At the end of last week Federica Mogherini met leading members of the Trump administration.
Mogherini, yet another Italian politician turned Euro-bureaucrat, is in fact the foreign policy chief of the European Union. She stood on her dignity, or rather the dignity of the European Commission, issuing a warning to America not to interfere with politics in Europe.
We might reasonably wonder what American armed forces have been doing for the past 70 years, effectively providing the defence of Continental Europe and so sparing local politicians the need to raise taxes to pay for it themselves. But this free riding by Europe is apparently an acceptable form of interference. On anything else, America has to be “warned”.
Mogherini went on to surpass herself, claiming that “the strength of the EU and the unity of the EU I believe is more evident today than it was”. Certainly, this “strength” and “unity” are on full display in the latest instalment of the Greek debt crisis. Output in Greece is over 20 per cent lower than it was in 2007, 10 years ago. And the Germans are showing the greatest reluctance to put their hands in their pockets yet again to bail out the Greeks.
More generally, the data on output – GDP – reveal an absolutely fundamental split between the economies of the EU. What we can think of as Greater Germany has performed far better since the financial crisis than the Club Med.
In the former group, to Germany itself we can plausibly add economies such as Austria, Poland, the Czech Republic, the Netherlands and Belgium. The Club Med is represented by France, Spain, Portugal, Italy and Greece.
To put it starkly, Greater Germany has recovered since the financial crisis and Club Med has not. In every individual year since 2009, Greater Germany has grown faster than Club Med.
Output in the former is just over 14 per cent higher than it was in 2009, the year of deep recession with output shrinking almost everywhere in the Western economies. In the latter, it has also risen, but only by 2 per cent. And growth of 2 per cent was typical for just a single year in the decades prior to the crisis.
In 2009, the two blocs were of very similar overall size. Total output in each was around €5 trillion, with the Club Med group being slightly the larger of the two. Stripping out inflation, output in Greater Germany is now around €700bn higher than it was in 2009, and Club Med has registered an increase of only €100bn. Even removing Greece from the latter makes little difference, given that the Greek economy makes up less than 5 per cent of the Club Med group as a whole.
A massive gap has opened up between two groups of economies within the EU in the space of less than a decade. One has grown almost as much as the dynamic UK. The other languishes with growth close to zero. Strength? Unity? It’s just the way Mrs Mogherini tells them!
Possibly the single most important of the tensions stoked up by President Trump is the rivalry between the United States and China. Economic strength will be the ultimate determinant of this struggle for the position of Top Nation.
Comparisons of the size of economies, particularly ones at very different levels of income per head, are fraught with difficulties. Taking a deep breath, annual output in China is currently around $10 trillion a year, compared to $17 trillion in America.
Over the past 30 years, the US has grown at an annual average rate, after allowing for inflation, of 2.4 per cent, and China by 9.3 per cent. If we project these rates forward, the Chinese economy will be as big as the American by 2024. By 2037, it will be more than twice the size.
We can allow for some slowdown in China’s growth, to, say, 7 per cent a year, and a bit faster expansion in the US, to take account of the fact that the average over recent decades is influenced by the impact of the financial crisis. Even so, we soon reach a situation where the two are of comparable size.
But a paper in the latest issue of the world-class Journal of Economic Perspectives argues persuasively that the sustainable Chinese growth rate in the medium and longer term is much lower, in the range of 3 to 4 per cent a year.
Hongbin Li and colleagues, based both in Stanford and top universities in China, note that Chinese growth since the start of the economic reforms in 1978 has been the fastest that any large country has sustained for such a long period of time. But much of this is due to the rapid transition from a centrally planned to a market oriented economy. Forty years ago, virtually no-one operated in the private sector. Now, well over 80 per cent of workers do so. This shift obviously cannot be repeated.
Closely intermingled with this has been the massive move of population from the countryside to the cities – or more precisely, from low productivity agriculture to higher productivity urban economic activities. But the annual growth rate of rural-to-urban migration has fallen from over 11 per cent in the 15 years before 2000 to only 3 per cent since. And the authors argue that the growth of migration almost certainly will decline further given that “rural-based surveys are finding that less than 10 per cent of young able-bodied rural individuals are now living (and working on farms) in rural areas”.
Until 2011, the authors point out that China enjoyed what they call a “demographic dividend”. The age group of the working population was unusually high as a share of the population as a whole. But because of what the authors tactfully refer to as “the fall in fertility” since the early 1980s, this is now declining fast. The One Child Policy was mainly responsible, but higher incomes also reduce birth rates.
China remains a huge and growing economy. But projections that it will overtake the US within readers’ lifetimes seem fanciful.
Image: Chinese Lanterns by Suloke Mathal is licensed under CC by 2.0
The office for National Statistics last week estimated that the UK economy grew at an annual rate of 2.4 per cent in the final quarter of last year. This is slightly above the long-term average growth of the past three decades.
But a Financial Times survey this month showed that the majority of economists remain just as pessimistic about Brexit’s likely effect on Britain’s economic prospects as they were a year ago.
How can this be? Why is the economics profession so overwhelmingly opposed to Brexit?
The reasons rest on two important underpinnings of the discipline. First is a belief in the benefits to society of free trade. There is substantial empirical evidence which backs up economists’ views on this matter.
As the referendum showed, this is a contested issue. The Cambridge economist Bob Rowthorn has pointed out that “there has already been a sharp fall in the size of the Euro-area economy as a proportion of the world economy, and it is hard to see how this trend will not continue”. The deals we need are with fast-growing countries like India and China, and with enormous and innovative markets like the United States. Whether we can get a better deal in or out of the EU is a matter of judgement, not theory.
But the more important reason is that economic theory is in essence about equilibrium. It is about how best to allocate a fixed amount of resources in a static world. Economics has relatively little to say about dynamic processes, about change, about disruption, evolution, innovation, about behaviour out of equilibrium.
This emphasis on a static world leaves many economists unable to see the serious failings of the EU, both actual and potential. In the 1970s and into the 1980s, before the impact of the Thatcher reforms had been felt, it was indeed sensible to look to Europe for inspiration. The UK was plagued by high inflation and low growth.
But now we have had nearly two decades of the euro, one of the most efficient job destruction machines ever created. The combined impact of the euro and their own internal corruption has led output in Italy, Portugal, Spain and Greece to be much lower now than it was 10 years ago. This is a recession without parallel in economic history in its length and severity.
The ability to innovate is the key to long-term growth, as America has shown with Microsoft, Google, Facebook and others. Economic theory has very little to say about innovation. And this blinds the economics profession to the failings of the EU.
As published in CITY AM on Wednesday 1st February 2016
Economic Research Council talk on Monday 20th February 18.30 – 20.00: I will be discussing why so many economists are opposed to Brexit.
Book your ticket here. A limited number of Early Bird tickets are available for £15 each.
Following a Financial Times survey in January that showed that nine times as many economists are opposed to Brexit as are in favour. I will explain why the thought processes of economists traps them in the past, and makes it difficult for them to appreciate the importance of change and innovation, expanding on how Brexit opposition has intensified over the past year, despite the strong post-Brexit performance of the UK economy.
The Economic Research Council, Britain’s oldest economics-based think tank, is dedicated to extending the reach of economic education, debate and leadership. In support of this, the ERC raises the profile of economic conversations; we host events to cultivate wider accessibility, inclusion and civic participation.
We British like traditions. A well-established one which comes round every year is the “winter crisis” in the NHS. Health provision is a political hot potato not just for this government, or indeed for any particular UK government, but for governments across the developed world.
One of the key assumptions made by economists about human behaviour is that there is no limit to the amount of things that people want. In the splendid jargon of economic theory, this is referred to as “non-satiation”.
But regardless of what name we give to the concept, health is an excellent practical example of it. When the NHS was founded in the late 1940s, many thought that the demands on its services would dwindle over time. As the new system gradually improved the health of the population, fewer would require the NHS.
Nigel – now Lord – Lawson once pronounced that “the NHS is the closest thing the English people have now to a religion”. Certainly, any politician tampering with it too much risks his or her career. A striking illustration was provided in the General Election of 2001. The Labour government proposed closing the hospital in Kidderminster on the grounds that it was just very bad. This provoked fury, and a local doctor stood and won as an Independent, destroying the incumbent Labour rising star and holding on until 2010. A subsequent independent inquiry carried out for the NHS showed unequivocally that the hospital was even worse than had been initially thought.
An Institute of Economic Affairs monograph by Dr Kristian Niemietz shows how things could be run much better. The intriguing title summarises the contents: “Universal Healthcare without the NHS”. Niemietz begins with a simple point to debunk the popular view that the NHS is the envy of the world: its structure has never been copied anywhere outside the UK.
In fact, in international comparisons of health system outcomes, the NHS almost always ranks in the bottom third of developed world countries, sitting with places such as the Czech Republic and Slovenia. If the UK’s breast, prostate, lung and bowel cancer patients were treated as in Germany, 12,000 lives a year would be saved.
Most European countries use a social health insurance (SHI) system, in which even homeless people have health coverage. Essentially, these systems are based upon means-tested insurance. Niemietz regards each individual one as having its own particular flaws and irritations, but they routinely achieve much better outcomes for patients, while preserving the concept of universal access.
Their experience shows that, for example, charging for GP appointments does not damage health, and that ordinary people can be trusted to make sensible choices from a range of health insurance plans. The alternative to the NHS is not American, but European health care.
We are, quite rightly, steaming ahead with Brexit, but Europe still has valuable things to teach us in the case of health provision.
A bookseller in the Yorkshire Dales has hit the headlines, branded a “shopkeeper from hell”. He called a customer a “pain in the arse”, and has been the subject of numerous complaints to the local parish council about his rudeness. To complete the outrage, he charges 50p as an entry fee to his shop.
The incident is at face value simply an amusing and trivial story. But it also raises interesting issues in economic theory.
In principle, if the bookseller kept on offending potential customers, he would be driven out of business by market forces. People would no longer use his shop and would take their custom elsewhere, thereby costing him potential sales.
In a much more important context, Milton Friedman made a very similar argument about discrimination in employment in the United States. In the process of hiring, Friedman believed that a profit maximising company would always choose the best person for the job, regardless of his or her background. To do otherwise would impose unnecessary costs on the firm, and it would be driven out of business by its non-discriminatory competitors.
Discrimination of all kinds does appear to be much lower in capitalist economies than under other forms of social and economic organisation. But it is not at all clear how much of this is directly due to market forces.
Economic theory focuses on equilibrium, the situation which notionally exists when all the various incentives, costs, profits and so on have worked their way through the system.
But economics says very little about both the process by which equilibrium is reached, and how long it takes to get there. A very distinguished British economist, Tony Atkinson, died at the start of the year. A brilliant paper he published when in his early 20s showed that, in the core model of growth in economic theory, moving from one equilibrium to another would take over 100 years.
In practice, market forces do work. But they are an imperfect filter of firms’ evolutionary fitness to survive. Numerous studies show that the most efficient firms in an industry often record productivity levels three of four times higher than the least efficient. And these differences persist. Inefficient companies can survive for a long time.
The 50p entry fee, refunded if a purchase is made, raises a further issue for economics. The shop is next to a bus stop, and the owner believed that many browsers were simply taking refuge from the wind and rain, with no intention of buying.
So the proprietor was simply creating a market, in this case proper shelter and warmth for bus travellers. But the entry fee generated general outrage. This is clearly not an area in which the use of markets is believed to be appropriate.
The same sentiment is behind the otherwise inexplicable support for a return to state ownership of railways. Anyone who can remember British Rail will shudder at the memory of just how awful it was. Yet, like health, many believe that it is not morally correct to use markets in this context.
Economics and experts are under attack. But economics can illuminate many aspects of everyday life.
As published in CITY AM on Wednesday 18th January
Image: Closing Down by Philafrenzy is licensed under CC by 4.0
Economic forecasters are in the dock. Last week, none other than the chief economist of the Bank of England, Andy Haldane, was confessing the crimes of the profession.
The failure to predict the financial crisis was, Haldane said, economic forecasting’s “Michael Fish” moment. Thirty years ago, the BBC weatherman predicted that the UK would avoid the hurricane which devastated the south of England.
Haldane went on to admit that the Bank had “not anticipated” the strength of the economy after the Brexit vote. This is something of an understatement. The Treasury predicted an immediate recession, with the economy shrinking dramatically in the July to September period at an annual rate of up to 4 per cent. The latest Office for National Statistics estimates show that it grew at an annual rate of 2.5 per cent, almost the complete opposite of the prediction made in June.
He attributed these forecasting failures to the fact that economic models assumed that people behaved rationally. However, they had been “irrational” in continuing to spend after the Brexit vote.
This tells us a lot about the mindset of the economics profession. Economists were overwhelmingly in favour of Remain. If you think that the European Union is a great economic success story, bursting with dynamism and innovation, then it would be irrational to continue to spend after a Leave vote. You should be saving for a rainy day. Consumers have taken a different view, but one which may very well be rational.
A serious problem for economic forecasters, and indeed the profession as a whole, is groupthink. Writing about the crisis of the 1930s, Keynes said: “a sound banker, alas, is not one who foresees danger and avoids it, but one who, when he is ruined, is ruined in a conventional way along with his fellows, so that no-one can really blame him.” There is a real reluctance to go out on a limb and risk being proved wrong.
But there is a deeper reason why forecasts repeatedly fail. The problem is that the data on key variables such as GDP and inflation does not contain very much genuine information.
To make successful forecasts in any scientific setting, the data needs to have regularities which can be identified. No-one, for example, can successfully predict over time the outcome of the next shake of a fair dice. The outcome is completely random.
Economic data is not quite as bad as this from a prediction perspective. But the economy is bombarded continuously by so many different events that it is hard to pick out any underlying structure.
Imagine watching a hospital soap in which a screen shows the regular heart beat of a patient. Imagine now the screen plagued by constant interference. It would be difficult to distinguish the “signal” (the heart beat) from the “noise” (the interference). This is what economic data is like. And this is why forecasts are often wrong.
As Clint Eastwood said in Magnum Force: “a man’s gotta know his limitations”. Time for forecasters to wake up to this fact.
As published in CITY AM on Wednesday 12th January 2017
Last year was a year of celebrity deaths. But perhaps the most significant of all received very little coverage. Just before Christmas, Thomas Schelling, Nobel Laureate in economics, died aged 95.
In the early, tense years of the Cold War between America and the Soviet Union in the late 1940s and 1950s, Schelling’s ideas were enormously influential in preventing nuclear conflict from breaking out. As he pointed out in his Nobel Prize lecture, there was a real danger of this.
The US government invested heavily in the then new science of game theory. How do you handle a weapon which is so devastating you do not want to use it, while at the same time convincing the other side that you might? Schelling was instrumental in creating the strategy of credible threats.
But his mind ranged powerfully over a wide range of disparate issues. Our understanding of crime, obesity, smoking, binge drinking – a whole host of social problems – has been improved substantially by Schelling’s work. He saw that there are underlying similarities in how they develop.
His most important work in this area was published in 1973, in a paper with the fantastic title “Hockey helmets, concealed weapons and daylight saving”. Schelling’s inspiration was a piece in the sports section of a newspaper about ice hockey, a game even more brutal than Rugby League.
A star player had suffered serious head injuries from the flying puck while not wearing a helmet. The reporter interviewed other leading players, none of whom wore helmets. It was clear that they understood the very real dangers involved. A rational economic person, weighing up the costs and benefits, would always wear a helmet. But when asked why he didn’t, a top boy answered “I don’t because the other guys don’t”.
Schelling crystallised this into a mathematical concept he called “binary choice with externalities”. The choice facing an individual is binary. Either you wear a helmet or you don’t. Either you smoke or you don’t. But your choice may affect how other people in your peer group make their choices.
If no one else wears a helmet, you look soft by wearing one. If all your friends smoke, you may do so just to fit in. So the decision of an individual can have effects which are “external” to the decision itself. Understanding this is crucial to policy-makers trying to influence the outcome. Rational choice theory may not always apply.
His ideas on game theory live on. Indeed, they appear to have influenced President-Elect Trump. Trump has sent out many signs that he wants to work with Putin’s Russia. But just before Christmas, he tweeted, inexplicably to many, that America should expand its nuclear arsenal. He was in fact making a credible threat. Putin, an ex-KGB man, knew that it was Reagan ratcheting up defence spending which finally broke the old Soviet Union. So Trump signals in a single tweet: we want to cooperate, but if you don’t, your economy will collapse as you try to keep up with us.
Thomas Schelling, polymath of genius, I salute you!
As published in CITY AM on Wednesday 4th January
Image: Bomb by _Gavroche_ is licensed under CC BY 2.0
It’s certainly been an eventful year. But rather than dwell on the past, what sort of things can we expect in 2017? Here are a few eclectic predictions.
Sweden may become the world’s first cashless economy. Notes and coins are already fast disappearing as a means of payment, and retailers are legally entitled to refuse to accept them. Cash transactions make up less than 2 per cent of the total value of transactions in the Swedish economy. Over half of bank branches have no cash in hand and refuse to accept cash deposits. ATMs are increasingly hard to find.
The central bank, the Riksbank, is well advanced with its plans to launch its own digital currency, the e-krona. If this idea is adopted more widely by central banks, and it certainly feels like one whose time will come, where will this leave Bitcoin? Possibly as the international criminal’s e-currency of choice, possibly for use as baby sitting tokens, or equally possibly, it will become extinct.
Switching tack, there may be quite a lot of sympathy for the antics of the rail unions next year, certainly more than the Tory MPs demanding government curbs imagine. The long-suffering commuters of Southern will disagree with this point. Others, however, might look at South West trains, their near neighbour, and wonder how they manage to run a successful and profitable franchise without having driver-only operation of trains.
More widely, anti-globalisation sentiment is unequivocally on the rise. Any liberal still baffled by the US election might usefully read a paper in the July 2016 American Economic Review by Justin Pierce of the Federal Reserve and Peter Schott of Yale. They show that the sharp drop in US manufacturing employment after 2000 can be attributed to a change in US trade policy that eliminated potential tariff increases on Chinese imports. The electors in the rust belt states are the ones who suffered most.
The trade unions in recent decades have often been their own worst enemies, and have behaved stupidly. But sentiment is shifting, and the Prime Minister needs to be cautious.
Thinking of trade unions, readers of a certain age will recall the miners’ leader, Arthur Scargill, and his ludicrous attempts to conceal his essential baldness with a comb-over. President-Elect Trump, in contrast, has a truly marvellous barnet. His front-combing appears to defy the laws of gravity, just as his election appeared to defy the conventional laws of politics. Perhaps with Trump’s stylist, Scargill would have won the miners’ strike.
The crucial question is the hair style of Mark Carney. The crisp short-back-and-sides, with the immaculate side parting, is the epitome of the Daddy on the Daddies Sauce bottle of the 1950s and 1960s. Is this the real forward guidance which the governor of the Bank of England is trying to convey to us? That he expects a restoration of the economic conditions of those decades? GDP growth averaging 3 per cent a year, the government finances in balance, booming living standards, and unemployment of only 2 per cent. After Brexit, anything is possible.
As published in CITY AM on Wednesday 21st December
Image: bitcoin by fdecomite is licensed under CC by 2.0
The buzz-phrase of the moment in political discussion is “post-truth”. Shell-shocked metropolitan liberals are astonished by both Brexit and Donald Trump’s success. How could their own rational analysis not find favour with the electorate? People in the internet age must be no longer capable of recognising the truth.
Both the Brexiteers and Trump certainly created narratives about the future which appealed to people in a positive, exciting way. “Make America Great Again!”
But narratives about the future have always been important, not just in politics but in central banking too. During one of the recurring crises in the Eurozone, in 2012, European Central Bank president Mario Draghi proclaimed he would do “whatever it takes to save the euro”. Quite what he would have done if financial markets had continued to attack the currency is not at all clear. It was, in today’s terminology, a post-truth statement. But it worked. His narrative convinced traders and speculators to back off, and the euro lived to fight another day.
Of course, most elections aren’t fought on sweeping narratives about the future but on rather more mundane issues. Who can now remember, for example, what were the themes in the British general election of 2005, just over a decade ago? Even last year’s election was decided on pretty humdrum everyday stuff. Everyone knew things had been rather grim since the financial crisis, but could Labour be trusted to make them any better? In the marginal seats, the answer to this bread-and-butter question was a resounding “no”.
Memorable elections have been ones in which narratives about the future were important, when voters were asked to believe in a vision rather than dwell on the facts. At the end of the Second World War, Attlee’s Labour Party won a huge victory with its picture of a universal welfare state. In 1964, Harold Wilson overturned a massive Conservative majority with his portrayal of science and technology as the future, which Labour technocrats owned. The example of Mrs Thatcher needs no further description. And in 1997, Tony Blair projected a vision of peace and happiness in “Cool Britannia” – a post-truth concept if ever there was one!
The internet and social media certainly enable narratives so that they spread more rapidly and their noise levels are amplified. But the technology does not of itself create “post-truth”. There are far more dramatic and older historical examples of post-truth politics than the British examples above. Under Lenin and Stalin, the entire population of the Soviet Union lived “post-truth”. The reality of everyday existence diverged spectacularly from the narratives which the Communist Party worked so hard to create, and which so many people really believed.
The Brexiteers and the Trump camp knew how to use the networked society of social media. It is not just the message, but the maths which matters now. They understood which sites and tweeters to target, they grasped how to manipulate Google’s page rank algorithms. Despite their veneer of stupidity and supposed distrust of experts, they were actually much smarter than their liberal opponents.
As published in CITY AM on Wednesday 14th December 2016
Image: Donald Trump in Reno, Nevada by Darron Birgenheier is licensed under CC BY 2.0