Andy Haldane, chief economist at the Bank of England, hit the headlines last week with his confession that even he could not understand much of the material which pension providers give to customers. Less noticed, however, was a speech he gave the previous week at a dinner organised in aid of Children in Need on the fashionable theme of diversity.
The concept is dear to the heart of the liberal elite. Company boards, public institutions, all must embrace it without question. Each must have its “appropriate” quota of under-represented groups – every group, in fact, except white working class men. Mass immigration and open borders should be welcomed on the grounds that this makes society more diverse, which is unequivocally a Good Thing.
Haldane, one of the most original economists around, puts forward an altogether smarter set of arguments for diversity. A very deep seated human instinct is to be very wary of anything which is different. For much of our history, we have lived in small hunter-gatherer communities of 100 people or less. Groups of this size were very vulnerable to events which could make them extinct. The principal threats were conflict and disease, and the principal bearers of these were strangers. So it can be very sensible to prefer people who are similar to you and to distrust the unknown. As Haldane points out, this is “ecologically rational” behaviour.
But decisions which are rational for the individual can have consequences which are, collectively, bad. It is perfectly rational for everyone to head to the exits if the fire alarm sounds in the theatre. But the collective consequences are potentially catastrophic.
Haldane notes that economists call this an externality problem. He argues that a certain amount of diversity can generate positive externalities for society and the economy as a whole. Taking a very broad sweep of history, he cites Ancient Greece, medieval Italian cities and the London of Elizabeth I as examples of cosmopolitan, diverse cultures in which creativity flourished. Shakespeare was very much the product of that latter era, when England was opening up the world. And diversity, Haldane argues, in addition offers protection against the dangers of “group think”.
Some of his other examples are less convincing. He cites the results of the Harvard economist Alberto Alesina that a 1 per cent increase in the population arising from skilled immigrants raises long-run output by 2 per cent. But the point here is surely that they are skilled rather than that they are immigrants. And, incredibly, Haldane gives the Monetary Policy Committee as an example of successful diversity.
Cultivating creativity requires what Haldane calls cognitive diversity, which may not be related at all to ethnic or gender diversity. Cambridge in the middle of last century consisted almost entirely of white, upper class men. Yet Keynes in economics, Wittgenstein in philosophy and, most important of all, Crick in biology generated world-changing ideas.
Haldane’s speech is a powerful counterweight to the tick-box mentality which currently dominates the thinking on diversity in policy circles.
As published in City AM on Wednesday 24th May
Greater Manchester Police staged a simulated terror attack in the massive Trafford Park retail complex last week. As with many real life atrocities, the carnage began with the cry “Allahu Akbar!” Following a storm of protest on Twitter, the police felt forced to apologise. Almost at the same time, a frenzied chorus rose up demanding the resignation of the BBC’s political editor, Laura Kuenssberg, for having had the temerity to suggest that the local election results were something less than a complete triumph for the Great Leader and Teacher, Jezza. This campaign was halted by the extremely sexist nature of many of the comments posted by left wing Twitterati.
The way the Kuenssberg saga ended is in fact very unusual. Following a storm of outrage on social media about a statement or an action, the ‘guilty’ party almost invariably confesses his or her crime and issues a heartfelt apology to the raving crowd.
Social media is a new and radically disruptive technology. It is hardly surprising that traditional institutions and social norms have not yet adapted to the challenges which are raised. Many thousands of voices were raised against the police for their allegedly racist opening cry, with virtually no one springing to their defence. It seemed that public opinion was firmly against them, and so they bowed to pressure and apologised.
But Twitter, along with other social media outlets, is in many circumstances simply an echo chamber. When the polling booths in the Scottish referendum closed in 2014, many in the SNP leadership were convinced they had won. Their researchers has carried out seemingly sophisticated analysis of social media, and concluded the ‘Yes’ campaign was ahead. The actual result gave rise in turn to all sorts of conspiracy theories, bouncing backwards and forwards between die hard pro-independence Scots. Late last summer, the US Army carried out a routine training exercise called Jade Helm 15. This sparked a torrent of concerns on social media, a prominent one being that the federal government was planning to invade Texas and civil war was imminent.
Guido Caldarelli at Lucca and Gene Stanley at Boston published a paper in January this year in the prestigious Proceedings of the National Academy of Science. They find that the problems are widespread in social media, with users frequently forming communities of interest which foster confirmation bias, segregation and polarisation. Biased narratives fomented by unsubstantiated rumours, mistrust and paranoia proliferate.
How do we know whether to take a trend on social media seriously, of whether to just dismiss it as a bunch of fruitcakes egging each other on? Santa Fe-based scientists Rich Colbaugh and Kristin Glass (I am currently working with them) have found that a topic which has only a small number of mentions in each of several different social media communities is potentially far more significant than one which has a huge number in just one. Public bodies need to learn how to differentiate between social media topics, and not just routinely capitulate to the mob.
As published in CITY AM on Wednesday 18th May 2016
Concerns are growing about a marked slowdown in the UK economy. The Lloyds Bank purchasing managers’ index, for example, fell to 52.1 in April, its lowest point since 2013. The initial estimate for GDP, total output, in the first quarter of this year shows an increase of just 0.4 per cent on the final quarter of 2015.
Growth since the start of 2015 has been only 2.1 per cent, a rate which is a rough benchmark as to whether employment rises or falls. Indeed, in February, the latest month for which we have data, the Labour Force Survey showed that the total number of jobs in the UK was unchanged since December.
On the positive side, the economy has definitely grown since the recession, with output being up by 7.3 per cent on its previous peak value just before the recession in the first quarter of 2008. And these are the official estimates, which may not be able to cope with measuring accurately activity in the new cyber economy.
But economic slowdowns and recessions do happen. Indeed, they are a fact of life. The upsurge in inflation in the 1970s, when it reached 25 per cent, captured the mind-sets of policy-makers and prevented them from realising that low inflation, which we have now had for over 20 years, is normal. In the same way, the long period of continuous expansion during the 1990s and 2000s distorted expectations about what is normal. This period, which economists dub the Great Moderation, during which Gordon Brown claimed he had abolished boom and bust, makes people think, incorrectly, that recessions are very unusual.
We have quarterly GDP data in the UK going back to 1955. Economists have a fairly arbitrary definition of a recession as being at least two successive quarters of negative growth. Since 1955, we have had eight such periods. So, on average, we have a recession once every seven or eight years. We had one in 2008-09, and we might think that, on the law of averages, one is due now.
Things are not so simple. Economists write about the “business cycle”, as though the fluctuations in economic growth were regular. But this is a piece of jargon. The Nobel Laureate Robert Lucas pointed out 40 years ago that the key feature about economic ups and downs is that most sectors of the economy tend to move together, so we can presume there are general factors driving the economy. Specific factors will influence specific industries, but these do not cause the economy as a whole to boom or shrink.
The gaps between recessions are in fact pretty irregular. For example, there was one in 1956 and another in 1957. The recession of 1973 was followed quickly by the one in 1975. In contrast, there was a gap of 17 years between the 1990-91 contraction and the financial crisis.
Decision-makers do not like uncertainty, and Brexit is certainly creating this. Capital spending by companies stopped growing in the late summer of 2015. So it might all bounce back after 23 June.
As Published in City AM on Wednesday 12th May 2016
Image: Pound Coin by Andrew Writer licensed under CC by 2.0
The crisis at BHS has focused as much on the ethics of Phillip Green’s behaviour as it has on the plight of the company itself. Sir John Collins, who put his name forward for a knighthood, has said Green should be stripped of it if his handling of the beleaguered company is found to have lacked integrity.
Green is by no means the only prominent businessman to have faced criticism in recent weeks. Last month, almost 60 per cent of BP shareholders voted at the AGM against the £14m pay package for the chief executive in a year in which the company reported record losses, cut thousands of jobs and froze its employees’ pay. Hours later, over 50 per cent of Smith and Nephew’s shareholders rejected the remuneration committee’s decision on executive bonuses, despite the fact that its shareholder returns were below the median of its peer group.
It is a natural human tendency to look for specific reasons why these headline grabbing events take place. So we feel that perhaps these attacks were justified because of the varying degrees of poor company performance in each of the examples. But Sir Martin Sorrell, who has built up a global media business from scratch and really has created shareholder value, is expected to face similar criticisms at the WPP AGM in the summer.
At the opposite extreme, the business world is replete with examples of huge rewards being handed out for poor performance with no comeback at all. One of the harbingers of the financial crisis in the autumn of 2008 was the collapse of Bear Stearns investment bank in March of that year, and the virtual destruction of its shareholder value. Yet James Cayne, the chairman and chief executive, walked away unscathed with the $40 million he had been paid in cash. Fred Goodwin at RBS did have his knighthood annulled, but he was one of the very few financiers to suffer despite the ravages which they caused.
It did seem that revolts against massive pay-outs would take off in the ‘shareholder spring’ of 2012. The august Institute of Directors pronounced that companies must respond to shareholders’ anger or risk discrediting the wider business community. In the end, the protests just fizzled out.
In terms of shareholder discontent with executive remuneration, we have examples where poor performance stirs this up, examples where even exceptionally poor performance does not, examples where even good performance provokes the shareholders, and examples where a protest movement simply fades away after lots of initial sound and fury.
So it is challenging, to say the least, to construct a logical explanation of what causes shareholders to get stirred up. We should think of it instead as being more like a fashion item. Once something starts to become popular, it is likely to become even more popular, simply because it is popular. We may just have reached a tipping point, where the large institutional shareholders now feel it is the done thing to pillory top executives, almost regardless of their performance.
As published in City AM on Wednesday 4th May 2016
Image: Sir Martin Sorrell by Chip Cutter is licensed under CC BY 2.0
The Queen’s 90th birthday has quite rightly dominated the media over the past week. Her Majesty continues to break all sorts of records, spending longer on the throne than Queen Victoria and being our oldest ever reigning monarch. But longevity should no longer give cause for surprise. The oldest participant in the London Marathon was 88, a mere whippersnapper compared to the 92 year old who ran the event in 2015.
Robert Fogel, an economic historian based at Chicago, was one of the first people to draw attention to the dramatic lengthening not just of life spans, but of active life which was about to take place. In his Nobel Prize lecture in 1993, he correctly predicted that the number of older people in the US would rise much more rapidly than the Census Bureau was predicting. Now, there are 45 million Americans over the age of 65, a big chunk of the entire population of the UK, and 6 million aged 85 and over.
Fogel worried about the implications for health care and pension costs, concerns which are widespread in policy making circles today. In terms of pensions, the obvious solution is to raise the retirement age. But governments face resistance to this. Even George Osborne has not dared to go further than legislating for an increase in the pension age to just 67 – in 2028! Retirement is popular. A key reason, as Fogel pointed out, is the vast increase in the supply and the quality of leisure time activities for what he quaintly described as the “laboring classes”. In addition, the relative prices of leisure services such as movies, television and travel have fallen substantially.
Yet there are signs of behavioural change taking place from the bottom up. Last November, the Department of Work and Pensions (DWP) published a report on the employment statistics of workers aged above 50 over the past 30 years. The number of people in employment over 50 has grown faster than the population aged over 50. A lot of the growth has been amongst women in the 50 to 64 year old age group.
In addition, the employment rate for people over 65 has doubled since the mid-1980s, from 4.9 per cent of the relevant population to 10.2 per cent. Initially the rise was in the 65-69 age group, but over the most recent decade, the over 70s have increased their participation rate in the labour force to 9.9 per cent.
The problem of how to fund the pension costs of an ageing population remains a serious one. We need to encourage more older people to work. Economics can help, but the mainstream approach has its limits. This essentially describes an equilibrium situation, and then tells us what the new equilibrium will look like after a change has disturbed the old one. But the pensions issue is about how we adapt as a society to a situation which is out of equilibrium, how we manage the process of change in disequilibrium. Behavioural economics has more potential to help.
As published in CITY AM on Wednesday 27th April 2016
Image: Chelsea Pensioners by Defence Images is licensed under CC BY 2.0
Rather like a quantitative version of Hello! magazine, the Panama papers made headlines everywhere. Read all about the vast amount of money a particular celeb has got stashed away. Salivate, be titillated or be outraged, according to your fancy.
The story was covered heavily by the Guardian, the in-house newspaper of the metropolitan liberal elite. But the popular reaction was not quite what they were hoping for. Many people seem to regard the revelations contained in the Panama documents as just the way the ultra-rich and powerful are meant to behave. Rather like Conservative MPs and sex scandals, tax evasion and foreign dictators seem to go together quite naturally.
John McDonnell, the shadow chancellor, demanded an immediate and full public inquiry in the House of Commons. He could perhaps consult Yanis Varoufakis, one of his economic advisers, who of course was so successful in running the economy during his time as Greek finance minister.
Or the Left could more usefully ponder a fundamental principle in economic theory, the concept of so-called revealed preference. Economists attach relatively little value to surveys of opinion. This extends far beyond political opinion polls, though these serve to illustrate the point. In the 1980s, for example, survey after survey showed large majorities in favour of higher public spending financed by higher taxation. Yet the electorate consistently returned Margaret Thatcher to power when they had to make an actual decision.
Just because voters dislike tax avoidance by global companies and the super-rich, it does not mean that they themselves want to pay any more tax. We saw this in the general election last year, where there was a decisive swing away from Ed Miliband’s Labour to the tax-cutting Conservatives in the marginal constituencies of England and Wales.
Economists believe that it is only by their actions that people reveal what their preferences really are. Faced with a hypothetical question, their answers are unreliable, so we observe what they genuinely think by the decisions they make. The Journal of Economic Perspectives had a symposium on this question in one of its 2012 issues. The discussions are technical, but the top MIT econometrician Jerry Hausman summed it up neatly when he wrote: “what people say is different to what they do”.
The plain fact is that we have data going back over 50 years on the total amount of tax which governments are able to levy on the British people. Regardless of who has been in power, no government has been able to lift the percentage of national income which goes in tax above the 38 per cent mark. This includes all taxes: income, capital, corporation and the rest.
Politicians have to understand the wishes of the electorate if they themselves want to stay in power. Gordon Brown might have doubled the size of the tax manual when he was in power, but the tax take was if anything slightly low when he was booted out in 2010, at 34.9 per cent of GDP.
For all the fine sentiments expressed in surveys and the outrage over tax dodging, the revealed preference of the British electorate is to keep taxes low.
As published in CITY AM on Wednesday 20th April
Image: Taxes by Got Credit is licensed under CC BY 2.0
Life imitates art, as the sporting world has shown this week. The Grand National was won by a horse which had never previously won a steeplechase. The US golf Masters was won by Danny Willett, who nearly did not take part at all because of the birth of his son. With only nine of the 72 holes remaining, last year’s winner Jordan Spieth held a massive five shot lead, but blew it.
In soccer, Leicester City has secured a place in next season’s Champions League, and looks certain to clinch the Premier League title. The last team apart from Arsenal, Chelsea or the two Manchester teams to win was Blackburn in 1995. The most successful Rugby League side in history, Wigan, was taken to pieces 62-0 in the third heaviest defeat of its entire 121 year existence by Wakefield, a club which escaped relegation last season by the skin of its teeth.
Every single one of these events would have offered long odds against beforehand. The 33-1 of the National Winner represented by far the most likely of the four examples. Wigan has played well over 5,000 games in total, yet was slaughtered by a team it usually beats comfortably.
These things capture our interest precisely because they are unexpected. On a much more serious note, the financial crisis of the late 2000s also came as a complete surprise to most. It was a shock to financial institutions to discover that asset prices follow what is called a fat-tailed distribution. Very large changes are indeed rare events. But they are hundreds or thousands of times more likely to happen than on the assumptions which both banks and regulators made in the run up to the crisis. In their models, very large price changes could effectively never happen at all.
Humans do seem to have difficulties in anticipating the unusual. The Survey of Professional Forecasters (SPF) in America publishes information on a wide range of economic variables predicted by numerous outfits in the country. A centrepiece is the forecasts for quarterly GDP growth, where there is a track record going back almost 50 years.
One quarter ahead, the predictions are a bit like the curate’s egg, both good and bad in parts. The good bit is that, averaged out over every single quarter since 1968, the forecasts are spot on. But very large errors can be made in predicting any specific quarter. For example, when the recession had already begun, the average prediction reported by the SPF for the final quarter of 2008 was a fall in GDP of 1.1 per cent at an annualised rate. The actual number was a collapse of 8.2 per cent.
Recessions fortunately remain rare. But even just nine months into the future, the SPF has never predicted negative GDP growth at all.
I once tried to give up forecasting for Lent, but it is a difficult addiction to cure. Perhaps we should all employ an artist or science fiction writer to help us envision unlikely events.
As published in CITY AM on Wednesday 13th April
Image: Horses racing by Roger Blake licensed under CC BY 2.0
The potential closure of the Tata steel plants, and the plight of Port Talbot is a tragedy for those directly affected. A key question is: if the banks could be saved, why not steel? From a purely political perspective, the topic has legs. The loyal, hard working Welshmen, fearful for their families’ futures, contrasted with the arrogant pin striped bankers, ripping everyone off. It is a difficult narrative for the government to counter.
Away from the hurly burly of politics, the challenge takes us to some issues at the very heart of economic theory. Economics for beginners starts off with a simple diagram showing how much firms would supply of a product at different prices, and how much consumers would demand. The point where these two curves cross tells us the price which exactly balances supply with demand. In the technical phrase, the market clears.
A fundamental question in economics has been whether it is possible to prove that a set of prices can be found which would clear every single market, so-called ‘general equilibrium’. Supply and demand would be in balance everywhere, and so there would be no unused resources. It is a problem which is easy to state, but exceptionally hard to prove. No less than seven out of the first eleven Nobel prizes were awarded for work in this area.
Readers may recall having to solve quadratic equations at school. It has been proved that there is a formula which solves every such equation. Plug in the numbers, and out pops the answer. The general equilibrium problem is similar, but at a much harder mathematical level. Can some formula, as we can think of it, be found which proves that a set of prices can be found for every economy?
The work may be esoteric, but it has great practical influence. Much of regulatory policy, for example, is designed to try and remove impediments to the workings of markets, to try and bring about the desired state of general equilibrium, where all resources are fully utilised.
A crucial problem for this work, in many ways the crown jewel of economic theory, is that it has proved very hard to establish that money has any special significance. It is simply another commodity. This thorny theoretical issue was highlighted by the financial crisis, which the mainstream, equilibrium models could not explain. In essence, both money and steel are equally as important. Economists will realise I am compressing points here, but in this framework if the banks can be saved so, too, can steel.
Economists not obsessed with equilibrium, like Keynes, often take a completely different view. Money is decisively different, because it is the only product which appears in every single market. Disruptions to money are not confined to a particular part of the economy, but have an impact everywhere. Milton Friedman believed that the Great Recession in America in the 1930s had a monetary explanation for this very reason. Money is fundamentally different to steel. The banks had to be saved, steel is just an option.
As published in CITY AM on Wednesday 6th April 2016
Image: Steel by Ben Salter licensed under CCY BY 2.0
A short visit to the Highlands last week was refreshing. The scenery is just as spectacular as ever, and the people just as welcoming. But elsewhere, the tectonic plates are shifting. Last week, a televised debate took place amongst the political leaders contesting the elections to the Scottish Parliament in May. It resembled a bidding contest in which each participant had to outdo the previous one in terms of boasting about how much public money they would spend. The excellent Ruth Davidson from the Conservatives was the conspicuous exception.
The sense of unreality was heightened when visiting the prosperous market towns of Perthshire, which would not be out of place in the Home Counties. Yet the polls suggest that they are about to vote for the SNP in large numbers, waiting to be fleeced to subsidise the less energetic denizens of the old industrial belt of Central Scotland.
Under the SNP government, the health service has deteriorated markedly and education has gone backwards. But it seems they will be returned to power with a large majority. These problems are not believed to be the fault of the Scottish government but, in some mysterious way, the English.
If we plump for Brexit and North of the Border they do not, the strategy is to vote for independence and apply to be a member of the EU. But would the EU want them? To put it in perspective, no one imagines that Portugal, say, is an important country which possesses clout in the European Commission. Yet its population is over 10 million, and there are only 5 million Scots.
In addition, the public finances are shot to pieces. The Government and Expenditure Review Scotland announced earlier this month that the deficit in Scotland’s public finances is almost twice that of the UK as a whole. Scotland’s net fiscal deficit was £16.7 billion, some 9.7 per cent of its GDP, compared with UK figures of £89 billion and 4.9 per cent. The EU already has enough basket cases in the Mediterranean. Why would the Germans welcome another country which they would have to bail out?
The Alice in Wonderland flavour is heightened by the posturing on tax. The SNP had been firmly committed to a top rate of income tax of 50p. At the start of last week, Nicola Sturgeon pronounced that it was not possible. Why? She had just discovered that only 17,000 people in Scotland earned enough to pay it. But these contribute no less than 14 per cent of the total take from income tax, and may simply move. In the leader’s debate, she was once again in favour of the 50p rate, but only in the sense of St Augustine: “O Lord, make me chaste, but not just yet”.
Scotland epitomises the problems which all centre-Left governments face. They want high public spending, but the electorate will not pay the necessary tax. They cannot finance it by issuing debt for very long. The only solution is to find a kindly uncle who will pay, in this case the English.
As published in CITY AM on Wednesday 30th March 2016
Image: St Andrew’s Flag by Jim Bradbury is licensed under cc by 2.0
Inequality is one of the major political topics of our times. Rather like a Shakespearean tragedy, the current splits in the high command of the Conservative Party have many themes. But an important one, and the ostensible reason for Iain Duncan Smith’s resignation, is the treatment of the working poor, a concept which until fairly recently seemed to have been banished forever.
Like sending ten year olds up chimneys, the idea that people in work would not really have enough money to cope belonged to the distant past – well, to the depression years of the 1930s rather than the child labour of Dickensian times, but it was all a very long time ago.
Increasingly, this is no longer the case. A snippet from the arts world illustrates the point. The famous actor Robert Lindsay is president of the Royal Theatrical Fund, a charity which helps struggling actors. In the Sunday Times, he is quoted as saying that “there are household names who are now earning so little, people stop them in the street and ask for their autographs, but the spotlight has gone out for them”.
A survey of nearly 1,800 British actors by Casting Call Pro in 2014 found that no less than 75 per cent of them had earned less than £5,000 during the previous year. Only 2 per cent had earned more than £20,000, a figure which itself is only approximately what someone on the Living Wage in London and working 40 hours a week would make.
A key driver of rising inequality is technology. Fears abound that robots and artificial intelligence will destroy up to half of all existing jobs, but history suggests they will be replaced by completely different ones. The problem is more subtle. The stupendous proliferation of data and information in cyber society is changing fundamentally the way in which people make choices.
In more mature markets, such as the fast-moving products in supermarkets, consumers are still able to operate in ways described in the economic textbooks. They are familiar with the different brands and their various qualities and are able to compare prices. So they make choices essentially on the features of each of the various alternatives on offer, as “rational” choice theory says they should.
But in other contexts, people are bombarded with so much information that it is literally impossible to process it in this way. Eric Beinhocker of the Institute for New Economic Thinking estimated that, in New York City alone, consumers are presented with a potential 10bn different choices every day. They have to find some different way in which to navigate the maze. A good rule of behaviour is just to choose something which is already popular: you think other people have done the work for you, and have decided it is a good choice.
This self-reinforcing behaviour drives highly unequal outcomes. Things become popular simply because they are popular. Footballers, actors, film directors who are thought to be good get a bigger and bigger share of the pie. In cyber society, everyone loves a winner.
As published in CITY AM on Wednesday 23rd March 2016
Image: Scales of Justice by James Cridland licensed under CC BY 2.0