The Euro zone lurches into yet another crisis, with fears of deflation and a further drop in output. There are several dominant explanations of why Europe has been unable to recover from the crisis. Most commentators subscribe to them either on their own, or in various combinations, depending on their tastes.
One puts the blame squarely on excessive public debt. Confidence can never be restored until this is tackled. Another perspective points to low productivity and high unit labour costs in the Mediterranean economies. Until they transform their economies, they will never be able to compete with the dynamic economies of Greater Germany – Poland, Austria, Sweden and the like. A related but separate argument puts the Euro itself in the frame. One size does not fit all, and some countries need to leave. George Soros has an original perspective on this, suggesting that Germany should exit, and a Deutschmark appreciation would make the residual Euro zone economies competitive again.
An intriguing new book by Philippe Legrain, European Spring: Why Our Economies Are in a Mess, challenges every single one of these ideas. At first sight, Legrain is the epitome of the successful Eurocrat. He is British, but his father is French and his mother Estonian. He, somewhat ostentatiously, has command of numerous languages. And he has just completed a spell as head of the strategic policy team advising Manuel Barroso, recently retired President of the European Commission.
But the first part of his book is a no holds barred attack on the two central institutions of Europe, the Commission and the European Central Bank. He documents in impressive detail mistake after mistake made by these two august bodies, before, during and after the 2007-09 financial crisis. For example, during the 2010-12 period, there were many similarities between the state of the UK economy and that of the Euro zone. Yet the latter suffered devastating financial panics, whilst we did not.
Legrain points accusingly to European level policy makers. They consistently misdiagnosed problems, treating the fact of Greek insolvency as a question purely of liquidity, and the liquidity issues of the rest of the GIPSIs (his marvellous phrase for Greece, Ireland, Portugal, Spain and Italy) as failures of solvency. Unlike the American authorities, who have closed down 475 banks since 2008, Europe continues to prop up zombie banks, which stymies the recovery. Further, they completely failed to control the narrative with which policy changes are received by the markets, and which is the key to the effects such changes have.
The second part is an impassioned plea to make Europe more competitive in ways which will gladden the hearts of many readers. Cut income taxes, scrap restrictive labour laws and revere entrepreneurs. The scale of the challenge of implementing such policies is shown by the recent decision by Luddites in Germany to ban the Uber taxi app. If Steve Jobs had been French, he would have ended up as a programmer in a nationalised industry with a job for life and a gold plated pension.
As published in City AM on Wednesday 9th September
Lurid stories about the excesses in the UK housing market continue to proliferate. True, there is some evidence of a cooling, as the price rises tempt more sellers into the market and temporarily increase supply relative to demand. But at the same time we learn in the Sunday Times that the good burghers of Cobham enjoyed on average – on average! – an increase in the value of their homes of no less than £647,000 over the past twenty years. Other areas in the Home Counties saw similar huge capital gains.
The Bank of England is known to be concerned about the possibility of a new house price bubble, of prices being driven further and further away from levels which can be justified in terms of fundamental economic circumstances. Such bubbles end in tears, and some readers may recall the dramatic collapse in prices which took place at the end of the so-called Lawson boom at the end of the 1980s. In many places, house prices did not regain theses peak levels until the early 2000s.
The real worry is that any such bubble would have damaging effects on the rest of the economy. The new buzz phrase in policy circles is ‘macro prudential’. Central banks are now much more aware of the damage that shocks in just one sector can cause, as their effects cascade across the economy as a whole. And it was in the housing sector that the financial crisis began in the United States.
Much of the public outrage about the crisis rests on the belief that the incentive structures in financial institutions encouraged people to take huge risks, with no personal downside. Wall Street, it is alleged, knew about the risks of a financial collapse, but simply carried on securitising mortgages of ever decreasing quality.
A new paper in the American Economic Review undermines this widespread perception. Ing-Haw Cheng, of the Ivy League Dartmouth College, and colleagues from Michigan and Princeton analyse the personal home transaction data of managers in securitized finance in the period immediately before the housing crash. In other words, when they were buying and selling on their own accounts, using their own money, did they behave as if they were aware of the housing bubble and the looming crisis?
The conclusion is stark. In general, these managers neither timed the market correctly, nor were they in any way cautious in their own transactions in the housing market. They seemed unaware of the overall problems in this market. Indeed, a sizeable proportion of securitisation agents were particularly aggressive in increasing their personal exposure to housing in the run up to the crash.
The problem, Cheng and colleagues conclude, was not the incentive structure. It was a problem of psychology. Company ethos fostered both over-optimism and groupthink. Different beliefs about the housing market were not encouraged. A massive divergence arose between the dominant narrative on Wall Street about the housing market, and what was actually happening to prices. Monitoring beliefs seems crucial to avoiding the next crisis.
As published in City AM on Tuesday 22nd September
Sir James Mirrlees is one of the mere handful of British recipients of the Nobel Prize in economics. As his fine old Scottish surname might suggest, he has been active in the debate on independence. His latest intervention, which has attracted considerable publicity, is to pronounce that an independent Scotland should be willing to repudiate its share of the UK’s public sector debt. This would be, Mirrlees asserts, a bargaining chip to be used to ensure that a currency union with the rest of the UK will be set up. The Bank of England would continue to act as a lender of last resort to the Scottish banking system.
We might usefully recall the nature of the distinguished work which led to Sir James being elected to the Nobel Laureate. It is almost as far removed from monetary theory as it is possible to be in economics. It consists of some highly mathematical work on the concept of optimal rates of tax. It implies that marginal tax rates should fall, not rise, with income. Indeed, the marginal rate on the highest earner of all should be zero. This rather limits its use in practice.
The idea that one of the first acts of a fledging nation would be to repudiate its debts seems similarly impractical. Such an act would immediately brand Scotland as part of the club formed by countries like Argentina and Russia, serial defaulters with dodgy economies.
The debate in Scotland is pervasive, dominating both the media and many personal relationships, as even a cursory visit there will make clear. But it has a fairytale quality to it, with the pro-independence camp, like the Red Queen in Alice in Wonderland, inviting the electorate to believe at least six impossible things before breakfast.
A persistent theme is that Scotland is so important that everyone else will simply fall in with its demands. The main political parties in the UK may insist that the Bank of England will not underwrite the Scottish banking system after independence. But this is mere bluff, Scotland is too valuable to the rest of the UK. The European Commission may say, not once but several times, that Scotland would cease to be a member of the EU and would have to re-apply to join. But they are wrong! Europe could not afford to be without Scotland. Spain and Belgium say they would veto any such application, but they simply do not know their own minds. Scotland, with its vast population of 5 million, will exercise its influence.
The fundamental problem facing an independent Scotland would be the familiar one of a small, social democrat government in a globalised system. Its freedom to act independently, to have high public spending and at the same time keep interest rates low, is very constrained. It is very tempting to wish them “oan yir merry way!” and let them find out. But that would be unfair to the many thoughtful Scots who continue to see the benefits of the Union.
As published in City AM on Tuesday 26th August
The latest employment figures confirm the buoyancy of the UK labour market. In the quarter April-June of this year, employment rose by 167,000 on the previous quarter, to an all-time high of 30.60 million. Unemployment also fell, by no less than 132,000. Taking a somewhat longer perspective, the low point for employment was reached in the first quarter of 2010. Since then, the total has expanded by no less than 1.8 million, a 6 per cent rise. The same is true for total hours worked, which are up by 8.4 per cent over the same period.
Many commentators see this as something of a paradox. Total output, GDP, has only risen by similar amounts. The trough for output during the recession occurred in the middle of 2009. Employment changes tend to lag behind output, as companies take time to adjust to new conditions. But even juggling around with the dates, it is clear that the overall productivity of the economy, whether in terms of output per employee or output per hour worked, has essentially been flat for four or five years. This is certainly very unusual. Productivity tends to rise rather quickly during a recovery, with output changes running ahead of increases in employment.
A simple explanation is that the price of labour has fallen sharply. Since the start of 2008, just before the start of the recession, average weekly earnings have only increased by 10 per cent. There is a variety of ways to measure inflation, but broadly speaking prices have risen by 20 per cent over the same period. So in real terms, the cost of employing someone has fallen by around 10 per cent. The ultimate expression of this is of course the notorious zero hours contracts, with an estimated 622,000 people, or 2 per cent of total employment, being on them.
The political economy of the earnings figures is intriguing. In January 2008, average weekly earnings were £434. But the earnings of both the public and private sectors were very similar, with the private sector being just £6 a week ahead. By the time of the General Election in May 2010, this had altered dramatically. Gordon Brown essentially tried to gerrymander the election by stuffing money into the pockets of the group most likely to vote for him, workers in the public sector. Their average weekly pay rose to £466, compared to only £449 in the private sector. The coalition has been trying to close the gap, and to some extent has succeeded. But on the May 2014 estimates, average public sector pay is still £11 a week more than in the private sector.
Developments in the labour market present Ed Miliband and Ed Balls with a challenge. Balls in particular committed himself firmly to the view that there could be no recovery under austerity policies. But despite the weakness in average earnings, it is almost always true that people are better off in employment than on benefits. The real paradox is that Britain’s cut-price labour market is actually reducing inequality.
As published in City AM on Tuesday 19th August
The Premier League kicks off again this weekend. Given the abysmal showing of our boys in the World Cup, a falling off of interest might be expected. But increasingly, the competition attracts many of the best players from all over the world. A self-reinforcing process has been set up on a global scale. The more popular both the League and its individual clubs become across the world, the more money is brought in through TV rights, merchandise sales and so forth. Even better players can be employed, which increases its attractiveness even further.
Yet this very process makes the competition more boring in the sense that the outcomes at the end of the season become more predictable. The places really worth playing for are the top five, which guarantee entry into European competitions. If we step back in time, to the days of the old Football League Division One, which became the Premiership in the 1990s, there was frequent turnover in these elite positions. Fifty years ago, in 1963/64, the names of the top five are very familiar: Liverpool, Manchester United, Everton, Spurs and Chelsea, in that order. But both three years before and after, in 1960/61 and 1966/67, just two of these finished in the top five. Spurs were in fact the only one of the 1963/64 teams to claim a top five slot in each of these three seasons.
In recent years, turnover in positions at the top has atrophied. Over the past ten seasons of the Premiership, Arsenal have been in the top five in every single one, and both Chelsea and Manchester United have appeared on nine occasions. Liverpool and Spurs feature in six. Manchester City muscled their monied way to success in 2009/10 and have been in the top five ever since. The only rank outsider to finish in the top five in the past decade was Newcastle, squeezing into fifth in 2011/12. The top half dozen clubs now effectively form a league within a league.
The decline in turnover has accelerated during the lifetime of the Premiership. The winners in the opening season were, predictably, Manchester United. But, almost incredibly from the vantage point of 2014, the next five were Aston Villa, Norwich, Blackburn Rovers and QPR. Even during the first decade, top five turnover fell. Manchester United filled one of the slots in each of the ten seasons, with Arsenal and Liverpool on eight and seven respectively. But Leeds, now vanished to the nether regions, was in the top five on seven occasions also. Other clubs had a chance.
The situation is not so dire as it has been since time immemorial in Scotland. No team apart from Celtic or Rangers has won the championship since 1985. Until Rangers went into liquidation in 2012, there was only a single season in which these clubs did not fill the top two slots in the Scottish Premier League.
Perhaps the fans like it this way. To paraphrase TS Eliot ‘human kind cannot bear too much excitement’.
As published in City AM on Tuesday 12th August
Many readers at this time of the year will be looking forward to their summer break, perhaps contemplating with a certain amount of envy their colleagues who have already departed. But is leisure good for you? A bit of a no brainer one might think. Indeed, until recently the consensus amongst applied economists was that even enforced leisure, by being made unemployed, seemed to be a good thing.
Recessions obviously make more time available for leisure as unemployment rises and opportunities for overtime shrink. The financial crisis led to more innovative ways of expanding leisure time amongst the labour force. Many people were given the option of switching to a part-time basis with reduced income rather than losing their job altogether. The most extreme version of this is of course zero hours contracts. Given the choice, most people in these situations would choose to work, and work full time, rather than being forced to take more leisure time.
But there is a substantial literature suggesting that recessions actually increase longevity, and lead to a general improvement in the overall health of a nation. The most famous example is the sharp increase in life expectancy which took place during the 1930s in the United States, at the time of the Great Depression when unemployment rates touched 25 per cent. This, however, is basically attributable to massive improvements in the public provision of better sewers and better water supplies not just in that decade, but throughout the opening decades of the 20th century.
The academic work investigating outcomes in more recent decades assigns specific short-term benefits to the health consequences of recessions. The levels of smoking are reduced, because people cannot afford to buy as many cigarettes. People take more physical exercise. They walk rather than use cars or public transport. The splendidly named Tinna Asgeisdottir demonstrated very clear health benefits of the financial crisis in Iceland in a National Bureau of Economic Research (NBER) paper. Economists have even discovered positive benefits for the health of people in care homes. During recessions, the quality of staff competing for these jobs rises, because relatively skilled people are made unemployed, and so the overall standard of care increases.
These findings may seem somewhat implausible, but they emerge from careful statistical analysis of large scale data sets. However, a new paper in the American Economic Association’s journal Economic Policy does find strong evidence that recessions are particularly bad for workers approaching retirement age. Courtney Coile and colleagues at the NBER merge data from sources such as the US Census and the Vital Statistics data base from the National Center of Health Statistics and examine the survival probabilities of those in the 55 to 65 age group. Even for this group, the short-term experience of a recession is for mortality to fall. But it soon rises quite sharply, resulting in lower survival rates at older ages. Of course, one reason is peculiar to America, namely the lack of access to health care when unemployed. Perhaps in Europe even this group benefit from enforce leisure.
As published in City AM on Tuesday 5th August
Does inequality in the output of scientists matter? Inequality is a fashionable topic these days, and evidence for its existence is keenly sought in all sorts of places. John Ioannidis, a health policy researcher at Stanford, and his colleagues have found it in the research outputs of their fellow academics. In a paper published in the prestigious journal PLoS ONE, they searched the entire published scientific literature in academic journals over the period 1996-2011.
They discovered that a grand total of over 15 million individuals had published a paper in a peer reviewed scientific journal. However, only 150,000 had published something in every single one of those years. And these individuals were authors of almost 42 per cent of the total number of articles which appeared. It appears to give a new dimension to the Occupy Wall Street slogans. Less than one per cent of scientists ‘own’ almost half the academic literature in the world between 1996 and 2011.
Reactions from some academics have been dismissive. There has been a massive growth of journals in recent years, to meet the demands on academics everywhere to publish something, somewhere. The phenomenon was satirised decades ago in Kingsley Amis’ classic comic novel Lucky Jim. The young academic anti-hero, struggling in his career, publishes, in a brand new journal based in Argentina, a totally futile article entitled ‘Economic Consequences of the Development of Ship Building Techniques 1450-1485’. Such journals now proliferate and, as Chris Cramer of the University of Minnesota remarked in ‘Nature’, ‘some would probably publish your local phone directory if you coughed up the page charges’.
But Ioannidis and his colleagues consider their findings to be rather disturbing. If a few established researchers dominate the literature, they suggest, it will be difficult for younger scientists to make their mark: ‘The research system may be exploiting the work of millions of young scientists for a number of years without being able to offer continuous, long-term stable investigative careers to the majority of them’.
Their own discoveries should in fact lead them to conclude that this inequality in scientific output is actually a good thing. The 1 per cent may publish nearly half of all the papers. But they account for almost 90 per cent of the papers which have more than 1000 citations. This is how the scientific community assesses the quality and importance of an article. Scientists have to acknowledge previous work in their area, and they do this by citing papers already published in the literature. The more a paper is cited, the more important it is. A citation level of more than a 1000 puts the authors in the field of sight for a Nobel Prize.
The implication is that research grants should be allocated in an even more concentrated way than they are now. Some should be scattered in a ‘blue sky’ way, to encourage young researchers. But the elite one per cent is responsible for almost all the progress made in science over the past two decades and should get most of the cash.
As published in City AM on Tuesday 29th July
The financial crisis has undoubtedly created a demand in popular culture for works which portray capitalism in a bad light, such as the recent best seller by Thomas Piketty. Piketty’s writing has gathered increasing attention from economists, and his arguments do not really bear scrutiny.
The focus of Piketty’s work is the long-run evolution of the ratio of capital to income. He claims that this is now very high by historical standards, and will rise even further as the 21st century unfolds. Wealth will become more concentrated and inequality will rise inexorably even more.
The message that capitalism inevitably leads to greater inequality is one that many people want to hear. Unfortunately for them, it is wrong. Piketty assembles an impressively large amount of empirical evidence. This shows clearly that from around 1910 to 1970, inequality actually declined sharply across the West.
Piketty argues that there were special factors involved in this period, which will not be repeated in the future. But modern capitalism was essentially formed in the decades either side of 1900. A truly massive merger and acquisition movement took place, and for the first time ever, companies existed which operated on a global scale. So we have had a globalised capitalist economy for approximately 120 years. For half this period, inequality fell, and in the other half it rose. The belief that capitalism always creates inequality is scientific nonsense.
A devastating theoretical and empirical critique of Piketty is made in a recent paper by Bob Rowthorn, former head of the economics department at Cambridge. Rowthorn became in his younger days an expert in Marxist economics, and so is ideally placed to appraise Piketty’s work.
Piketty shows that there has indeed been a sharp rise in the ratio of wealth to income in the early 21st century, to around 5 or 6 compared to just 2 to 3 in the 1950s and 1960s. Rowthorn points out, using Piketty’s own data, that the whole of this increase is due to capital gains in both housing and the equity markets. In real terms, the ratio has been constant in Europe and has actually fallen in America. This is highly relevant. A crucial part of Piketty’s argument about the future is that he believes that the rate of economic growth will be low. But if growth is low over many decades, it is very hard to believe that there will not be a reversal of the increases in real estate and share prices, and Piketty’s measure of the ratio of wealth to income will fall.
From a theoretical perspective, mainstream economics has a great deal to say about the evolution of the ratio of capital to income, and the implications for wages and profits. Piketty uses this theory. But, as Rowthorn points out, the theory is set out in real terms, not in the current price terms which Piketty uses for his empirical evidence.
Economics can be very useful, not least in exposing the fundamental flaws in popular opinions.
As published in City AM on Tuesday 8th July
The UK economy is doing well. Even so, it is not often that we are placed unequivocally at the top of a world ranking of any kind. But a team of economists led by Nicholas Gruen of Lateral Economics in Melbourne has done just that. In their recent report on the economic potential created by the concept of open data, it turns out that the UK government has been leading the world. On the Open Data Index, we score 100 compared to America’s 93. There is then a big gap to the next group, Australia, Canada and Germany, placed in the high 60s.
Open data is the idea that certain data should be freely available for everyone to use as they wish, without restriction. So what? Well, scaling some previous work carried by the McKinsey Global Institute, Gruen and his team estimate that open data has the potential to increase output in the G20 economies by no less than $13 trillion over the next five years. This could even be a substantial underestimate. The feedback loops between data provision and the value created by open analysis are strong.
Open data comes in many forms. Public sector information, such as outcomes in the health service or the spending of local councils is an important example. The ability of people to access and analyse this data creates pressure for improvement in the provision of public services. A GP who routinely prescribes expensive branded medicines rather than the generic products which are just as good, can be identified. A council with a very expensive refuse collection service or with large numbers of highly paid bureaucrats, can be exposed.
Research or science data which is publicly funded is an area where much more can be done. About twenty years ago, a leading American economics journal attempted to replicate the results of influential articles on applied monetary economics. Some had had a direct and powerful impact on policy. Most of the results could not be repeated, some dramatically so. But the effort involved in discovering this was huge. Now, if the data were placed on the web and made freely available, a graduate student could do the work in a couple of days. The replication of results is something which is all too often lacking in academic work, especially in the social sciences. Open data makes it much easier to carry out, and so reduces the chances of shaky, or even outright bogus, results surviving.
As the economy and society become more knowledge-based, data are core assets, creating value in their own right and driving social and economic innovation, growth and development. Open data is yet another example of the vast potential for innovation which has been created by the technology of the internet. Just as with the steam engine in the 18th century, genuinely revolutionary technologies may take many years to reveal their full economic impact. Fashionable worries about the slowing down of innovation are completely misplaced. And Britain stands to be a major beneficiary.
As published in City AM on Monday 7th July
In London and much of the South East, the recovery has been well under way for a considerable time. House prices boom and restaurants are packed. The economic data for the UK as a whole looks just as encouraging, with employment being at its highest ever level.
Yet there are persistent complaints that the recovery is not spread evenly. Many areas are alleged to still be in the doldrums. The bogeyman of austerity is invoked to explain the geographically uneven nature of the recovery. Restraint on public spending has undoubtedly worked for the economy as a whole, contrary to the beliefs of liberal commentators. There is perhaps a kernel of truth in the allegation at a regional level. Like all governments, the coalition has rewarded its own supporters in terms of the allocation of central funds to local authorities. As a result, many councils in the North are facing a punishing squeeze on their spending levels. And it is precisely in these areas where state spending plays a large role in the local economy.
But the uneven spread of prosperity as the recovery gathers pace is nothing new. There is a huge amount of inertia in the labour market experiences of different local areas. So once a town experiences a high rate of unemployment, it becomes very difficult to alter its relative position. The rate of unemployment still varies with the overall state of the economy, though the rate in such an area remains relatively high. The town continues to feel poor compared to more dynamic locations.
There are around 400 local authorities across the UK as a whole. If we take the rates of unemployment in these areas in 1990 and compare them with the rates in 2010, the correlation is very high, at 0.81. An area with relatively high unemployment in 1990 had a very good chance of experiencing the same thing no less than twenty years later. In a recent article in Applied Economics Letters, I show that the same result holds for relative unemployment rates within the individual regions of the UK. Incredibly, the correlation within regions over a 20 year period is even higher than across the UK as a whole, at 0.88.
This very strong persistent of relative prosperity, or rather the lack of it in some areas over a long period of time, does call for a thorough reappraisal of policy. Even within an individual region, poor local areas essentially remain relatively poor compared with their immediate neighbours. Conventional regional policies, on which many billions have been spent, have not worked. At least the coalition abolished the futile Regional Development Agencies. But, equally clearly, the market mechanism is not providing the answer. Twenty years is a long period of time over which incentives ought to work.
George Osborne’s proposal for high speed rail links to connect the North within itself more effectively has attracted a lot of criticism. But it is exactly such imaginative, potentially risky, concepts which are needed. Conventional thinking has failed completely.
As published in City AM on Tuesday 24th June