The Happy Band of the Self Employed 

Posted by on October 16, 2014 in Economic Theory, Employment, Financial Crisis, Markets, Politics, Recession | 0 comments

The Bright Side PaulHow many workers does the typical American firm employ?   Actually, it is a trick question. The answer is ‘zero’.  More than 50 per cent of all companies in the United States are one person operations – the owner, and no-one else.

This fragmentation of size is increasingly reflected in the UK.  Here, the main growth is in self-employment rather than through one-person companies, but the principle is the same.  According to the Office for National Statistics, in 2014, 4.6 million people were self-employed in their main job, accounting for 15 per cent of those in work, the highest percentage since data were first collected 40 years ago.  Total employment in the second quarter of 2014 was 1.1 million higher than in the first quarter of 2008, just before the economic downturn. Of this increase, 732,000 were self-employed. So the rise in total employment since 2008 has been predominantly among the self-employed.

Good news, of course, which reflects the flexibility of the British labour market, though it seems to come at a cost.  The ONS estimates that the average income of the self employed has fallen by no less than 22 per cent since 2008.   Ed Miliband and the conventional Left denounce these developments.  Proper jobs have not been created, and people have been forced against their will to take large cuts in pay.

Earlier this year, a major study by the Royal Society of Arts exploded this as a myth.  Only 1 in 4 who started up in the recession said that escaping unemployment was a key motivating factor. A much more common answer was to achieve greater freedom. The self-employed are also happier than typical employees. Eighty-four per cent agreed that they were more satisfied in their working lives than they would have been in a conventional job (66 per cent completely or strongly so). The RSA argued that forgoing material benefits for more meaningful returns is a sign of a new ‘creative compromise’ at work.

In fact, basic economic theory suggests that well-being increases when people are offered more flexibility in the trade off between work and leisure.  To caricature the old days, you were offered a 40 hour week, take it or leave it.  But being self-employed allows you to choose your own point on the supply curve.

The RSA’s ideas are being taken forward in an exciting way in a new book by Adam Lent, director of their Action and Research Centre.  The book, Small is Powerful, is, naturally, crowd funded.  Lent argues that not only is the era of big government, big business and big culture over, but that this is unequivocally a Good Thing.  Intriguingly, in the wake of the recent by-elections, Lent writes about Zombie Politics, and why big politics continues despite nearly everyone having lost the faith.  He does not really deal with the issue of how, in the internet economy, the small can suddenly become terrifyingly big, witness Google and Facebook.  But his book opens a window on how our world is changing.

As published in City AM on Tuesday 14th October


Can Nanny make you stop drinking?

Posted by on October 9, 2014 in Economic Policy, Politics, Public Policy | 0 comments

alcohol1The National Institute for Health and Care Excellence (NICE) has been the butt of much ridicule over the past week.  A pill designed to reduce alcohol consumption among problem drinkers will be made available across the NHS.  But the concept of problem drinkers is so wide that it embraces people who enjoy a couple of modest glasses of wine a day.  Indeed, the treatment is not really aimed at serious alcoholics who knock back litres of vodka with meths chasers.

There are now vast swathes of behaviour which Western governments attempt to modify.  The government has its so-called ‘nudge’ unit dedicated to precisely this end.  Obesity, smoking, the amount of exercise people take, voting registration, recycling, energy consumption are some of the examples.  On the latter, it is not just the amount but the mix.  Hectored for years that diesel fuel was morally superior to petrol, some unfortunates followed the advice and switched their cars to diesel. They now find themselves on the receiving end of a volte face on the matter by the bureaucracy.

There is a literature in top ranking economics journals on the impact of such interventions.  In general, there is a short term effect which gives the policy makers what they want, but gradually, the reactions become muted and people revert to their old patterns.  There are exceptions, but most of these attempts to change behaviour fail.

An interesting paper in the latest American Economic Review by Hunt Allcott and Todd Rogers shows the enormous efforts which are needed to alter the decisions which people make in the long term.  In the United States, nearly 100 utilities hire a company called Opower to send home energy reports every month to millions of households.  Households receive information on personal energy use, social comparisons and energy efficiency information.

The real interest in the Opower work is that some of the programmes were set up as controlled scientific experiments.  Allcott and Rogers examine three of the longest running ones, which started in the late 2000s.  Highly sophisticated metering devices were installed.  Households, from a very large sample, were selected at random to receive the information.  And after two years, some of those getting the reports were randomly assigned to have them stopped.  This way, both post-intervention persistence and the incremental effects of continued treatment can be measured.

Unsurprisingly, there is an immediate reduction in energy consumption after receipt of the first report, though this impact decays rapidly.  In households discontinued after two years, the subsequent decline is much lower.   The sheer frequency of the reports does seem to alter behaviour.   But there are further reductions in energy consumption in households who continue to receive the information, suggesting that people take a very long time to completely change their habits.

In the UK, attitudes towards wearing seat belts and drink driving did eventually change, but it took a very long time.  Short-term trendy campaigns to ‘nudge’ behaviour are just not going to work.  Governments have to be in it for the long haul.

As published in City AM on Tuesday 7th October

Groupthink and the troubles at Tesco

Posted by on October 6, 2014 in Corporate Structure, Economic Theory, Markets | 0 comments

Analysis  and Statistics of Data as BackgroundThe latest fiasco at Tesco could prove an embarrassment for more than just the retailer. There appears to have been an over-recording of profit of some £250m, and some are asking questions about the company’s auditors.

Of course, the full story has yet to emerge, and Tesco’s auditors did flag issues in their most recent report. Further, no-one is suggesting that this is remotely like the scandal at Enron, which led to the effective dissolution of that firm’s auditors Arthur Andersen, then one of the five largest audit and accountancy partnerships in the world.

But getting this sort of thing right is very tricky. Financial professionals are only human, after all, and everyone makes mistakes from time to time. Regrettably, the instinct of many people is to call for tighter regulations to “prevent this happening again”. It is a litany familiar from the long succession of inquiries into child abuse scandals, and it has hardly been a successful one.

Clamping down on the ability of professionals to make judgments, and trying to cram everything into a tick box, is a recipe for failure. This whole approach is one of the most damaging legacies of the Gordon Brown era. We also see the problem in China at the moment: the rigorous clampdown on corruption is leading to a virtual paralysis of the government machine, with no-one wanting to risk making a decision of any kind.

One of the best ways of avoiding the sorts of problems which have arisen at Tesco is to try and ensure that there is diversity within management. Diversity in this context means that opinions which differ from those of the majority are encouraged rather than frowned upon. The phenomenon of groupthink can be very dangerous indeed, as the financial crisis showed. Financial institutions, regulators and accountancy firms all relied, for example, on models of risk which depended upon the assumption that very large changes to asset prices were almost never seen. Even though it had been established beyond doubt scientifically that this was not true, groupthink prevented more realistic assumptions being built into the models.

A key practical question, of course, is how to detect when diversity is disappearing within an organisation. An intriguing recent paper by David Tuckett, director of UCL’s Centre for the Study of Decision Making Uncertainty, uses the power of computer technology to shed some light on the problem. He analyses, or rather gets algorithms to analyse, very large-scale text databases to detect when groupthink is emerging and different perspectives are being squashed. One of them is the internal email database of Enron, and the other is Reuters’s’ news feeds, containing millions of articles concerning Fannie Mae. In both cases, clear early warning signals could have been identified.

I work with Tuckett on other topics at the Centre, so maybe I see the results through rose-tinted glasses. But innovative ways are needed of trying to avoid the persistent accounting problems which dog our corporate sector. Regulation alone will not work.

As published in City AM on Tuesday 30th September

Low or zero inflation is normal: competition keeps it that way

Posted by on September 23, 2014 in Economic Policy, Economic Theory, Euro-zone, GDP, Politics | 0 comments

CoinsFears of deflation are rising across Europe.  Inflation keeps edging down to lower and lower rates.  Eurostat estimates the rate of inflation in the Euro zone in the year to August to be only 0.4 per cent, compared to 1.3 per cent in the year to August 2013.  Negative rates were observed in seven EU countries.  Remarkably, the rate of just 1.5 per cent in Austria and the UK is the highest in Europe.

The current inflation situation is perceived as being in some way abnormal.  Such a way of thinking is understandable for policy makers whose formative years were the 1970s and early 1980s, when inflation was in double digits in many countries.  But a longer historical perspective shows that inflation rates close to zero can persist for many years.  We have been here before.

During the late 19th and most of the 20th century, the leading world economies were America, the UK and Germany.  The general historical experiences and economic policies these three countries have followed over this period have been very diverse.  Not least, America remained physically untouched by war, and Germany was laid waste in the mid-1940s.  These two economies were devastated by the Great Depression of the 1930s, with unemployment rising above 20 per cent, whilst the UK escaped relatively unscathed in comparison.  Germany had fascism, Britain and the US had democracy.  The differences are huge.

But a striking feature is that their experiences of inflation have been very similar over the past 150 years.  The one exception was the very brief period in the early 1920s when political turmoil led German inflation into stratospheric rates of millions of per cent.  Those few years aside, the average rate in the US since the late 19th century has been 2.0 per cent, 2.9 per cent in Germany, and 3.0 per cent in the UK.  And a relatively small number of years push the averages up.  Inflation was high in the Second World War and after the quadrupling of the oil price in the early 1970s.  Apart from that, the typical rate of inflation is just above zero.

The one common feature across the three economies and across time is that markets have been allowed to function, and companies have had to operate in a competitive environment. Competition in the labour market restrains wages, and competition in goods and services markets makes it difficult to enforce price increases.  Of course, markets differ in practice from the competitive ideal of economic theory, but competition is the unifying theme.

The implication is that it is extremely difficult for the authorities to stimulate inflation.  This would be an effective way of eroding the value of debt.  It worked in the UK in the late 1940s and 1950s. Even modest rates of inflation, inherited from the Second World War and boosted by the Korean War, brought the public debt to GDP ratio of 250 per cent after the war back to sustainable levels.  But low or zero inflation is a perfectly normal state of affairs.

As published in City AM on Tuesday 23rd September

Coping with Uncertainty: the Red Hot Topic in Economics

Posted by on September 16, 2014 in Economic Policy, Politics | 0 comments

UncertaintyAfter months of Trappist silence, a whole plethora of large companies has pronounced on the adverse consequences for Scotland of a Yes vote tomorrow.  The sectors span the economy, from oil to banks, from supermarkets to phone companies.  But what will be the effect of these interventions?

From the perspective of a rational economic person, they must make people more likely to reject independence.  Jobs will be relocated out of Scotland and the prices of goods and services will rise.  The public finances of the Scottish government will be weaker than is claimed, with much less oil being available. Serious doubts have been raised about the financial stability of Scotland as a whole, as problems with its currency arrangements are aired.  There is a distinct impatience amongst those who operate in this rational world with how voters seem to make up their minds. Certainly, at times this can seem bizarre. On a recent visit to Scotland, I was told in all seriousness by one woman that she was voting ‘Yes’. On a recent holiday, she had noticed on her passport the Royal Coat of Arms, in which the Scottish Unicorn appears chained to the Lion of England.

There is obviously the wider issue as to the importance of economic factors are in how people are casting their votes. But in terms of the companies’ announcements, their impact depends upon credibility. If they are perceived mainly as scare stories, their effect may be the complete opposite of what is intended, pushing people more firmly into the ‘Yes’ camp. It is the question of credibility which makes the impact difficult to assess.

Many of these issues are difficult and complicated, where even experts may legitimately disagree. The level of uncertainty around their impact is inherently high, not least because the consequences of such actions stretch far into the future.  Economists are starting to appreciate that their standard model of so-called rational behaviour may not be very helpful in describing how people actually make decisions in such circumstances. Discussion of this issue was prominent at both the Institute for New Economic Thinking conference in Toronto in April, and at the recent World Economic Forum gathering in Kuala Lumpur, each graced by the presence of Nobel Laureates. The fashionable new phrase is ‘radical uncertainty’.

An effective strategy for making decisions when outcomes are very uncertain is simply to copy what other people do. There are many nuances to this, but it is often a good rule of thumb to use. Keynes wrote about ‘the psychology of a society of individuals, each of whom is attempting to copy the other. The American economist Armen Alchian took the concept further in the Journal of Political Economy in 1950. Interest in his brilliant paper, ‘Uncertainty, Evolution and Economic Theory’, is reviving rapidly. The tools and the maths to formalise the concept did not exist in the days of Keynes and Alchian. But the question of how people decide under uncertainty is now a red hot topic in economics.

As published in City AM on Tuesday 16th September

After the BRICs, the GIPSIs: Tackling Europe’s Problems

Posted by on September 11, 2014 in Economic Policy, Economic Theory | 0 comments

EuroThe 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

Wall Street no smarter than Mr and Mrs Average

Posted by on September 2, 2014 in Capitalism, Corporate Structure, Economic Policy, Markets | 0 comments

Wall StreetLurid 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

Scottish Independence and Fairytale Land

Posted by on August 26, 2014 in Uncategorized | 0 comments

Scottish IndependenceSir 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

Employment is rising because labour is cheap

Posted by on August 19, 2014 in Economic Theory, Employment, GDP, Politics | 0 comments

Employment2The 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 predictability of the Premier League

Posted by on August 12, 2014 in Economic Theory, Executive Pay, GDP, Markets | 0 comments

FootballThe 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