You have no right whatever to speak on behalf of the Government. Foreign affairs are in the capable hands of Ernest Bevin . … a period of silence on your part would be welcome.”

Now imagine the Liberal Democrats win the 2010 election. For financial – or other – reasons the party leadership decide to defer or abolish our pledge to abolish tuition fees.

The head of the party’s Federal Policy Committee, unanimously backed by all members of that committee, writes to Nick Clegg to tell him he must not do that, and that FPC is the sovereign policy-making body. But we all know the reality: Clegg will mimic Attlee’s response to Laski.

People vote for MPs and not for parties, and it is MPs and not parties that have the authority of the popular mandate. That is the way that the British constitution works.

It may be that FPC defeats the leader over tuition fees, but, if it does, it is a pyrrhic victory that would disappear as soon as we gain power. More important than this particular skirmish, or this particular issue, is the underlying incompatibility of our party and our country’s constitutions.

If we are serious about being a party of power, isn’t it time that we came up with a way in which party members can have a say in developing policy and the like, that works with the way the British constitution works, not against it?

* Tim Leunig teaches at the London School of Economics and is an occasional contributor to Lib Dem Voice.

The first prediction was right, in spades – I will write again in 5 and 10 years time about the second.

The prediction provoked a short but high quality exchange in the comment column. Not everyone agreed: Nick Rouse wrote of a “primitive economist’s models that bear no resemblance to reality” while in May, Mary Matthews wrote that “Boy, did you get it so wrong”, before adding “Economists cannot predict the future and trying is a waste of time.” (NB: I respect the fact that neither of you hid behind Anonymous in your commenting).

Economists’ predictions will always have large error bounds because we are trying to predict the aggregate results of individuals’ idiosyncratic decisions. But oil producers and users need to think about likely price trends when making investment decisions. Forecasting is necessary.

Predicting that a price will fall when it is more expensive than usual, and demand and supply are elastic, is likely to be right. As petrol prices rose in the forecourts, people cut back. The number of miles driven fell a little, sales of fuel inefficient cars fell (particularly in the US, where the price rise was highest in percentage terms), and people slowed down on the motorway, quite dramatically. In addition, the prospect of getting more than $100 a barrel for stuff that had been worth much less only a year before led oil producing nations to increase supply.

Demand fell, supply rose, and today Bloomberg report that West Texas Intermediate is $48.58 and Brent is $49.23. These are lower than long term prices, since at these levels deep water exploration, and Canadian and Venezualan oil shales will not be profitable. But oil prices may not rise this year, for three reasons.

First, stocks are high. Last year stocks were low, so bad news led to spikes in prices, as people worried that we would run out of oil (which Nashville did, by the way). This time we could get some short term very low prices, if oil needs to be moved and storage is not easy to come by. Oil is expensive to store, particularly on ships.

Second, demand is low. People remember how much high oil prices hurt, and may well continue to buy cars that do not expose themselves to that risk, even though prices have fallen. And there is a recession in many places.

Third, populist regimes such as Iran and Venezuela need oil revenues. When the price falls, they may be tempted to increase output to try to make up for the lower revenues per barrel. Otherwise they risk losing political support. That in turn, however, will lower the global price.

The prediction: the oil price will not reach even half its 2008 peak in 2009.

* Tim Leunig teaches at the London School of Economics and is an occasional contributor to Lib Dem Voice.

What are the benefits of going to university?

Going to university is profitable for individuals, on average, and for any given A-level grades. Although a handful of degrees (e.g. medicine) are particularly profitable, once you take into account A-level grades, most subjects are equally valuable (classicists earn more than media studs grads because classicists generally have better A-level grades).

Second, the “profitability” of going to university remains even as graduate numbers have increased. This tells us that demand for graduates is elastic: if you create more of them, employers will hire them on graduate salaries, and the country becomes richer.

Third, post-1945 technology has been “skill-biased”: its use has been greatest in countries with high skill levels and the biggest beneficiaries have been those with highest skills.

This suggests that the optimal number going to university will continue to increase, both at undergraduate and MSc levels. 80% of people whose parents went to university go to university themselves, and it is possible that the optimal proportion of the population for university is as high as 80%. It is certainly much higher than today’s levels, which are low by world standards. We need a policy that stacks up for more people going to university.

Given skill-biased technology change, increasing university education reduces income inequality, since otherwise demand for graduates will outstrip supply, causing pay rates for already well-off graduates to rise. Increasing university numbers will increase national income, and reduce income inequality.

Fees do not deter

As Julian said, entry to university is almost background-blind. Those with good A-level grades from top, middle and bottom are almost equally likely to go to university. The current fee structure is not deterring anyone from going to university, even though lots of people claim it would have deterred them and will deter others.

There are very few kids from poor backgrounds at university because schools are managing to overcome the educational effect of poverty (poverty itself, low aspirations, poorly educated parents, lack of role models).

If we believe that no-one should be enslaved by poverty, ignorance and conformity, it follows that addressing schools’ failures to overcome social background is a or even the pressing concern.

Furthermore, in that fees do not put kids from poor backgrounds off going to univ, and given that those going to univ are disproportionately affluent, moving money from this group to fund the pupil premium is both liberal and progressive.

Finally, the only way we can increase the numbers going to university, is if our schools prepare more university-ready students. That does mean a big step change in school results, which will cost big money, but has the potential to break the intergenerational poverty cycle.

Local universities

As Paul Holmes says, poorer students often choose to stay at home and study locally. The obvious solution to this would be lower accommodation prices (for which house-building is the best solution so that rents fall).

That said, part-time students, those who are married, have kids in school, etc, will want to go to a local university, and we should celebrate “mainstream universities” who cater primarily for such groups. Going to a local university is not necessarily a sign that the system has failed.

Graduate degrees

We need to think seriously about graduate level courses. Many students pay LSE £10-£15k for a one year MSc (plus London living costs) because those courses enhance their earnings. Since we recruit by word of mouth to a large extent, they must be right! Yet the British government funds virtually no MSc students. (Hence LSE has lots of British undergraduates, and few British MScs). Both our party and the government needs to think about how we are going to fund 10%, 20%, 30% of people through a graduate degree.

University funding levels

British universities are dramatically underfunded. It doesn’t affect LSE that much, because we have non-EU undergrads and postgrads to cross-subsidise EU undergrads. Providing one textbook for every nine students (have you seen the price of law textbooks?), videoing lectures, paying copyright fees to scan readings and put them on line, keeping class sizes down, providing specialist software, and yes, paying faculty who are actually good enough at their subjects to teach them at university level is expensive. The debate nationally about raising fees is in the context of that debate. If the govt decides to double fees it will be because they know that universities that don’t have as many foreign students as we do cannot provide a decent university education on their current budgets. What is the Liberal Democrat answer to this? Saying that we can sort-of afford to abolish the current loans for the current students does not mean we can afford to abolish loans to fund universities at sensible levels, for sensible numbers of students.

Getting the long term picture right

In its panic and determination to “do something now” government must not forget its role in securing the long-term underpinnings of the economy. There are three areas in which Britain has serious problems.

Our education system fails individual citizens and the country, whose only decent long-term future is to have a very highly skilled workforce. There is little correlation between parental income and intelligence at age 3, 80% of people whose parents went to university go to university, and going to university is the best thing you can do financially. It seems likely therefore that the long-term outcome is for 80% of people to go to university whatever their background, and perhaps half the population to do a graduate degree. We need expand universities and more importantly give kids from poorer backgrounds a decent education so that they can go to university. Failure to do so will increase income inequality: high skill employers will raise wages to compete for the limited number of people with degrees, while low skill employers will offer low wages, as the number of unskilled people competing for those jobs will be very large. Getting education right makes us richer, and more equal.

Britain’s infrastructure is creaking, particularly in the southeast. Our motorways are clogged, our most important airport is full, and twice out of the last three times that I have tried to get on the tube at Holborn station the station has been closed completely owing to overcrowding. We need to invest more, particularly in congested areas, otherwise internationally footloose businesses will move elsewhere and we will end up a second-rate economy.

Finally, and not withstanding recent falls in house prices, housing is too expensive. Millions growing up in Britain cannot expect to buy or rent without government benefits. Few people aspire to live on benefits, and when life on benefits is inevitable no matter how hard you work at school is it any wonder that so many young people feel so alienated? We must reform housing supply so that house prices do not rebound dramatically after current falls. Housing needs to be once more for the many and not the few. That would ensure that a much higher proportion of people, whatever their natural ability or educational attainment are able to choose a place to live of their own, and to live in it without involvement from the state. As liberals that should be a priority.

Tax policy

The rapid deterioration in the fiscal position should worry us all. The British tax system is much more pro-cyclical than people previously thought, so that tax revenues fall dramatically even when the downturn is relatively small. (Remember, the economy has only just started to decline, so the fall in tax revenue so far is massively disproportionate to the decline in the real economy).

The government’s previous fiscal rules did not work, and we need to develop some better ones. The first thing to do would be to look at the cyclicality of the tax system, piece by piece. It does not ultimately matter how cyclical the tax system is, so long as we know how cyclical it is. The more cyclical the tax system, the more important it is to run a (massive) fiscal surplus in boom years that can then be used when the economy turns down. In general, there seems to be some correlation between the most progressive elements of the taxation system and the extent to which the tax system is procyclical. Those of us who believe strongly in progressive taxation should therefore be calling for much greater fiscal surpluses in good years.

Interest rates and the Bank of England

The Bank of England’s monetary policy committee has done well. They did not rush to cut interest rates when inflation still looked to be a real threat (don’t forget that this summer saw the highest level of inflation for a decade). But as soon as there was a serious prospect of deflation they cut interest rates dramatically, and have made it very clear that they would do so again.

The bank has been given a job to do: keep inflation on track. Exogenous events, such as the huge oil price rise, mean that inflation cannot be held perfectly on track. But the Bank of England has done as well as anyone could expect. Calls to change the Bank of England’s mandate as soon as we don’t like a particular decision are at best foolish.

Anybody who has read the recent Bank of England minutes will know that the Bank cut interest rates to 3% because that is what they thought was needed to keep inflation at 2%. They did not do it to refloat the economy. The fact that deflation rather than inflation is now the threat shows us that stagflation is not an issue: we are not back in the 1970s. Were inflation to be a threat the Bank of England would be raising interest rates rather than cutting them (and would be right to do so). That inflation is not a threat, and that we have not entered the wage price spiral is a demonstration of just how successful Bank of England independence has been, and demonstrates more generally that inflationary expectations are fairly low, and that workers are sensible enough not to demand high wage rises when doing so would simply lead to unemployment. The contrast with the 1970s is very apparent, and must make it less likely that unemployment will surge in a way that it did in the late 1970s and early 1980s.

Fiscal policy

Much has been written about the need for a fiscal boost. The debate has been poor, with politicians and the media muddling up underfunded tax cuts, tax cuts funded by spending cuts, and tax cuts funded by rises in other taxes. The last two have no impact in this context, and will not be considered.

Underfunded tax cuts, or unfunded spending rises, are not what Britain needs at the moment, for three reasons. First, the British government has spent the last 10 years spending as though there were no tomorrow. Tomorrow has now arrived and the kitty is bare. We have one of the world’s highest structural deficits. There is talk of the deficit rising by more than £200 billion over the next couple of years. You would have to more than double income-tax to pay that off. Even if you wanted to pay it off over 10 years it would require a huge rise in taxes. Or we could never pay it off, and pay £10bn+ a year in extra interest payments, for ever. But £10bn is not trivial – if we had done the same in the last downturn, which £10bn of recent public expenditure would you be happy to see disappear to pay higher interest payments? Or do you prefer £10bn in extra taxes? If we were Australia or Canada, who have big surpluses, then we could think about a fiscal stimulus. But thanks to the least prudent chancellor since Anthony Barber, we do not have that option.

Second, a fiscal boost may not be needed. Interest rates have already fallen dramatically, putting a lot of money into the pockets of people with mortgages. Someone with a £200,000 tracker or variable rate mortgage is currently £4000 a year better off. At least some of that money will be spent, keeping the economy afloat. In addition, the pound has fallen dramatically helping every firm that exports, or which competes with imports. Foreign students applications to British universities have increased noticeably this autumn. Lower interest rates and a lower value of sterling will both helped refloat the economy and may be sufficient of themselves.

Third, a fiscal boost may actually be harmful. The Bank of England have been explicit that underfunded tax cuts without a credible repayment plan are inflationary, and make it less likely that they will cut interest rates in the future. Underfunded tax cuts mean higher interest rates.

Of course, automatic stabilisers (lower tax revenues as the economy declines, and higher spending on items such as welfare payments) should be allowed.

Bank lending

It is important not to resume borrowing levels of two years ago. Indeed, we can calculate the optimal level of mortgage lending. Net lending should equal the value of new houses built, minus deposits on those houses, plus the same for houses bought by newly-formed households, and those moving to larger houses, minus regular capital repayments on the existing mortgage stock. Housebuilding rates are low and the deposits are high (sensible from the bank’s point of view, in the context of falling prices), so net mortgage lending should be low.

MoneySupermarket.com reports first-time buyer five year fixes at 6.6%, 2 year remortgage fixes at 4.5%, and the usual standard variable rate is 5.5%. The mortgage market is working pretty well.

What is not working is interbank lending. On any given day some banks have spare money, and others are short. Banks can lend to and borrow from the Bank of England, but it pays little interest and demands good security. So instead they borrow and lend among themselves, at the “London interbank rate”. This is usually slightly higher than Bank rate, reflecting a higher level of risk. At the moment it is much higher, and the reasons that this are not well understood. We need to work out why this rate is so high.

It is not the market rate, being set each day by six people meeting together. The solution may be a proper market in which supply and demand interact to clear, minute by minute, day by day, rather like stock markets, and in which each bank borrows at a rate that reflects other bankers’ perception of the riskiness of their bank.

Interbank lending is needed for business lending to resume properly. Clearly banks should be cautious about lending in a downturn, but banks are not lending where it would be profitable. This has potentially serious problems for the wider economy, since cash flow problems can force good businesses to go bankrupt, and lack of finance prevents innovative firms from investing and expanding. Governments may need to push banks, or supplement them on a temporary basis. If they do that the loans should later be sold on to banks.

For example, the Bank of England could make loans related to base rate, but with the proviso that when the London interbank rate returns to a more normal margin over the bank rate the loan becomes a normal one based on the London interbank rate, and which would then be sold to a private bank.

Bank bailouts

The economic downturn was precipitated by financial problems. This is a sign of a successful financial sector: they are there to bear risks other people do not want to bear, and are correspondingly prone to crises from time to time. Since the underlying rationale of a bank is to borrow short and lend long, the threat of bank runs will always be with us.

Banks in Britain needed government assistance to distinctive reasons. Some banks, such as Northern Rock, lent imprudently. Their shareholders should receive nothing. This will encourage shareholders in other firms to monitor management more closely, and will reduce the bill to taxpayers. The government should close down Northern Rock as quickly as possible: Britain has lots of banks and losing one that behaved so badly would be a good thing. Better monitoring of management by shareholders, or better regulation, should prevent another North Rock.

Other banks had liquidity problems caused by relying on interbank lending rather than retail deposits. These banks made sensible loans, and both management and shareholders can consider themselves unlucky. But luck is part of business and if you don’t want to take the risk don’t buy shares. Only government was large enough to underwrite these banks’ refinancing and rightly drove a hard bargain. These banks should and will survive, and taxpayers are likely to get a reasonable return for their investment: the underlying loan portfolio is good.

In essence, bank “bail out” policies were successful: no retail depositor lost their money, runs on banks were stopped pretty quickly, and a 12% return for taxpayers on preference shares looks like a pretty good deal.

The only blot on the government’s copybook is suspending competition law to allow Lloyds and Halifax Bank of Scotland to merge. When banks are too big to fail they can take gambles without worrying about the consequences. This merger should be stopped, and undone later if it is not stopped now.

This lecture is the sort of thing that Chancellors and members of the monetary policy get to give, not opposition politicians. It says something of the respect with which Vince is held by serious economists that he was invited to deliver it. And did he deliver. This was a serious speech, by a serious economist, for serious economists. If that’s you, read it in full.

For most people it was a speech about bubbles, going back to the Tulip mania in the 1630s, and talking about our recent housing market. Vince has – to his credit – been worried about this since 2003. His proposals were:
1) The Bank of England’s mandate should include asset as well as general prices (using the Swedish model, and as advocated by former MPC member Sushil Wadhwani);
2) Bank capital adequacy rules should be tightened in booms, to stop banks getting carried away;
3) The creation of a counter-cyclical national land value tax;
4) That banks should offer those with mortgage arrears shared ownership;
5) That government should allow social housing agencies to borrow to buy 150,000 properties a year at wholesale prices from desperate building firms;
6) That we need more credible (read, more restrictive) fiscal rules; and
7) That we need more liberalisation in energy and food markets – both of which have seen big price rises recently, unlike more liberalised sectors.

The press release, powerpoint slides and full speech are here.

Let me quote him precisely: “the UK is enjoying the benefit of currency flexibility and the devaluation of the pound against the Euro is giving a stimulus to manufacturing.” Doesn’t sound like someone who wants to join the single currency, does it? He acknowledges that things may change, but he doesn’t exactly go out of his way to make it sound likely: “conditions may well change to make membership of the Euro the right option for Britain and in these circumstances the LibDems would make that case, subject to a referendum”.

I think that this is essentially the Labour Party’s position: the Euro is not the right option now, but if it becomes so, then we will support it. I guess that, for better or worse, we will not enter the next election promising a referendum on the Euro. Indeed, this speech raises the possibility that we will pledge to keep the pound for the next parliament.

Here are some of the proposals.

The good

1. The depositor protection system doesn’t work – as the Northern Rock queues show. It needs reforming – although Nick didn’t say how.

2. Bank charges should be transparent. Yes! But what about government charges? Prescription costs are far higher than the medicine cost in almost all cases…

3. Make it harder for banks to repossess houses.

4. Return the capital gains tax system to how it was in 1997, before Labour messed it up.

5. Non-doms limited to 7 years, before being taxed like the rest of us, just as in pretty much every other country.

6. All market participants to reveal positions, making it easier for the market to understand who it doing what – and particularly, who is shorting the market.

The bad

1. “There are minimal benefits to provincial Britain of this growing concentration of economic activity in London”. This is not true: as Nick acknowledges, almost a quarter of income tax revenues (with similar proportions for some other taxes) come from City of London employees. Put simply, many of Middlesbrough’s schools are paid for by London bankers.

2. “There is a strong case too for disconnecting retail banks and investment banks as occurred in the USA”. This is bizarre as the US banking system is in trouble, and because the only UK bank to need bailing out (Northern Rock) was a retail only bank.

3. Including “asset prices, and specifically house prices” in the definition of inflation. It would be very odd to include share prices in inflation – M&S recovery share price rise was not inflation. Including house prices is problematic for two reasons. First, £100,000 at 5% is smaller than £100,000 at 10%, so including the price without consideration of the rate gives a distorted picture. Second, if we done this since 1997, then interest rates would have been higher to cool the housing market. Higher interest rates (and remember ours are already higher on average than in the US, Europe and Japan) reduces investment, raises the value of the pound, cuts exports, and increases unemployment. Still convinced that you want to include house prices in the measure of inflation? Thought not. We should sort the housing market properly, not by some financial quick-fix.

The ineffective

1. Nick think that governments routinely bail out banks. Only one (Northern Rock) has been bailed out, and even there government exposure is limited. In all other cases banks in trouble do exactly what Nick wants them to do: hold a (discounted) rights issue. Shareholders are forced to bail out the bank. That is what they are for – taking profits in good times, and losing out in bad. The Royal Bank of Scotland asked shareholders for £12bn, while Halifax Bank of Scotland requested £4bn. The current system is pretty close to working as it should do.

2. Nick wants counter cyclical capital adequacy rules so that banks hold more capital in booms and less in slumps. There have been lots of calls for this recently, but it may be unnecessary if banks successfully hold rights issues when they need more capital.

3. Nick expressed concern that the City has few spillovers into poor neighbouring Boroughs, such as Tower Hamlets, but offered no policies to change this. In reality, the best way to tackle this is my raising education standards and expectations in underperforming areas – as our pupil premium is designed to do.

4. Shareholders to approve executive pay. Either this will be ineffective, or if it cuts pay it will lead to more private equity, which has no shareholders.

5. Greater provision of generic financial advice. The person taking out too much debt is unlikely to discuss finance with a well-meaning person first.

6. “Newly emerging financial participants – whether it be in Hedge Funds or Private Equity – need to demonstrate that they accept the responsibilities which go with their growing influence” – what does that mean in practice?

Overall a good speech, with real substance worth discussing.

The concept of pupil premium is was widely supported in the education session. I asked the obvious question: How large must the pupil premium be for the child of Somalian immigrants in Lambeth, compared with a child who is white, living in an affluent suburban area, and with well-educated parents, if we want both to have an equal chance of doing well at school?

No one at the conference knew: because we have never had a pupil premium in Britain we cannot know the answer. But there is some evidence from the United States, contained in Woessmann and Peterson Schools and the Equal Opportunity Policy.

In this book is the authors ask a different but related question: if we hold educational spending for whites constant, how much do we need to spend on the education of blacks for them to have equal educational outcomes? It turns out that the number is very large: spending on black pupils needs to be nine times as high as that on whites.

What does this mean for Liberal Democrats? If we imagine that one in three children received some element of the pupil premium, ranging evenly from almost nothing to nine times the baseline level of funding, then the policy would more than double expenditure on education, and would cost approximately £90 billion.

Of course the final figure could be less. Perhaps the correct figure for Britain will not prove to be nine times, perhaps it will only prove to be four times. Perhaps it will not need to go to one in three students, perhaps only to one in five. But even then the pupil premium would require £24 billion. Whatever the final figure, and we cannot find that out until we try it, it is clear that the £2.5 billion the party says that it will allocate to a pupil premium should be considered a down payment on a work in progress, not a policy completed.

This is not to criticise the party: it has done well to find £2.5 billion has a down payment. Nor should we underestimate the amount of money that a government can find over time. In the first 10 years of the Labour government, government spending rose by more than £140 billion in real terms. A government committed to better educating those who currently do badly in schools could certainly find £24 billion in normal economic circumstances over the duration of one parliament, provided that they made it an absolute priority.

It is worth asking whether such a policy would pass cost benefit analysis. The evidence from America, sadly, is no. In narrow economic terms, taking into account only the additional wages earned, and the greater cost of education, is that spending nine times as much on the education of blacks as whites would yield an investment return of just 1.2%. We could no doubt had a little for reductions in crime obesity and other social ills associated with poor education and resulting poverty. But it would be naive to say that such a policy will pay for itself over the long term.

Of course, there is more to life and economic and investment returns. Liberal Democrats believe that no one should be enslaved by poverty, ignorance or conformity. It says so on our party membership cards. But I think we also believe, well, most of us at least, that people should not be enslaved by the accident of their birth. To that end I think the pupil premium is a right and proper policy for the Liberal Democrats, even if the return is lower than the cost of capital. The challenge for the party is to find a proper sum of money to fund this policy: there is no doubt that we can transform the lives of millions of young people in Britain. But it will take real money to achieve that goal.

">Tim Leunig is a lecturer at the London School of Economics, and writes a regular column on economics for Liberal Democrat Voice.

There was considerable criticism that Nick said little about his approach to the economy during the leadership election. It is clear from his speech today that there is little if anything that separates Nick Clegg’s view of the economy from that of Vince Cable. Some passages – such as on debt – were pure Vince, while others, such as those on trade, showed Nick’s history in this area.

Thus Nick told his audience that “I am economic, as well as a social, liberal”, before going on to add that “I am a proud inheritor of the British liberal tradition that has stood up, through the centuries, for free trade, and against protectionism”. He went on to state how Liberal Democrats supported entrepreneurialism, economic growth, competitive markets and globalisation, albeit with internationalist politics to regulate the effects.

This was a much stronger and more unambiguous statement than many of us had expected. The phrase “I am an economic liberal” is not one which everyone in the party is happy to subscribe. Nick must have known what he was doing when he said it and by saying it in his very first speech he set the tenor what is likely to be his long leadership of the party.

He went on to talk with pride about the roles that he had played in developing economic policy earlier in his career. He talked about his role as an international trade negotiator leading the European Union team on China and Russia’s accession to the world trade organisation. He talked about being trade and industry spokesman in the European Parliament pushing through single market liberalising legislation in record time. He talked the opening telephone markets across Europe to competition and liberalising European energy markets.

He pledged that the Liberal Democrats will be “a party committed to economic liberalism, internationalism, to fair taxes, and to competitive, fair markets.” This is a vision to which your correspondent is happy to subscribe, it will be interesting to see what reaction it provokes within the party.

Tim Leunig teaches at the LSE and writes an economics column for LibDemVoice. This is the first of a series looking at the wide-ranging speech that Nick gave yesterday.

January is the time for predictions. Every year economists make them. Sometimes we are right, and sometimes wrong. Some predictions, like inflation, are easy, but others are not. The oil price is not.

For fifty years, 1921-71, the oil price was fairly stable at c. $20 a barrel (in today’s terms). That was surprising: the price yo-yoed in the mid-nineteenth century and was fairly volatile 1880-1921. But neither the booming 20s nor the great depression, a world war, nor a post-war boom seemed to affect oil prices at all. Oil prices were one thing you just did not have to worry about.

That changed in the 1970s. Oil rose first to $50, and then to $100 in today’s terms. The effects were huge and many policy makers handled it badly. By the 1990s oil seemed to settle down again, with prices remaining around $20 in the mid-90s, rising to the mid-$20s as the century ended. And then, from 2002 we have 5 years of relentless rises to reach $100 again.

So the question is, will it continue? And why aren’t we suffering as we did in the 1970s? The first question requires a prediction, the second an explanation.

My prediction is that oil prices will not end 2008 materially higher than they are today, and that they will be at least a third lower in 5-10 years. The second prediction is the stronger. Oil prices at today’s level are unsustainable because there is plenty of non-OPEC oil in the world that is highly profitable to extract at $100 to the barrel – indeed, there is plenty that is profitable to extract at $50 to the barrel. Canada has the second highest oil reserves after Saudi Arabia, but Canadian oil is in oil shale, which costs $40 a barrel to extract. For years Saudi Arabia made good money extracting oil for a $1 and selling it at $20; if the oil price were $60 then Canada could make similar money. The fact that Canada can produce oil profitably at $50-60 makes it hard for oil to stay above $60 in the medium term. If we know that oil prices will be lower in 2013-2018 than they are today, the question is, when will they turn?

That one is harder. But there are three reasons to think that the turning point will be soon. First, the global economy is softer, and the strength of demand pressures has been one of the biggest causes of rising oil prices. Second, the current US administration will become increasingly powerless as the year goes on, and will be replaced by a less militaristic one in November. That will reduce fears about Middle-Eastern security, and also about Venezuela. Brown appears less militaristic than Blair, and Sarkozy’s approach to Russia shows that he is keen on energy flowing. China will not destabilise an oil country. The big risk, as ever, is that Saudi Arabia, or another major Middle-Eastern oil producer could fall victim to terrorist attacks, either in the oil fields, or at national level. But it is not a large risk.

So why are Western economies not suffering from the $100 barrel? There are two reasons. First, the energy intensity of the economy has fallen dramatically. British output per head doubled between 1970 and 2001, but our energy use per head rose only 6%. Broadly speaking we halved the economy’s energy intensity, so that an oil price shock hits us only half as hard as it once did. Oil would need to hit $200 a barrel to have the same effect now as $100 did in the 1970s. That is very unlikely. Second, the original price spikes came when OPEC turned the taps off, and decided to auction the oil they had. This price spike comes primarily because of high demand, mainly from China. But high Chinese oil demand stems from China growing quickly, and that reduces inflationary pressures, since cheap Chinese goods are replacing more expensive goods produced elsewhere. The lack of oil-led inflation means that central banks have not had to increase interest rates and that we have avoided recession. Indeed, all the talk is of interest rates coming down, not going up. Interest rates coming down below 5% with oil at 1970s levels, and without an inflationary boom? We live in a different world to that which Antony Barber and Denis Healey had to deal with. And three cheers for that!

Dr Tim Leunig teaches at the London School of Economics. His predictions, along with those of other economists, can be found here.

But let’s be clear here. Ming has made Vince our Shadow Chancellor. David Cameron has not appointed John to any position in his cabinet.

Do we really think that the Tories want to see John Redwood on television more often, treated with the respect that he thinks he warrants?