This is a combination of two big parliamentary financial statements.

First, the Comprehensive Spending Review sets out spending plans for each department for the three years 2008/09, 2009/10 and 2010/11.

Second, the annual Pre-Budget Report (which is normally in late November) which sets out the government鈥檚 forecasts and projections for the economic growth, and for its own tax, spending and borrowing until 2012/13.

What do we already know about the statement?

We already know the spending totals for the next three years (they were set out in the Budget and should be confirmed in the CSR). What is new is the departmental allocation of those totals.

We also already do know a number of departmental budgets, most importantly:

• Education, which gets a real spending increase (i.e. above inflation) of 2.2% a year
• Home Office / MoJ combined which get 0.7% a year real cut
• Defence, which gets a 1.5% real increase each year

We also know that spending on the running costs (or administration) of Whitehall departments is set to be cut by an ambitious 5% a year for the three year spending review period.

What to look out for?

1. A possible downgrade of the government鈥檚 economic forecast for next year.

In the March Budget, the Treasury used a forecast of 2.5% growth for the UK economy next year. At the time, independent forecasters said it would be 2.3%. Now, independent forecasters say 2.1%.

Mr Darling should probably cut the forecast by at least a quarter point. He may choose not to 鈥 but would then look incautious in his assumption.

2. General spending restraint.

The total spending figures already set out tell us that spending will grow at 2% above inflation for the next three years. That compares with a rate of 3.2% over the last ten years. These figures will simply be confirmed 鈥 but lets not forget the overall story.

To put it at its simplest, for public spending, the party鈥檚 about to end. We鈥檙e in the last year of it.

Crucially, over the last ten years, public spending has grown faster than the rest of the economy. Over the next few years, it will grow more slowly than the rest of the economy.

This implies that the share of national income spent by government will slowly fall from about 42.6 % this year, to 42.1% in 2011.

It also implies that the chancellor鈥檚 plans 鈥渟hare the proceeds of growth鈥 using the Conservatives definition of that phrase.

3. The NHS is about to feel a squeeze.

Health is the most interesting department to await its spending settlement.

It will do far better than other departments in this tight spending environment 鈥 but it will still feel like dramatic retrenchment. Spending there has been growing at over 6.2% a year over the last ten years. It鈥檚 likely to be more like 3.5% now.

Also look out for the other departments though - , local government, , will all find out their fate.

4. The government鈥檚 is probably borrowing slightly more than they thought at the time of the Budget.

It has become something of a tradition for Gordon Brown to rattle through the borrowing figures in his Budgets and pre-Budgets. In fact, in every Budget and pre-Budget since 2001 with only one or two exceptions, Mr Brown has had to admit his borrowing is worse than he had previously thought.

We will have to see how fast Alastair Darling can read lists of numbers when he stands up. But he will probably at least have to follow his predecessor in confessing to higher than expected borrowing.

That鈥檚 because so far this financial year, the data indicates tax receipts are coming in below the forecasts in April (companies in particular are not paying as much as expected).

The most important measure of borrowing is the so called 鈥渃urrent balance鈥 or 鈥渃urrent budget鈥 which is the borrowing measure used for calculation of the Golden Rule. It is the amount of borrowing which is not used to cover investment spending, but is used to cover day to day spending. (I suppose one can say it is like the government鈥檚 credit card borrowing, rather than the mortgage to buy a house!)

At the moment, the government鈥檚 Golden Rule implies this measure should balance out over the economic cycle, so that any deficits are offset by surpluses. On the government鈥檚 assessment, we are just in the first year of a new economic cycle.

Back in the March Budget, Mr Brown expected to have a deficit of 拢4 billion this year, (a slight improvement on the 拢4.7 billion last year). However, this year鈥檚 borrowing figure might now have to be upgraded to five or six billion.

It is not ideal that we now enter a possible economic slowdown, with the current Budget in deficit. There has not been a surplus in the Golden Rule measure of borrowing for six years.

5. There will be something else as well. A rabbit out of a hat.

The Pre-Budget Report is not really an occasion to announce tax changes 鈥 that鈥檚 for the Budget.

But chancellors can do as they please, so don鈥檛 be surprised if there if some tax change is announced. Or indeed, if there is some other dramatic measure on the day. In fact, I鈥檒l re-phrase that. Be surprised if there is not some other dramatic measure on the day.

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