Paste your Google Webmaster Tools verification code here

Let’s join the IFS in acknowledging our misplaced fetishisation of economic data

Let’s join the IFS in acknowledging our misplaced fetishisation of economic data

Tomorrow, the Office for National Statistics (ONS) will publish its latest estimates on how much the UK economy grew between October and December 2017, compared to July to September.

Last month, the ONS thought that there was an increase of 0.5 per cent.

The economy cannot be put in a set of scales and measured. Total output, GDP, has to be estimated by the ONS. As more information comes in, the estimates change.

The numbers will be pored over, particularly in the context of Brexit. A revision down to 0.4, for example, would bring joy to Remainers.

A depressing feature of much of this kind of commentary is the lack of understanding it shows about the uncertainties which surround even the revised numbers. A revision of just 0.1 per cent tells us virtually nothing.

The United States is probably the world leader in economic data estimates. But the Bureau of Economic Affairs’ (BEA) view of growth rate of the economy in any given period can alter quite dramatically over time.

The financial crisis burst on the world in the autumn of 2008. Earlier that year in April, the initial estimate of the BEA was that the American economy had grown just 0.15 per cent in the January-March period over the previous three months. Pretty slow, equating to only 0.6 per cent if sustained over a whole year. But at least it was a positive number.

Now, the BEA believes that US GDP fell by nearly 0.7 per cent in that quarter, an annual rate of 2.7 per cent in fact.

In other words, America was already in a full-blown recession. If only policymakers had known.

This misplaced fetishisation of numbers is the subject of an intriguing article by Paul Johnson in the latest edition of the monthly magazine Prospect.

Johnson is the director of the highly respected Institute of Fiscal Studies (IFS), an outfit which lives and breathes economic and social statistics. But he has become concerned not only about how numbers have come to dominate policy debate, but about the illusion of knowledge which addiction to numbers has created.

His Prospect piece opens with the statement: “I trade in numbers and am passionate about them. But I have also learned to be very cautious in their company.” He offers guidelines to navigate the thicket of data which bombards us on a daily basis.

The first is to be aware of the limitations of statistics. An increase in crimes, for example, might be genuine, or it might just reflect an increase in the propensity to report a crime.

His second point is to take into account the broad picture, and not be seduced by the apparent precision and certainty conveyed by decimal places. GDP growth of around 0.5 per cent a quarter, for example, means that growth is sufficient to keep employment numbers up. It does not really matter whether it is 0.4, 0.5 or 0.6.

The limits to knowledge about economic and social systems is a constant theme of this column. The IFS is a very welcome convert to the cause.

As published in City AM Wednesday 21st February 2018

Image: Regulatory Documents via Max Pixel is licensed under CC by 0.0
Read More

Master the art of brinkmanship to run Brexit rings around Barnier

Master the art of brinkmanship to run Brexit rings around Barnier

Michel Barnier invokes a wide range of emotions this side of the Channel.

To his credit, the EU’s chief Brexit negotiator appears to have a stronger grasp of the insights of game theory than his UK counterparts.

Thomas Schelling, the polymath winner of the Nobel Prize in economics, advanced the science of game theory in many ways. Funded by the US security forces at the height of the Cold War, Schelling formalised the concept of credible threats.

How could America convince the Soviet Union that, if necessary, it would launch a nuclear strike? This would have been a highly irrational act, and game theory is meant to be played by entirely rational people.

One way to do this is by brinkmanship, defined by Schelling as “the tactic of deliberately letting the situation get somewhat out of hand, just because it being out of hand may be intolerable to the other party and force his accommodation”.

This seems to be exactly what Barnier is doing. His draft document published last week includes a so-called punishment clause that would allow Brussels to ground aircraft and block trade if the UK failed to obey EU rules during the transition period.

The counter ploy to such an irrational move – which would harm the EU as well as the UK – is not to cower and capitulate. It is to play brinkmanship yourself.

A threat to, say, drop a tactical nuclear device on Hamburg would not work. This would be unbelievable.

But we could threaten to walk out of the talks all together. Several European countries such as Poland appear to be seriously concerned about this prospect.

But we need back-up material for this to seem like a real threat; Barnier has to think that we would really do this.

Much of the doom and gloom from the Remain camp is all about short-term economic prospects if we leave. Our negotiating team should make it clear that in the longer run the UK would be better off outside the grip of the central planning mentality of the European Commission, even if there were transitional costs.

The Markets in Financial Instruments Directive II (Mifid II), designed to offer greater protection to investors, is a perfect illustration.

Introduced at the start of this year, and at least seven years in the making, Mifid already runs to several thousand pages of regulatory requirements. In this mindset, both bureaucracy and rules can eliminate risk.

But it is so complicated that it is virtually beyond the powers of a human to grasp. Certainly, experts like Phil Treleaven at University College London believe that it is riddled with contradictions.

We do not need the madness of Mifid II. The EU is frightened of an innovative, lightly taxed UK, which embraces, rather than resists, the rapid pace of change in the world economy.

If the government really believed this itself, we could play brinkmanship to our heart’s content and run rings round Barnier and his cronies.

As published in City AM Wednesday 14th February 2018

Image: Regulatory Documents via Max Pixel is licensed under CC by 0.0
Read More

How European commissioners really allocate EU funding

How European commissioners really allocate EU funding

“Pork barrel” has been a theme in American politics for almost as long as the United States has existed.

Many members of Congress work hard to secure public works projects, agricultural subsidies and the like for their own districts, almost regardless of the economic arguments for and against.

Surely the European commissioners would rise above such petty behaviour? After all, the European Union claims that they “represent the interests of the EU as a whole”.

It turns out that many of them have had their noses in the trough, both literally and metaphorically. A new scientific study shows that the agricultural commissioners have systematically over the years ensured that their own country receives more than its fair share of funding.

This cannot be dismissed as the product of some swivel-eyed Brexiteer. The findings are published in a paper in the latest issue of the American Economic Review (AER), probably the most prestigious academic economics journal in the world.

Kai Gehring of Zurich University and Stefan Schneider of Heidelberg find that “there is a significant positive relationship between the commissioners’ country of origin and the agricultural fund spending these countries receive during their terms in office”. Their highly sophisticated statistical analysis concludes that “this translates on average into about €850m per year for the country of origin of the respective commissioner”.

There are many anecdotes along the same lines. One which is very relevant in the light of the current Volkswagen emissions scandal is how, in 2007 and 2008, the German commissioner for enterprise and industry, Gunter Verheugen, repeatedly opposed a planned commission proposal to reduce new cars’ carbon dioxide emissions.

As Gehring and Schneider state, “his success in weakening the initial proposal was widely perceived as support for the German car industry”.

The current study is the first in-depth scientific analysis of the allocation of funds by the commissioners.

In economic terms, the Commission structure is a principal-agent one. The national government which makes the nomination is the principal, and the commissioner is the agent of the government. It would be surprising if their interests were not aligned to some extent, particularly since many commissioners want to return to political life in their own countries.

Tellingly, the authors note that they had to restrict their investigation to agriculture because “a lack of data and transparency” did not allow them to quantify the effects for the other directorates general. But it does not seem unreasonable to believe that they operate in a similar way to agriculture. The overall effect is to divert some €1.5bn a year to a few select countries, those which hold the big-spending portfolios.

The AER paper analyses almost three decades’ worth of data. So we might plausibly conclude that this has been going on ever since we joined the EU in 1973.

If we add back in the interest on the extra monies we have had to hand over as a result, even though the cost to us may be difficult to estimate, the study gives plenty of scope to come up with a big number.

As published in City AM Wednesday 7th February 2018

Image: EU Flags by Thijs ter Haar is licensed under CC by 2.0
Read More

There are economic lessons to learn from TfL’s hated bus announcement experiment

There are economic lessons to learn from TfL’s hated bus announcement experiment

The Transport for London (TfL) bus experiment has proved to be overwhelmingly unpopular.

Supposedly at every bus stop (but more usually once the bus has pulled away) a disembodied voice informs the passengers that the bus is about to move.

The hated announcement is being run as a trial for four weeks. TfL will then evaluate its effect on the number of accidents on the buses themselves.

A conflict between individual and collective welfare is exposed by the reactions to the experiment.

Collectively, we do not want it to continue, but individuals have little incentive to stop it in an effective way.

For example, public spirited individuals could fall down and claim that this was due to the motion of the bus. The statistics would then show an increase in accidents. Even the most obdurate bureaucracy would find it hard to persist with the experiment

The “victims” would bear costs as individuals, such as the time spent reporting it, plus the risk they might actually injure themselves. But they would create a benefit for everyone else. The voice on the buses would be switched off.

The concept of the winners compensating the losers has been a fundamental principle of economic theory for at least 100 years. It is important in public policy making, in the cost-benefit analysis which is carried out to decide whether a public infrastructure project should go ahead.

This is the rationale for the soon-to-be-abolished tolls on the Severn crossings, for example. The users benefit from a much-reduced travel time, but the non-users lose by having to pay taxes to build the bridge in the first place.

In general, the problem with implementing this in full is that the gainers are small in number relative to the losers. They tend to object vociferously to the charges levied on them, so that they rarely pay the full amount of their benefit to compensate everyone else.

With the bus scheme, the reverse is the case. Large numbers benefit from the ending of the scheme, and only the small number simulating an accident would lose.

But a public body such as TfL could hardly be expected to set up a scheme which would undermine its own experiment.

We might then ask why a market has not emerged to compensate those willing to simulate a fall. In a market, individuals could be paid the full costs they incur.

With social media, setting up such a market would be easy. But there would be two main problems.

The first is that of trust. How would participants be reassured that the relevant monies would be paid? The issue of institutional trust is a fundamental reason why markets are difficult to set up in many contexts.

There is also what economists call the free-rider problem. How many of those who dislike the voice would simply leave it to others to make the payment? There would be no coordination mechanism for ensuring that everyone paid.

Annoying though it may be, the bus experiment shows that even everyday issues often raise fundamental aspects of economic theory.

As published in City AM Wednesday 31th January 2018

Image: London Bus via Pixaby is licensed under CC by 0.0
Read More

Carillion shouldn’t be brought under state control, but maybe central banks should be

Carillion shouldn’t be brought under state control, but maybe central banks should be

A strong thread in the acres of print about the Carillion debacle is that the private sector should not really be involved in infrastructure projects. The public sector would, apparently, do it better.

Readers who experienced life under the nationalised rail and telephone systems might be forgiven their scepticism.

One idea which is taking hold is that the government can borrow more cheaply than any private company, so it must be more effective for the state to carry out major infrastructure projects.

The interest rates at which different outfits can borrow are plain for all to see. But they are just the tip of the iceberg. We need to look below the surface to see the real economic argument.

Philip Booth of the Institute of Economic Affairs set it out clearly at the weekend. People will lend money to the UK government more cheaply than to a company mainly because the risk of default is much lower. Indeed, the British state has not defaulted on its debts for well over 300 years.

But the risk of an individual project failing may be considerably higher. The huge overrun of costs on the Aberdeen bypass, for example, was one of the reasons for the demise of Carillion.

If this happens to a company, it can go under. The government simply passes the unforeseen costs onto the taxpayer.

The general rate at which the government can borrow does not reflect the true level of risk on a specific project. Ideally, the voters who ultimately pick up the tab would understand this, but in practice it is not spelt out to them. There is an information failure.

All this said, there is a strong argument for bringing some key aspects of economic life back under public sector control.

Central banks are by far the most important example. In the 1990s, mainstream macroeconomists pushed the idea of independence for these banks, and it took hold. One of Gordon Brown’s first acts as chancellor in 1997 was to make the Bank of England independent.

All sorts of benefits were meant to flow from this. But it is hard to discern any of them in practice. The Bank conspicuously failed to head off the financial crisis of the late 2000s. And once the crisis had hit, its initial response was to worry about the esoteric theoretical concept of “moral hazard” rather than saving capitalism.

If the chancellor gets things wrong, the government can be booted out. The Monetary Policy Committee can’t be.

If MPs wanted to change this and take back control, a precedent has been set. The Highways Agency was set up as an executive agency in 1994. But in 2015, the coalition re-constituted it as a company owned by the government.

In practice, transport ministers do not seem to have exercised much control over it. There is an ongoing shambles, for example, with road works both on the M6 north of Birmingham and on the M60, Manchester’s equivalent of the M25.

But in principle they could. It is time to restore control to elected politicians. To, in a word, renationalise the policymaking bodies.

As published in City AM Wednesday 24th January 2018

Image: Carillion by Terry Robinson is licensed under CC by 2.0
Read More