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Innovation is the only way to recover from the Covid crisis

Innovation is the only way to recover from the Covid crisis

One silver lining of the Covid-19 crisis has been a surge in innovation.

Enterprising firms have invented both new products and different ways of delivering existing ones.

Innovation is the life blood of any prosperous economy. Innovation is much more than a scientific invention. It turns inventions into things of practical and affordable use to people.

The ability to deliver innovation in a sustained way is the one single quality which distinguishes capitalism from all other forms of social and economic organisation.

Yet our understanding of it remains imperfect.

MIT Nobel laureate Robert Solow laid the foundations for the modern theory of economic growth over 60 years ago. His neat mathematical model postulated that growth was caused by increases in the amount and quality of both capital and labour used in the productive process, and by innovation.

But when the theoretical model was applied to real world data, it created a problem for economics. The increases in the inputs which could be readily measured — capital and labour — could only explain a small fraction of the growth which had taken place.

By implication, most of the huge growth experienced in the west was due to innovation. But innovation itself was not explained in the Solow model.

Despite various attempts to do better, including an ingenious one which won the Nobel Prize for another MIT economist Paul Romer, economists are still far short of a convincing explanation of innovation.

Matt Ridley, the author and scientific polymath, has made a valuable contribution in his recently published book How Innovation Works.

Ridley describes how major innovations arose in a wide range of sectors, such as energy, public health, food, transport and computing.

From this mass of detailed, empirical description, he synthesises some general principles, the vital ingredients for success.

A classic image of innovation is Archimedes jumping out of his bath shouting “Eureka!” But Ridley makes clear that such moments are exceptionally rare, even if the story is true.  This is for two reasons.

First, innovation is almost always a gradual process. It involves re-combinations of existing ideas and methods of production rather than single revolutionary events.

Second, innovation is, as Ridley puts it, a team sport. The myth of the isolated genius is deeply ingrained, but it is a myth. Innovation requires collaborations and building on what went before. Even Isaac Newton, one of the greatest minds in world history, acknowledged that he “stood on the shoulders of giants”.

Innovation also requires an acceptance of failure.  When Edison perfected the electric light bulb, he had tried 6,000 different materials for the filament before discovering what really worked.

The book ranges far wider than just the science. For example, Ridley argues that the EU has evolved into a system in which innovation simply cannot flourish. Of Europe’s 100 most valuable companies, not a single one was formed in the past 40 years. What a massive contrast with America.

Innovation is key to a successful recovery from the Covid crisis — and Ridley’s book offers excellent insights on how to make it happen.

As published in City AM Wednesday 1st July 2020
Image: Silver Cloud by lfranks via Pixabay
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The government should have been working on multiple tracing apps all along

The government should have been working on multiple tracing apps all along

The NHS contract tracing app has been scrapped in favour of a system developed by Google and Apple.

Although health secretary Matt Hancock has been heavily criticised for this failure, the UK is by no means alone.

For example, Denmark, Germany and Italy each tried to build their own app, based on the same type of centralised system as was attempted in the UK. But they have already ditched their efforts and taken up the decentralised approach of Apple and Google.

Australia is widely perceived as having had a “good” Covid-19 crisis. But the same cannot be said of its tracing app. It seems to have had serious problems working with iPhones at all.  The Aussies, too, are now taking the Google/Apple approach.

The simple fact is that most technological innovations fail.

The government can be criticised legitimately for not appreciating this fundamental feature of new technology. But it is a more subtle critique than merely pointing to the failure itself.

Given the importance of the tracing app, it would have been perfectly reasonable for the government to have pursued parallel tracks. At the same time as trying to develop its own NHSX app, it could have been collaborating with Apple and Google too.

Critics might have tried to pan this as an example of waste. But there is rarely such a thing as wasteful competition.

Spending on two completely different approaches at the same time would have been a hedge against the uncertainties which are inherent in the development of new technology.  No matter how smart you are, or how much prior information you gather, you just do not know whether an innovation really will work.

The tech companies themselves protect against this uncertainty by holding far more cash than conventional economic theory regards as rational. At the start of the Covid crisis, Apple, Microsoft and Google’s parent company Alphabet between them held over $450bn in cash or marketable securities.

Pharmaceutical companies face a similar challenge  Most new drugs fail. They fail when they are still in the lab, and they fail once they go out for testing to get regulatory approval.

In America, for example, there are three phases to the test process, each more demanding than the last.

The time scales are long. Andrew Lo, an MIT polymath, and his colleagues published a paper last year in the journal Biostatistics. They gathered a sample of over 400,000 clinical trials carried out between 2000 and 2015. Even after all the initial development work in the lab was completed, the typical successful drug took 8.3 years to obtain approval.

This puts into perspective the current frantic efforts to develop treatments and vaccines for Covid-19.

The probability of obtaining regulatory approval varies widely across categories. But overall, when a candidate drug enters phase one trials, its chances of eventual success are less than 10 per cent.

The government should embrace the idea that money spent on technology or drugs which fail is not money wasted. Indeed, the real mistake is not to risk enough, to stake everything on a single project.

This is the true failure of NHSX.

As published in City AM Wednesday 24th June 2020
Image: Covid tracing app by Gerd Altmann via Pixabay
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History shows us that slavery is an economic catastrophe as well as a moral one

History shows us that slavery is an economic catastrophe as well as a moral one

Slavery has certainly been in the headlines in the past couple of weeks.

Given this sudden interest in this area of history, it is worth considering the economic lessons it can teach us, as well as the moral ones.

Slavery was abolished in England itself in the twelfth century. Then in 1772, Lord Mansfield gave his famous judgment that as soon as any slave set foot on British soil, he or she was automatically freed.

Clearly, some people became rich by trading or owning slaves abroad. There is nothing new or unusual about this. Taking a broad sweep of human history, the societies in which slavery does not feature form a very distinct minority.

It was Karl Marx who coined the phrase the “ancient mode of production” to describe the economies of both Ancient Greece and Rome. Greece, of course, gave us the concept of democracy itself. Yet, ironically, its economy was built on slavery.

Rome developed the concept even further. With a plentiful supply of labour from its military conquests, the aristocracy owned vast tracts of land, maintained by slaves.

Yet although individuals became rich through slavery, Rome as a society did not.

When the Empire was at its maximum extent in the second century AD, the living standard of the average Roman citizen was the highest the world had yet seen. Indeed, it was probably not surpassed until the early modern era.

Yet the Roman economy, prosperous though it was, remained at the living standard of purely agrarian societies. It never got “lift off”, as Europe did in the eighteenth and nineteenth centuries.

The fundamental problem was that an economy based on slavery has little incentive to adopt new, more efficient ways of working. Indeed, for the individual slave there is virtually no incentive at all. If a particular task can be done better and more quickly, there is always another one which he or she will be given. Innovations, when they did happen, spread only very slowly.

The inherent inefficiency of slavery as a method of production is clear from the experience of Stalin’s Soviet Union and Mao Tse Tung’s Communist China — the two great slave societies of the twentieth century.

The labour camps, filled with the so-called enemies of socialism, represented a huge drain on their economies. Output was low, and large amounts of resources were needed to run and maintain the system.

Slavery is of course morally repugnant, a stain on the histories of civilised societies. But it is also economically detrimental to the societies it ostensibly appears to benefit. The fact is that no society based on slavery has ever come anywhere near to delivering decent living standards for the average person.

The only system which has is capitalism. Britain and other areas of north west Europe started to become rich through a system based on the rule of law, the ability of individuals to profit from innovation and not be expropriated, and the freedom of labour to negotiate contracts.

Morality undoubtedly played a part in Britain’s leading role in abolishing slavery. But by the early nineteenth century, it had become an anachronism. Resources employed in slavery could be put to much more productive use under capitalism.

Perhaps, then, we should remove not just statues of British slave owners, but erase the whole corpus of Greek and Roman art, financed as it was by Marx’s slave-based ancient mode of production.

As published in City AM Wednesday 17th June 2020
Image: Antique Statues via Wallpaper Flare
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Get the Bank of England focused on the real economy

Get the Bank of England focused on the real economy

Economic policy is returning to its usual position of prominence.

Fears of a major rise in unemployment are starting to worry the government more than fears around Covid-19.

The chancellor’s imaginative schemes concerning furlough and other measures to protect jobs create potential problems elsewhere. So much money is being borrowed that the ratio of public sector debt to GDP has soared above 100 per cent.

The last time we were here was at the end of the Second World War. Then, the debt ratio was a massive 250 per cent.

The Labour government of that time has a reputation for being the most left-wing in British history. It nationalised the mines and railways, and created both the modern welfare state and the NHS.

But it reacted to the massive level of public debt with impeccable orthodoxy. Between 1947 and 1951, Labour ran public sector surpluses to help pay off the debt. These were huge, averaging some £50bn a year at today’s prices.

Will Rishi Sunak be forced into similar levels of austerity, cutting spending and raising taxes?

A timely and fascinating Policy Exchange paper issued last week argues that this would be completely the wrong thing to do. The authors — Gerard Lyons, Warwick Lightfoot and Jan Zeber — are not noted for any previous enthusiasm for fiscal activism, which makes the treatise all the more interesting.

They note that there was a further, perhaps more important, way in which the public debt mountain was brought back under control, in addition to the immediate post-war austerity.

The 1950s and early 1960s saw strong economic growth. A famous phrase coined in 1959 by the then Prime Minister Harold Macmillan was “you’ve never had it so good”.  This, plus a modest rate of inflation, helped erode the debt burden steadily and surely.

The point is that the debt which the government issues is denominated in money terms. If you buy a bond for £100 now and hold it to maturity in 10 years’ time, you get precisely £100 back.

During the 1950s, GDP grew in money terms at an average annual rate of seven per cent. The debt to GDP ratio is, quite simply, the outstanding stock of debt divided by GDP. There was essentially no net addition to debt in this period. But the growth in nominal GDP meant that the ratio was halved.

To tackle today’s debt, Lyons and colleagues call for a strategy of growth. Their most striking demand is to change the remit of the Bank of England from one of controlling inflation to one of controlling GDP in money terms — a combination of inflation and real growth in the economy.

The Federal Reserve in the US is also tasked with taking the real economy — output, jobs — into account, but others such as the European Central Bank remain shackled by a pure inflation target.

This proposal would certainly shake up the Bank of England after years of complacency under Mark Carney. Given the Prime Minister’s new-found interest in the economy, it could be an idea whose time has come.

As published in City AM Wednesday 10th June 2020
Image: Bank of England via Flickr CC BY-ND 2.0
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What can we learn from the Black Death? Be prepared, trust entrepreneurs, and have faith

What can we learn from the Black Death? Be prepared, trust entrepreneurs, and have faith

Can we learn from history?

An excellent book by Ben Gummer on the Black Death in fourteenth century Britain, The Scourging Angel, shows that we can.

Published 10 years ago, the book offers many intriguing parallels with the Covid-19 crisis.

Of course, the Black Death was almost incomprehensibly more lethal.  Around 50 per cent of the total UK population died in 1348–49. That is 33m deaths in current terms.

Modern scholarship has overturned the long-held idea that the plague was spread exclusively by fleas on rats. Contemporaries knew that it was spread from person to person by breath. The new coronavirus  is transmitted by droplets from the nose and mouth. Both diseases lingered on clothing and objects.

People back then worked out very quickly how plague might be avoided. Those who could fled from infected areas. If possible, they locked themselves away in castles or monasteries.

The peasantry — the vast bulk of the population — had far fewer options. But they did try to cut off contact with the world outside their own immediate village as much as possible.

Then, as now, there were inequalities in health outcomes. Because of their greater ability to practise social distancing, the nobles and church leaders had much lower death rates. Even so, these were still some 20 per cent.

There were arguments over the Medieval equivalent of PPE. In London, the demand for gloves rose dramatically. Master glove makers enticed away their rivals’ employees.  Unlicensed glove production, often of dubious quality, soared. The city fathers had to step in and enforce the regulations more effectively.

On a lighter if macabre note, a “William of Liverpool” was convicted of a different scam. A neighbouring village had no burial ground. For a substantial fee, he agreed to take the bodies and bury them on what he claimed were his extensive fields. Essentially, he then fly-tipped the corpses on his way home.

Then there is the economy. The current chancellor has had to be very innovative with his schemes to preserve jobs. The Black Death created the opposite problem: a massive shortage of labour.

But an equally innovative and imaginative solution was found. Maximum wage rates were fixed by legislation. The local nobility and gentry were given an incentive to enforce it: any fines collected from workers paid more than was legal could be offset against the overall amount of tax due from the county.

Two positive themes emerge towards the end of the book.

First, the authorities then took steps to try to mitigate the impact of any second wave of the plague almost as soon as the first had passed. The streets of London, for example, unimaginably filthy to modern eyes, were kept cleaner.

Here is a key lesson for Covid-19. If a new wave arrives in the winter, there is no excuse if the government is not prepared. The time to start is now.

The second point is that economic activity recovered remarkably quickly. London in particular was soon buzzing again. It was not state action which delivered this — it was confidence on the part of both entrepreneurs and consumers.

Now, as then, confidence is the key to recovery.

As published in City AM Wednesday 3rd June 2020
Image: Coronavirus street art by Evelyn Simak via Geograph CC BY-SA 2.0
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