The Brexit vote creates many uncertainties, exciting or frightening depending on your predilection. One thing which is certain is that the Leave victory was delivered by the less-skilled sections of the electorate.
It seems part of a more general stirring up of what we might think of as the dispossessed, those who feel left behind by globalisation. In France the Front National, in the Netherlands Geert Wilders’s Party for Freedom, in Germany Alternative fur Deutschland – throughout Europe, in fact, these discontents receive an increasingly sympathetic hearing.
Equity markets have been very volatile and nervous in the face of the uncertainties which Brexit creates. But there may be a good reason for this from a longer-term perspective.
Compared to 30 years ago, stock prices both in Europe and the US are at much higher levels. A key reason underpinning this is the shift from wages to profits as a proportion of national income which has taken place. The share of wages in national income has fallen, and that of profits has risen. Profits have grown faster than the economy as a whole, and so the potential future dividend stream from shares has gone up. As a result, shares have become more valuable.
Measuring the share of wages in national income is not as straightforward as it might seem. Should it, for example, include self-employed income or the remuneration of chief executives? In February 2015, the OECD, along with the International Labour Organisation, published a detailed study of trends in the G20 economies since the early 1990s. No matter which measure was used, the data show that the wage share declined significantly in almost every member state of the G20, and nowhere was there a significant trend increase.
The changes themselves may appear small. On one measure, for example, the wage share fell from an average of 69 per cent of national income in 1990 to 65 per cent now. But in terms of, say, the UK economy, four percentage points represents nearly £80bn.
More recently, there has been a levelling off in the downward trend. The distribution of income between wages and profits has been stabilising. Does Brexit signify a tipping point, when the trends of the last few decades might start to be reversed?
The economic orthodoxy, not just in theory but in practice, has been one of open borders for both labour and capital. Both must be allowed to flow freely. But there is an increasing groundswell of public opinion against this. Donald Trump, for example, supports a 20 per cent tax on all imported goods to protect American jobs. Bernie Sanders has opposed every free trade deal which the United States has negotiated, and vowed to “take on corporations which take their jobs to China”.
It is much easier to protect wages in a world of tariff barriers and restrictions on capital movements. Boris Johnson sees Britain as a global entrepreneur, but most Brexit supporters do not. Brexit would not be the cause of a long-term downward revision to share prices, but more a symbol of why it’s happening.
As Published in CITY on Wednesday 29th June 2016
Some things never seem to change. In the mid-16th century, in the course of her short reign Queen Mary, a daughter of Henry VIII, tried to restore Catholicism. To this end, she arranged to marry King Philip of Spain, at a time when Spain dominated Europe. The Spanish ambassador in London sent back a gloomy report. The English, he said, drink vast quantities of alcohol and hate all foreigners.
In the spirit of continuity, people from other countries continue to be baffled by us. We await the results of the referendum with keen anticipation. But it is not easy to explain to someone from Spain, as I had to do this week, that the areas of the UK which might benefit from Brexit are very likely to vote Remain, whilst those which would struggle will vote Leave.
Rational choice seems to have flown out of the window. The former mining valleys of South Wales, for example, whose income per head is one of the lowest in Western Europe, benefit substantially from an inflow of EU funds. Yet it appears that they will vote strongly to quit the EU. In contrast, London and the South East, which have a dynamic, innovative economy, are keen to stay in the EU.
It is obvious to anyone who has visited these places that the Thames Valley, for example, has a more successful and outward looking economy than, say, the old mill towns of the North of England. But how do we actually measure this? George Osborne is trying to redress regional imbalances with his Northern Powerhouse, and trying to boost the long term potential of the whole of the UK with his Productivity Plan. The problem is that the data produced by the Office for National Statistics is wholly inadequate for judging whether a local area has started to perform better as a result of his initiatives, or whether it has even got worse.
We can get an idea of the relative dynamism of each local authority area in the UK by looking at the stability of relative unemployment rates both across the UK as a whole, and within each of the UK’s regions. If an area if performing relatively badly, its unemployment rate is likely to be higher than not just the average in the UK, but compared to other areas in its own region, such as Yorkshire or Eastern England.
The numbers make depressing reading. Comparing unemployment rates in the 382 local authority areas in the UK in 2005 with the rates in 2015, the correlation is 0.88. In plain English, little change. If you were doing badly before the crash, you were still doing badly after it. Even if we go back to 1990, in general the poor areas are still poor, and the rich ones rich.
The map of local unemployment rates in Britain continues to be a mirror image of the referendum poll numbers. Another source of bafflement for Spain and the rest of the EU in the early 21st century.
As Published in CITY AM on Wednesday 22nd June
Image: Polling Card by Abi Begum as licensed under CC BY 2.0
The economic debate around Brexit has been disappointing. Far too many of the points focus on the short-term. Would Brexit precipitate a sterling crisis? Well, if it did, at some point the currency would bounce back? Would it tip us into a recession? Maybe, but recessions come to an end.
The key economic question, not just in the Brexit debate but one which faces the West as a whole, is what is going to happen to the long-term growth rate of the economy. It is the long term growth rate which determines living standards, which determines how much we can afford as a society to spend on health, education and pensions. Long-term growth rates reflect the underlying productive potential of the economy.
On this criterion, the Leave camp seems to have the debate in the bag. There is a strong consensus across economists, regardless of their views on Brexit, that the main determinant of long-term growth is innovation.
The European Commission pays a great deal of lip service to this, but Europe in general still lags considerably behind America in terms of innovation. Innovation is by definition disruptive. It creates new companies and industries, but at the same time destroys existing ones. The willingness of a country to embrace rather than resist change is crucial.
Old Europe, to use Donald Rumsfeld’s notorious phrase for the original, core members of the EU, has an abysmal record. True, the Germans implemented important structural reforms in their labour market in the 2000s, mirroring those introduced here by Mrs Thatcher in the 1980s. But long term growth rates in Old Europe have been falling now for nearly fifty years.
The average growth rate over a sufficiently long period is a good indicator of long-term potential. Over twenty years, for example, the short-term booms and busts will even themselves out. In the 1950s and 1960s, growth in the core EU economies was very high, at 7 per cent a year, reflecting the huge post war boom. In 2015, the average over the past two decades was barely above 1 per cent. In contrast, the 20 year average growth rate in the UK has been pretty stable. In 1970, it was 2.8 per cent a year. It is now 2.4 per cent.
Remaining shackled to a system which appears to prefer regulating to innovation does not seem such a good bet. But we have to take into account the likely response of the major players in the EU to Brexit. The fear is that the UK deciding to leave the EU would trigger similar responses across the continent. It would certainly give huge encouragement to already strong anti-EU feeling in many countries.
So the only rational response is to be punitive towards us, to try and make life as difficult as possible over as long a period as possible. Whether they love us or loath us, the EU would have no alternative. Couples getting divorced may wish the process were harmonious. But in reality, it is often nasty, messy and the bitterness can last for years.
As published in CITY AM on Wednesday 15th June 2016
David Cameron has tried to frame the Brexit debate into one based on economics. Standing with him is the overwhelming consensus of economists themselves, from academics to the International Monetary Fund (IMF). Their pronouncements are not having that much impact on the electorate if the polls are to be believed.
There is justification for this public scepticism. The arguments relate to what might happen to the economy at the aggregate, or macro level. How much will GDP rise or fall, how many jobs will be lost or created, what will happen to trade, to inflation?
At the individual level, or micro level as economists call it, a great deal of progress has been made in the past twenty years or so. But at the overall, macro level, mainstream economics has if anything gone backwards. Concepts such as rational behaviour and equilibrium have been incorporated into the thinking of macro economists, at the very time that their micro colleagues are challenging them.
Olivier Blanchard, until recently chief economist at the International Monetary Fund, has real form on the perils of believing orthodox macro economics. In August 2008, for example, just three weeks before Lehman Brothers collapsed and the worst recession since the 1930s burst on the world, he published a paper claiming that the state of macroeconomics was “good”.
The relationship between inflation and unemployment is a central building block of macroeconomics. Economists even have a special phrase for it, the so-called ‘Phillips curve’, named after the LSE based academic who discovered it in the 1950s. The curve in theory says: the lower is unemployment, the higher is inflation. This is the subject of Blanchard’s latest offering in the American Economic Review.
The Phillips curve is not just of academic interest. The Monetary Policy Committee, for example, has an inflation target, and unless they know what the curve looks like, they are not going to be able to do a very good job.
Blanchard sets out a formidable looking mathematical model. He then employs statistical techniques in conjunction with the theory, in the same way that, for example, the UK Treasury published one with their estimates of the trade costs of Brexit, and claims that “the US Phillips curve is alive and well”.
Up to a point, Lord Copper. For one of Blanchard’s conclusions is that “The standard error of the residual in the relation is large, especially in comparison to the low level of inflation”. Translated into English, this simply means that his model does a poor job at explaining what has been going on. This is hardly surprising. The unemployment rate peaked in the US at just under 10 per cent in 2010. Since then it has halved to stand at 5.0 per cent. But inflation is slightly lower, at 1.2 per cent compared to the 1.6 per cent average in 2010. The story is just the same in the UK and Germany. Since the crisis, unemployment has fallen sharply, and inflation has edged down. Macro models are by far the weakest part of economics.
As published in CITY AM on Wednesday 8th June
Martin Feldstein of Harvard is an economist who should always be taken seriously. Writing in 1997 about the forthcoming introduction of the euro, for example, he argued that “the adverse economic effects of a single currency on unemployment would outweigh any potential gains from trade flows”. He went on to predict that the euro was likely to lead to increased conflicts within Europe. Looking at the current state of the continent, his forecasts appear spot on.
In the latest issue of the American Economic Review, he reminds us of the crucial importance of reducing government deficits. The Brexit referendum has essentially frozen David Cameron’s government from taking almost any action at all. But despite a convincing General Election victory, the drive to cut the deficit was already slowing down. In particular, the government appears to have lost its nerve in terms of cutting public expenditure. At the slightest sign of protest or opposition, it backs down.
Feldstein’s paper on the American experience should spur Cameron to think again. Feldstein begins with an optimistic view of the US economy. Since the 1970s, the unemployment rate has only briefly dipped below 5 per cent, its current level, so America effectively is back at full employment. Inflation remains low, despite employment rising by 14m since 2010. Economic growth is limited by the absence of excess capacity rather than by demand.
In the longer term, the most serious risk to the American economy, Feldstein believes, is the explosive growth of national debt as a percentage of GDP which will happen unless there are serious measures taken to cut spending. The public sector deficit is the difference between income from taxation and public spending in any given year, and a deficit adds to the stock of debt which is outstanding.
Feldstein points out that the debt to GDP ratio has risen from less than 40 per cent 10 years ago to 75 per cent now. The comparable numbers in the UK are from 35 to 85 per cent. He suggests that a very effective way of controlling future increases is to raise the retirement age even more. He has a neat suggestion to counter legitimate worries that life expectancy has gone up more for the better off than it has for the poor. Just link the retirement age to lifetime earnings. The lower they are, the earlier you can give up work.
The shape of the recovery in the United States suggests that there is little to fear from following Feldstein’s arguments and really getting to grips with public expenditure. The trough of the recession was in 2009. By 2015, GDP in real terms had increased by 13.3 per cent. Despite scare stories that growth has been driven by unsustainable consumer spending, this rose at a virtually identical rate, by 13.9 per cent. Corporate investment, in contrast, has shot up by 51 per cent. And current public spending has fallen by 7.5 per cent.
Despite siren voices such as those of junior doctors, the UK government should keep its nerve too. The American experience shows that cutting public spending can expand the economy.
As published in City AM on Wednesday 1st June 2016
Image: National Debt Clock by Nick Webb licensed under CC BY 2.0
Andy Haldane, chief economist at the Bank of England, hit the headlines last week with his confession that even he could not understand much of the material which pension providers give to customers. Less noticed, however, was a speech he gave the previous week at a dinner organised in aid of Children in Need on the fashionable theme of diversity.
The concept is dear to the heart of the liberal elite. Company boards, public institutions, all must embrace it without question. Each must have its “appropriate” quota of under-represented groups – every group, in fact, except white working class men. Mass immigration and open borders should be welcomed on the grounds that this makes society more diverse, which is unequivocally a Good Thing.
Haldane, one of the most original economists around, puts forward an altogether smarter set of arguments for diversity. A very deep seated human instinct is to be very wary of anything which is different. For much of our history, we have lived in small hunter-gatherer communities of 100 people or less. Groups of this size were very vulnerable to events which could make them extinct. The principal threats were conflict and disease, and the principal bearers of these were strangers. So it can be very sensible to prefer people who are similar to you and to distrust the unknown. As Haldane points out, this is “ecologically rational” behaviour.
But decisions which are rational for the individual can have consequences which are, collectively, bad. It is perfectly rational for everyone to head to the exits if the fire alarm sounds in the theatre. But the collective consequences are potentially catastrophic.
Haldane notes that economists call this an externality problem. He argues that a certain amount of diversity can generate positive externalities for society and the economy as a whole. Taking a very broad sweep of history, he cites Ancient Greece, medieval Italian cities and the London of Elizabeth I as examples of cosmopolitan, diverse cultures in which creativity flourished. Shakespeare was very much the product of that latter era, when England was opening up the world. And diversity, Haldane argues, in addition offers protection against the dangers of “group think”.
Some of his other examples are less convincing. He cites the results of the Harvard economist Alberto Alesina that a 1 per cent increase in the population arising from skilled immigrants raises long-run output by 2 per cent. But the point here is surely that they are skilled rather than that they are immigrants. And, incredibly, Haldane gives the Monetary Policy Committee as an example of successful diversity.
Cultivating creativity requires what Haldane calls cognitive diversity, which may not be related at all to ethnic or gender diversity. Cambridge in the middle of last century consisted almost entirely of white, upper class men. Yet Keynes in economics, Wittgenstein in philosophy and, most important of all, Crick in biology generated world-changing ideas.
Haldane’s speech is a powerful counterweight to the tick-box mentality which currently dominates the thinking on diversity in policy circles.
As published in City AM on Wednesday 24th May
Greater Manchester Police staged a simulated terror attack in the massive Trafford Park retail complex last week. As with many real life atrocities, the carnage began with the cry “Allahu Akbar!” Following a storm of protest on Twitter, the police felt forced to apologise. Almost at the same time, a frenzied chorus rose up demanding the resignation of the BBC’s political editor, Laura Kuenssberg, for having had the temerity to suggest that the local election results were something less than a complete triumph for the Great Leader and Teacher, Jezza. This campaign was halted by the extremely sexist nature of many of the comments posted by left wing Twitterati.
The way the Kuenssberg saga ended is in fact very unusual. Following a storm of outrage on social media about a statement or an action, the ‘guilty’ party almost invariably confesses his or her crime and issues a heartfelt apology to the raving crowd.
Social media is a new and radically disruptive technology. It is hardly surprising that traditional institutions and social norms have not yet adapted to the challenges which are raised. Many thousands of voices were raised against the police for their allegedly racist opening cry, with virtually no one springing to their defence. It seemed that public opinion was firmly against them, and so they bowed to pressure and apologised.
But Twitter, along with other social media outlets, is in many circumstances simply an echo chamber. When the polling booths in the Scottish referendum closed in 2014, many in the SNP leadership were convinced they had won. Their researchers has carried out seemingly sophisticated analysis of social media, and concluded the ‘Yes’ campaign was ahead. The actual result gave rise in turn to all sorts of conspiracy theories, bouncing backwards and forwards between die hard pro-independence Scots. Late last summer, the US Army carried out a routine training exercise called Jade Helm 15. This sparked a torrent of concerns on social media, a prominent one being that the federal government was planning to invade Texas and civil war was imminent.
Guido Caldarelli at Lucca and Gene Stanley at Boston published a paper in January this year in the prestigious Proceedings of the National Academy of Science. They find that the problems are widespread in social media, with users frequently forming communities of interest which foster confirmation bias, segregation and polarisation. Biased narratives fomented by unsubstantiated rumours, mistrust and paranoia proliferate.
How do we know whether to take a trend on social media seriously, of whether to just dismiss it as a bunch of fruitcakes egging each other on? Santa Fe-based scientists Rich Colbaugh and Kristin Glass (I am currently working with them) have found that a topic which has only a small number of mentions in each of several different social media communities is potentially far more significant than one which has a huge number in just one. Public bodies need to learn how to differentiate between social media topics, and not just routinely capitulate to the mob.
As published in CITY AM on Wednesday 18th May 2016
Concerns are growing about a marked slowdown in the UK economy. The Lloyds Bank purchasing managers’ index, for example, fell to 52.1 in April, its lowest point since 2013. The initial estimate for GDP, total output, in the first quarter of this year shows an increase of just 0.4 per cent on the final quarter of 2015.
Growth since the start of 2015 has been only 2.1 per cent, a rate which is a rough benchmark as to whether employment rises or falls. Indeed, in February, the latest month for which we have data, the Labour Force Survey showed that the total number of jobs in the UK was unchanged since December.
On the positive side, the economy has definitely grown since the recession, with output being up by 7.3 per cent on its previous peak value just before the recession in the first quarter of 2008. And these are the official estimates, which may not be able to cope with measuring accurately activity in the new cyber economy.
But economic slowdowns and recessions do happen. Indeed, they are a fact of life. The upsurge in inflation in the 1970s, when it reached 25 per cent, captured the mind-sets of policy-makers and prevented them from realising that low inflation, which we have now had for over 20 years, is normal. In the same way, the long period of continuous expansion during the 1990s and 2000s distorted expectations about what is normal. This period, which economists dub the Great Moderation, during which Gordon Brown claimed he had abolished boom and bust, makes people think, incorrectly, that recessions are very unusual.
We have quarterly GDP data in the UK going back to 1955. Economists have a fairly arbitrary definition of a recession as being at least two successive quarters of negative growth. Since 1955, we have had eight such periods. So, on average, we have a recession once every seven or eight years. We had one in 2008-09, and we might think that, on the law of averages, one is due now.
Things are not so simple. Economists write about the “business cycle”, as though the fluctuations in economic growth were regular. But this is a piece of jargon. The Nobel Laureate Robert Lucas pointed out 40 years ago that the key feature about economic ups and downs is that most sectors of the economy tend to move together, so we can presume there are general factors driving the economy. Specific factors will influence specific industries, but these do not cause the economy as a whole to boom or shrink.
The gaps between recessions are in fact pretty irregular. For example, there was one in 1956 and another in 1957. The recession of 1973 was followed quickly by the one in 1975. In contrast, there was a gap of 17 years between the 1990-91 contraction and the financial crisis.
Decision-makers do not like uncertainty, and Brexit is certainly creating this. Capital spending by companies stopped growing in the late summer of 2015. So it might all bounce back after 23 June.
As Published in City AM on Wednesday 12th May 2016
Image: Pound Coin by Andrew Writer licensed under CC by 2.0
The crisis at BHS has focused as much on the ethics of Phillip Green’s behaviour as it has on the plight of the company itself. Sir John Collins, who put his name forward for a knighthood, has said Green should be stripped of it if his handling of the beleaguered company is found to have lacked integrity.
Green is by no means the only prominent businessman to have faced criticism in recent weeks. Last month, almost 60 per cent of BP shareholders voted at the AGM against the £14m pay package for the chief executive in a year in which the company reported record losses, cut thousands of jobs and froze its employees’ pay. Hours later, over 50 per cent of Smith and Nephew’s shareholders rejected the remuneration committee’s decision on executive bonuses, despite the fact that its shareholder returns were below the median of its peer group.
It is a natural human tendency to look for specific reasons why these headline grabbing events take place. So we feel that perhaps these attacks were justified because of the varying degrees of poor company performance in each of the examples. But Sir Martin Sorrell, who has built up a global media business from scratch and really has created shareholder value, is expected to face similar criticisms at the WPP AGM in the summer.
At the opposite extreme, the business world is replete with examples of huge rewards being handed out for poor performance with no comeback at all. One of the harbingers of the financial crisis in the autumn of 2008 was the collapse of Bear Stearns investment bank in March of that year, and the virtual destruction of its shareholder value. Yet James Cayne, the chairman and chief executive, walked away unscathed with the $40 million he had been paid in cash. Fred Goodwin at RBS did have his knighthood annulled, but he was one of the very few financiers to suffer despite the ravages which they caused.
It did seem that revolts against massive pay-outs would take off in the ‘shareholder spring’ of 2012. The august Institute of Directors pronounced that companies must respond to shareholders’ anger or risk discrediting the wider business community. In the end, the protests just fizzled out.
In terms of shareholder discontent with executive remuneration, we have examples where poor performance stirs this up, examples where even exceptionally poor performance does not, examples where even good performance provokes the shareholders, and examples where a protest movement simply fades away after lots of initial sound and fury.
So it is challenging, to say the least, to construct a logical explanation of what causes shareholders to get stirred up. We should think of it instead as being more like a fashion item. Once something starts to become popular, it is likely to become even more popular, simply because it is popular. We may just have reached a tipping point, where the large institutional shareholders now feel it is the done thing to pillory top executives, almost regardless of their performance.
As published in City AM on Wednesday 4th May 2016
Image: Sir Martin Sorrell by Chip Cutter is licensed under CC BY 2.0
The Queen’s 90th birthday has quite rightly dominated the media over the past week. Her Majesty continues to break all sorts of records, spending longer on the throne than Queen Victoria and being our oldest ever reigning monarch. But longevity should no longer give cause for surprise. The oldest participant in the London Marathon was 88, a mere whippersnapper compared to the 92 year old who ran the event in 2015.
Robert Fogel, an economic historian based at Chicago, was one of the first people to draw attention to the dramatic lengthening not just of life spans, but of active life which was about to take place. In his Nobel Prize lecture in 1993, he correctly predicted that the number of older people in the US would rise much more rapidly than the Census Bureau was predicting. Now, there are 45 million Americans over the age of 65, a big chunk of the entire population of the UK, and 6 million aged 85 and over.
Fogel worried about the implications for health care and pension costs, concerns which are widespread in policy making circles today. In terms of pensions, the obvious solution is to raise the retirement age. But governments face resistance to this. Even George Osborne has not dared to go further than legislating for an increase in the pension age to just 67 – in 2028! Retirement is popular. A key reason, as Fogel pointed out, is the vast increase in the supply and the quality of leisure time activities for what he quaintly described as the “laboring classes”. In addition, the relative prices of leisure services such as movies, television and travel have fallen substantially.
Yet there are signs of behavioural change taking place from the bottom up. Last November, the Department of Work and Pensions (DWP) published a report on the employment statistics of workers aged above 50 over the past 30 years. The number of people in employment over 50 has grown faster than the population aged over 50. A lot of the growth has been amongst women in the 50 to 64 year old age group.
In addition, the employment rate for people over 65 has doubled since the mid-1980s, from 4.9 per cent of the relevant population to 10.2 per cent. Initially the rise was in the 65-69 age group, but over the most recent decade, the over 70s have increased their participation rate in the labour force to 9.9 per cent.
The problem of how to fund the pension costs of an ageing population remains a serious one. We need to encourage more older people to work. Economics can help, but the mainstream approach has its limits. This essentially describes an equilibrium situation, and then tells us what the new equilibrium will look like after a change has disturbed the old one. But the pensions issue is about how we adapt as a society to a situation which is out of equilibrium, how we manage the process of change in disequilibrium. Behavioural economics has more potential to help.
As published in CITY AM on Wednesday 27th April 2016
Image: Chelsea Pensioners by Defence Images is licensed under CC BY 2.0