The Oscars have come and gone for another year. Winning an Oscar is very often the basis for either making a fortune, or turning an existing one into mega riches. Jack Nicholson has an estimated worth of over $400 million, and stars like Tom Hanks and Robert de Niro are not far behind.
Even winners who lack the instant recognition of these stars do not do too badly. Cuba Gooding Jnr has recently starred in the American civil rights film Selma. But after his 1996 Oscar for a supporting role in Jerry Maguire, he became notorious amongst film buffs for appearing in movies which were panned by critics and which tanked commercially. This has not stopped his wealth rising to an estimated $40 million.
The Premier League has provided us with another example of success apparently reinforcing success. Its recent TV deal with Sky and BT Sports is worth over £5 billion. Along with investment banking, soccer is one of the few industries which practices socialism, with almost all the income of the companies eventually ending up in the hands of what we might call the workers. The year immediately prior to the financial crisis, 2007, still represents a high point in the annual earnings of many people. But the average salary of a Premier League player has risen over this period from some £750,000 to almost £2.5 million.
At one level, films and football seem to provide ammunition for the sub-Marxist arguments of people like Thomas Piketty, arguing that capitalism inevitably leads to greater inequality. The rich simply get richer. This conveniently ignores the fact that over the fifty years between around 1920 and 1970, there was a massive movement towards great equality in the West, in both income and wealth.
During the second half of the 20th century, a profound difference in communications technology opened up between the world as it is now and all previous human history. Television by the 1960s had become more or less ubiquitous in the West. Vast numbers of people could access the same visual information at the same time. The internet has of course enormously increased the connectivity of virtually the whole world.
These advances in technology have altered the way in which people respond to information. The importance of social networks in influencing the choices made by individuals has risen sharply. The economic model of choice in which rational individuals carefully sift all the available information is no longer even feasible in many situations. Almost all click throughs on Google searches, for example, are on the first three sites which come up. It is simply not possible to work through the thousands, or even millions, of sites which are offered.
This means that self-reinforcing processes are set up. Things which become popular become even more popular, simply because they are popular. And because of communications technology, we know what is popular. In popular culture, a rapidly growing sector of the economy embracing both films and soccer, high levels of inequality of income are inevitable
As Published in City AM on Wednesday 25th February 2015
INEQUALITY is now a buzzword in Britain. Scarcely a week goes by without a new publication by an academic or journalist lamenting the levels of poverty facing swathes of the population. They are bolstered by a complicit metropolitan liberal elite, who shed crocodile tears for the poor, while ruminating on the current situation.
Unfortunately, much of the work coming out of universities can hardly be described as scientific. Rather, it could be described as “advocacy research”. In other words, research that is carried out with the intention of providing evidence and arguments that can be used to support a particular cause or position. And too often, the taxpayer is left financing such activity.
However, a new book on poverty, Breadline Britain, deserves to be taken more seriously. The authors, economist Stewart Lansley and academic Joanna Mack, wrote the first version in 1983 when they were producers at ITV’s current events programme, Weekend World. Over the next three decades, they continued to collaborate on the topic.
Lansley and Mack make the startling claim that one in three households now suffer from poverty. Their method of calculating this figure is intriguing. Instead of wrestling with intricate statistical methods, they simply go out and ask ordinary people what they consider to be the basic necessities for a decent standard of living. On this basis, the percentage of households lacking three or more of the items listed has risen from 14 per cent in 1983 to 30 per cent now.
Of course, like any measure of relative poverty, it is open to the valid criticism that in material terms the poor are far better off than they were. But it does serve as a useful reminder of the different qualities of life which are on offer in the UK today.
A key point in the book is that poverty is far from being confined to those on benefits. A rising proportion of the poor are in work. The authors cite the usual suspects of zero hour contracts and the spread of low pay. But there is one fundamental driver of these changes in labour markets which they do not face up to – namely, mass immigration.
Under New Labour, Britain’s borders were effectively opened completely. While the party was in power, immigration added more than 3m to our population. At the time, we were invited to believe that this would have no effect on real wages. Equally, we were assured that immigration was vital in combatting the effects of an ageing society. Critics such as Bob Rowthorn, then head of the Cambridge economics faculty, were pilloried for making the obvious point that immigrants themselves get older.
Unsurprisingly, the increased supply of labour has driven down real wage rates at the lower end of the market. And the imperatives of politics means that benefit levels have had to follow suit.
If Lansley and Mack are right, as the inequality debate persists, we must acknowledge the part that the liberal elite’s advocacy of mass immigration over the past two decades has played in impoverishing the indigenous working class.
As published in City AM, Wednesday 18th February 2015
EVERY year, the supermarkets hire substantial batches of high-flying graduates to work in their buying departments. The urban mythology is that these expensively-educated young people are paid to shout down the phone, browbeating suppliers to offer yet more discounts.
This hectoring seems to be at the heart of the recent decision of the Groceries Code Adjudicator to investigate Tesco, following allegations that the company delayed payments to suppliers and unfairly handled payments for shelf promotions. These particular complaints may prove groundless. Yet they don’t exactly serve to diminish sentiment that Britain’s large firms can act as ruthless short-term profit maximisers, squeezing their supply chain for every penny. Of course, even if that is the case, we could simply see it as being part of the workings of the free market, in which the most efficient survive. But given the relative sizes of our corporate giants and most of their suppliers, there is an inherent imbalance of power at play.
So how else could these supply chains be managed? Milk is a topical example, in which the much-maligned Tesco, along with Marks and Spencer and Waitrose, is cast as the good guy. It established long-term contracts with suppliers, in which the dairy farmers are probably getting around 30p a litre for milk. Amid allegations that supermarkets are using milk as a loss leader in price wars, other farmers are believed to be receiving as little as 20p a litre – below the cost of production. The National Farmers Union warns that many will be driven out of business; over the past decade, nearly 10,000 dairy farmers have left the industry.
Another answer can be found in many extant markets that function in more sophisticated ways, flying in the face of the simple economic textbook injunction of “slash costs and maximise profit”.
A 2012 paper by Alan Kirman of the University of Marseilles and Nick Vriend of Queen Mary, London, demonstrated this by studying Marseilles’ wholesale fish market. They obtained a data set documenting every single transaction that took place in the market, across a number of years. At the time, there were about 40 registered sellers, and around 400 regular buyers. The prospective buyer approaches a seller and says what he or she wants, and is quoted a price – crucially, no prices are advertised. The price quoted is on a take it or leave it basis, and there is no bargaining.
You would be forgiven for wondering how these non-conventional features translate into business. But for every type of fish, and across the market as a whole, the classic downward sloping demand curve is seen. A higher average price means less is bought. And in a reciprocal process, buyers become loyal to the sellers who offer them the highest utility. In turn, sellers tailor their products and services to these loyal buyers, who prompt higher gross revenues.
There is a lesson here for larger companies. Developing such longer term relationships may enable value to be created in the supply chain – in contrast to the conventional model, in which it is well and truly squeezed out.
As published in City AM on Wednesday 11th February 2015
Game theory is a big topic in academic economics. It is scarcely possible to graduate from a good university without exposure to its abstruse logic. So perhaps the Greek government, replete with economists, is using game theory to plan its tactics. Or is Chancellor Merkel herself being briefed with calculations carried out deep in a hidden bunker stuffed with game theorists?
The subject was invented in the 1940s by John von Neumann, one of the greatest polymaths of the entire 20th century. He made major contributions to the development of both the computer and the atomic bomb. But it is for his game theory that economists remember him. It appears to offer a rational, calculable way of dealing with uncertainty.
The United States military poured huge resources into the topic, using some of the best minds in the country, shortly after the Second World War, once the Soviet Union acquired nuclear weapons. Both the Americans and the Russians could be assumed to be rational in the sense of preferring to avoid a nuclear exchange. But, lacking certainty about the strategy of the opponent, might the best action be to launch a pre-emptive strike? This is the whole essence of game theory. In the jargon, you either play a co-operative strategy, or you defect. In other words, you either live with the nuclear stand-off, or you get your retaliation in first.
To co-operate or to defect, that is the question. The game being played in the current Greek tragedy is a multi-player one, but the principle is the same. The Greek government hints at a willingness to defect by cosying up to Putin’s Russia, scaring the NATO establishment. From a Greek perspective, the statements of hardliners in, for example, the European Central Bank is equivalent to a policy of defection being played against them. No concessions, according to this strategy.
This fundamental insight of game theory does tell us something about the world. Cartels, for example, are difficult to sustain. Although members benefit by keeping prices up, by playing a co-operative strategy, there is the constant temptation for individuals to defect, to believe that they can steal an advantage by going it alone. Even OPEC has not been immune from this pressure.
Beyond this important general contribution, game theory does not offer much guide in many practical situations. There are now literally tens of thousands of dense mathematical academic papers which try and obtain the optimal strategy. Even the brief bits of English in the articles would be incomprehensible to non-specialists. But the final answer has not yet been found.
Perhaps the biggest weakness is that game theory requires clear and distinct rules of the game. In the current Euro crisis, it is not even clear that the players are in the same game. For Greece, it is a one-off, they want to change policy in their own country. For the ECB, IMF, Germany, if they co-operate in this, the worries are about the next game in the sequence against Spain, Italy or whoever. Politics is a better guide than economics.
As published in City AM, Wednesday 4th February 2015
Many outrageous things happened around the world during the course of last week. But, judging by both the level of popular interest in the story and reaction to it, the most heinous was the decision of a mother to send an invoice to the parents of a boy who did not turn up to her son’s birthday treat. A demand for £15.95 was slipped into his schoolbag after he missed the outing to a local ski centre.
The adverse sentiments seem to be partly based on the feeling that it was inappropriate to introduce the principles of markets – a price was charged – into purely social relationships. Hostility to markets is a very widespread phenomenon. Many people get apoplectic at the idea of markets being introduced into the NHS. It was actually the post-war Labour government which began the process in 1951, charging for teeth and spectacles. But why let facts get in the way of a faith? Firms which fill gaps in the market by providing loans to high credit risk individuals are regularly pilloried for the rates of interest which they charge.
But the whole history of progress is based upon the gradual spread of markets across the range of human activities. In the distant mists of pre-history, humans were organised into tiny, self-sufficient groups in which markets were unknown. As the American anthropologist and best-selling author Jared Diamond points out in his latest book, The World Until Yesterday, life was pretty unpleasant. Nasty, brutish and short, as a famous philosopher once said.
Diamond has a wealth of evidence from areas like New Guinea, where primitive forms of human social structures survived almost until the present day. Contact with other small bands of people was largely based upon the principles of rape, pillage and murder. Strangers were intensely feared and liable to be killed on the spot.
As a species, it took us many thousands of years to start to work out that, in order to benefit from what other groups could produce, it was better to use markets and trade rather than invade and loot. In modern times, societies which have tried to suppress markets, like Stalin’s Soviet Union, Mao’s China and contemporary North Korea, have merely perpetuated grinding poverty for the masses. On a much less serious note, Ed Miliband’s pledge to buck the market and freeze energy prices has just left him looking foolish.
The real problem with the birthday party was that the bill was sent after the event, without prior consent of the participants. Places on the trip were limited, and telling people in advance that no shows would be charged would have been an efficient way to ration scarce resources. Otherwise, the only sanction would be social disapproval. And social norms are always open to exploitation by free riders. An example is in the NHS, where a modest charge to visit a GP would go a long way to reducing pressures on surgeries. Most people behave reasonably, but a minority abuse the system. We need more markets, not less.
As published in City AM on Wednesday 28th January 2015
Executive bonuses are back in the news. The Goldman Sachs pot of £8.3 billion has been prominent. German executive pay has overtaken that in the UK for the first time. Top management seems to have no shame. Some bad publicity today, but the fat cheque remains safely in the bank account.
How one longs for the days of Cedric the Pig! This was the unfortunate nickname bestowed upon Cedric Brown, the Chief Executive of British Gas whose salary was increased by 75 per cent to £475,000 at the end of 1994, at a time when the company was making staff redundant. This works out at just over £700,000 at today’s prices. We can usefully contrast this with the remuneration package of Iain Conn, the newly installed Chief Executive of Centrica, parent company of British Gas. We read on the Centrica website that his basic salary is £925,000. Well, perhaps not an indecent amount more than poor Cedric. But the text goes on ‘to provide continuity of incentive opportunity prior to new arrangements being established two transitional awards will be made’. ‘Continuity of incentive opportunity’ means he could be in line for share awards of up to three times his base salary, plus pension contributions and ‘other benefits’.
Compared to many leading companies nowadays, the remuneration committee of Centrica has acted with a certain amount of restraint. Last year, the average FTSE Chief Executive was paid 143 times the salary of their average workers.
Perhaps economic theory can be used to justify these various payments? An essential component of any basic course in economic principles is the so-called marginal productivity theory of wages. ‘Marginal’ here does not have its everyday meaning in English, but is a piece of scientific jargon. It means the additional value contributed to the firm by a particular worker. According to the theory, the massive increases in executive remuneration over the past two decades or so are entirely justified. People are paid what they are worth. Certainly, this sentiment is prominent in corporate justifications for pay packages. World class individuals are needed, who can deliver world class performances.
There are many practical criticisms of this description of how pay is determined. Yet even within the abstract confines of economic theory itself, it cannot be justified. Economics has no theory with which to explain the distribution of income. This result, which required many pages of maths to prove, was established as long ago as the early 1970s. The lineage is impeccable. Gerard Debreu received the Nobel Prize for his work on equilibrium theory, and Hugo Sonnenschein went on to become President of the free-market oriented University of Chicago. But only high level graduate students, once they have been thoroughly socialised as economists, are taught these theorems.
The simple fact is that executive pay is almost entirely determined by social values and norms. The sense of restraint, of noblesse oblige, which characterised much of Britain’s post-war history, has vanished. Until top management learns to behave respectably again, the problem will remain.
As published in City AM on Wednesday 21st January
Youth unemployment remains a serious problem in Europe. There is the tiniest glimmer of hope in that the number of young people under 25 unemployed in the Euro zone is 58,000 lower than it was a year ago. But that still leaves 3.4 million without a job. In Italy, the youth unemployment rate is 44 per cent, in Greece nearly 50 per cent and in Spain 53 per cent.
In principle, many of them could set up their own small businesses. A generation or two ago, this would not have been feasible. Economies were much more dominated by capital intensive industries. An unemployed steel worker, for example, could hardly set up a plant in his backyard. Massive industrial plants relied upon what economists call increasing returns to production to generate their efficiencies. In other words, the more a factory made, the lower would be its unit costs of production. But the key feature was the initial investment required to start the process in the first place.
In the modern service oriented economy, the capital requirements to set up a business are minimal. We are moving back in part to an economic structure which existed before the Industrial Revolution. Then, most producers were peasant farmers or specialist master craftsmen. If they employed anyone at all, it was on a small scale. It was the world described by the great early economists such as Adam Smith.
This is by no means a matter of pure historical curiosity. It led to a theoretical concept which still underpins a great deal of modern economic theory, albeit now heavily disguised by advanced mathematics. This is the idea known as Say’s Law. Put simply, it says that supply creates its own demand. A fully functioning market economy should never have any persistent involuntary unemployment, it pulls itself up by its own bootstraps. All that the unemployed have to do is to set up in business, and the market mechanism will take care of the rest.
The boom in self-employment and flexible hours working in the UK is entirely consistent with what appears on the face of it to be a highly abstract and unrealistic view of the world. But all scientific theories have to make assumptions and simplifications, the question is how realistic they are. For most of the 250 years since Adam Smith was writing, Say’s Law did not apply because of the structure of production. It is starting to become relevant again. Anyone who can read and write and has access to a computer can, for example, create an internet based business.
Part of Europe’s youth unemployment problem is cultural. They rely on the state for solutions. But the constraint of needing some capital to start a business might bite at a very low level. One policy to overcome this could be just to give Europe’s young unemployed a one-off payment of a few thousand Euros. Most of the money would be wasted, but some of them might take the chance to try and shape their own future.
As Published in City AM, 14th January 2015
Will 2015 be the year in which fantasy economics in Europe is finally put to the test? Somewhat to the surprise of many commentators, in December the Greek political class failed to elect a new president even after three attempts. Parliament has now been dissolved and an election will take place on 25 January. The left-wing Syriza party currently leads in the polls.
In Scotland, the nationalists have rebounded following their heavy defeat in the referendum and seem poised to annihilate Labour in the May 2015 General Election. Paradoxically, this could very well ease their path into a Labour-SNP coalition and accelerate effective independence in Scotland.
Syriza’s leader, Alexis Tsipras, invites the Greeks to believe that most of their debts can be written off, austerity policies abandoned, and the country can still keep the Euro as its currency. Both Alex Salmond and the new SNP leader, Nicola Sturgeon, keep straight faces when they tell the Scots they can be independent, rich, stay in the EU, have high public spending and their banks supported by the Bank of England.
The clear warning provided by Russia, moving into deep recession after the collapse of the oil price, does not seem to have given the SNP pause for thought at all. Indeed, Mr Putin and Ms Sturgeon apparently share the gift of clairvoyance. They both assure us that the fall in the oil price is merely a temporary dip and it will soon return to a level above $100 a barrel.
Tempting though it is to wish Syriza and the SNP in power to test their theories, this does not seem the most likely outcome. The Greek leftists currently lead the conservatives by only 3 per cent in the polls, and there is all to play for in the British general election.
But there is much more to it than this. The financial crisis has simply not brought fantasy parties into power. Despite the banker bashing rhetoric and the cries from academic economists to abandon austerity, the electorates still seem, stubbornly, to prefer middle of the road governments. In the Netherlands in 2012, for example, the Socialists at one point led in the polls during their election campaign, but were defeated. In Scotland itself, the Yes campaign lost decisively. France is a possible exception, but Hollande is now exceptionally unpopular.
Prospect theory, developed by Nobel Laureate Daniel Kahneman and Amos Tversky, helps understand why this has been the case. This theory in behavioural economics describes how people choose between alternatives that involve risk. Hilaire Belloc anticipated it a century ago in his poem ‘Jim’, a boy who ran away from his nurse and was eaten by a lion: “Always keep a hold of Nurse, for fear of finding something worse”. A key element in prospect theory is precisely that losses hurt more than gains feel good. Maybe Syriza is right and the Greeks can have it all. But if it goes wrong, the consequences could be very unpleasant indeed.
As published in City AM on 7th January 2015
As the seventh anniversary of the start of the economic crisis approaches, it is an appropriate moment to take stock. At the time, the recession was simply not recognised by conventional economic forecasts. These continued to foresee positive growth until the collapse of Lehman Brothers in the autumn of 2008. But the latest national accounts data now show that output began to fall in most Western countries during the winter of 2007/08.
The initial falls in GDP were sharp, but the overall outcome was in general better than that of 1930, the first full year of the Great Depression of the 1930s. The most dramatic contrast is America. Output was less than 1 per cent lower in 2008 than in 2007, in contrast to the 9 per cent fall in 1930. The financial crisis was a severe shock, but by the end of 2009, the worst seemed over. The standard definition of a recession is a fall in GDP over two successive quarters, and it ends when output grows again. As early as the autumn of 2009, this was the case in almost every Western country. Looking back to 1931, the second year of the crisis of the 1930s, output had continued to drop virtually everywhere, often at an accelerated rate. In Germany, for example, GDP was reduced by 6 per cent in 1930, followed by a further 10 percent collapse in 1931.
Optimism rose markedly in 2010 as a result. The nightmare of a potential repeat of the 1930s looked to be well and truly squashed. But as we move into 2015, the similarities between now and the 1930s become closer and closer. Across the West as a whole, the number of countries in which GDP is still below its 2007 peak level is almost the same as it was in 1936, seven years into the Great Depression. In Spain, output is 6.5 per cent below its previous peak, in Italy 9.5 per cent and in Greece a massive 26 per cent.
The total losses in output during the crisis in some economies are terrifying. To obtain this, every year we calculate the amount by which GDP falls short of its previous peak level, and sum these up to get the cumulative total. In Italy, the overall shortfall in output is 43 per cent of the value of GDP in 2007, and in Ireland it is 53 per cent. The Greek loss of 106 per cent may by 2016 exceed the highest previously recorded, which is the 132 per cent loss experienced by the United States 1929-1939.
The big difference between the 1930s and the late 2000s in North America and the UK is that the authorities followed expansionary monetary policies such as quantitative easing, which they did not do in the earlier period. It is hard not to conclude that the policies of the European Commission and the Central Bank have been catastrophic. The size and duration of this recession is set to break all records in several Euro zone economies.
As published in City AM on 16th December 2014
Very strange things have been happening in government bond markets. The yield on 10 year US bonds is currently around 2.25 per cent. It makes intuitive sense that the Germans, with their longstanding reputation for fiscal prudence, are enjoying a much lower rate, some 0.8 per cent. Similar levels obtain in most of the countries which we might now reasonably think of as Greater Germany, those with close ties to the Federal Republic. So rates are at or below 1 per cent in countries such as Austria, the Netherlands, Finland and the Czech Republic.
Yet it seems to defy reason that rates in other EU countries are below those of America, sometimes considerably so. 10 year French government bond yields are only 1 per cent. Almost incredibly, in both Italy and Spain they are under 2 per cent, lower not just than those in the US but fractionally lower than in the UK.
The massive falls in bond yields during 2014 are of course good news for the indebted countries. And the implication that the markets consider the risk of default to have virtually disappeared seems to be to the benefit of all.
But the worldwide trend to lower yields on long dated government bonds carries some gloomy implications. In the weird and wonderful world of economic theory, there is a marvellous concept that capital is ‘putty-clay’. An institution sits on a pile of cash, which as it stands can be made into almost anything. But once it is invested in, say, a research and development project, a new Big Data base or in building a new office, it becomes much more difficult to change. The putty has become clay.
At least, that is, for the time being. Given sufficient time, the clay can be transformed back into a much more flexible form. If we pull an even more fundamental tool out of the box of economic theory, that of long-run equilibrium, this tells us that the rate of return on all types of assets should tend to be the same. For the economy as a whole, where investments are made in machines and buildings, the rate of return is simply the rate of inflation plus the real rate of growth. And the same formula applies, in the long run, to government bonds. In the long run, both bonds and fixed investments are putty, not clay.
No-one ever made money using this simple algorithm, but in a mad sort of way it makes sense. Bond yields of 1 per cent or less do not just tell us that inflation is expected to be very low. So, too, is economic growth. Intriguingly, the yield on bonds in Poland, which is just as closely tied to Germany as the countries mentioned above, is some 2.6 per cent. And Poland has been the most successful EU economy in terms of growth over the ‘long run’ of the past twenty years. But for the rest of the EU, the message from the bond markets is gloomy.
As published in City AM on 9th December 2014