Major shocks to social and economic systems ruthlessly expose weaknesses which can be contained in more normal times. When the price of oil quadrupled in 1973/74, the different levels of resilience in the labour markets of Western Europe were quickly revealed. Inflation initially rose sharply everywhere. By 1976, it had fallen to 4 per cent in Germany, but was still 14 per cent in the UK. German workers realised that the oil price rise was out of the control of their own government. Demanding bigger money wage increases would be self defeating. It took the deep recession of the early 1980s, when unemployment rose to 3 million, and the defeat of the miners to bring British inflation back under control.
In the same way, the financial crisis of 2007 to 2009 uncovered deep structural faults in most of the economies of Southern Europe. The recovery in the UK took a long time to get hold, and it was only really in 2013 that we began to get over the shock. But GDP here is now 6 per cent higher than it was at the start of 2008, when output began to contract. In contrast, in Spain GDP is now 5 per cent lower than it was nearly eight years ago, and Portuguese output is 6 per cent lower. In Italy, the fall in GDP is as much as 9 per cent. So between 2008 and 2015, a dramatic gap of 15 per cent has opened up between the levels of GDP in the UK and Italy.
Membership of the Euro does not help. But there are much more fundamental issues. A fascinating paper by Gianluigi Pelloni and Marco Savioli in the latest issue of the Economic Affairs journal focuses on why Italy is doing so badly. A crucial reason is that Italy has a high level of corruption. Transparency International ranks the countries of the world on this measure. The least corrupt is Denmark. Germany and the UK come into the charts at 12 and 14 respectively. Italy is at number 69, along with Greece, Romania and Senegal.
Italy has suffered from a lack of restructuring of production. The products in which Italy specialises are very similar to those of twenty years ago. And the economy continues to be populated by vast numbers of tiny firms, specialising in commodities with low technological content in both the manufacturing and service sectors.
There are many barriers to both innovation and expansion. For example, access to credit is difficult and complex, as a 2013 World Bank study highlights. Start up costs are high. The average number of years of tertiary education in the population aged over 25 is only half that of France, Germany and the UK, so the workforce is less capable of dealing with technological advances.
Pelloni and Savioli do detect some positive signs in sectors such as chemicals, food and pharmaceuticals. But mere tinkering will not be enough. Drastic reforms are needed to deal with the structural weaknesses exposed by the financial crisis.
As published in City Am on Wednesday 25th November
The Chief Economist of the Bank of England, Andy Haldane, has been in the news with his predictions that up to 15 million jobs in the UK are at risk of being lost to automation. This is a huge number, around half the total number of people in work today.
Haldane injected a note of humour into his address to the Trades Union Conference, by suggesting that his own job was not at risk. It was unlikely, he said, that an “Andy robot” would be giving this speech to the TUC even ten years from now. Given the Bank’s recent track record in economic forecasting, a cynic might respond in kind. Surely Ernie, the name of the original random number generator used to draw Premium Bonds, could do just as well.
His speech was far more thoughtful and balanced than the more lurid attention grabbing points seized on by the media. Haldane pointed out that since the start of the Industrial Revolution over 250 years ago, there has been a steady and continuous stream of labour-saving advances in technology. It is these which drive productivity, the amount of output produced per worker. This has risen at an annual average rate of 1.1 per cent since 1750. In the UK, the employment rate today as a proportion of the total population is around 50 per cent, very similar to levels in the early 19th century. The same is true in other countries.
The good news does not end there. The share of wages in the overall economy is very similar to what it was in the 18th century. Real wages, living standards, have risen in line with productivity, in complete contradiction to Marx’s prediction that capitalism would make workers worse off. And technology has enabled people to work fewer hours and have longer holidays. Compared to a century ago, the average working week has fallen from 50 hours to 30.
The potential problem, according to Haldane, arises through the sheer scale of disruption which might take place. Eventually, automation will benefit society. But it might take a long time for the effects to be absorbed. Such pessimism may not be justified. The labour market is far more dynamic and evolutionary than most people imagine. The US Bureau for Labour Statistics describes the ‘vast amount of job churn’ which takes place every single quarter. Millions of companies decide to either expand or contract their workforce on a quarterly basis. Hundreds of thousands of firms open or close from one quarter to the next. Even in recessions, large numbers of jobs are created.
The net changes in employment, the difference between jobs created and jobs lost, in any single quarter are small. But they conceal a vast whirlpool of constant change and flux. The old Soviet Union had ‘secure’ jobs, but eventually it collapsed. Towns in our regions have a large proportion of the workers employed in ‘secure’ public sector jobs, but they are poor. Western economies are used to change. It is their life blood and it is what makes them successful.
As Published in City Am on Wednesday 18th November
Image: red vs blue by Robert Couse-Baker licensed under CC BY 2.0
The commercial property market in London has been booming for several years. The Bank of England is concerned about yet another property bubble building up. The executive director for financial stability, strategy and risk at the Bank, Alex Brazier, warned in a speech last month that positive sentiment in the industry must be “tempered by experience of past business cycles”, so that we are not doomed to repeat previous booms and busts. The Bank is constructing an index for banks and investors to show how prices compare with lending and cash flow. If the market pays attention, there will be less risk of it getting carried away.
The existence of bubbles, whether in property or equities, creates problems for economists. It is only two years ago that the Chicago-based Eugene Fama received the Nobel Prize for inventing the so-called efficient markets hypothesis nearly fifty years ago. All public information is believed to be incorporated in the price. So any extra material which the Bank, for example, provides is redundant. Rational investors are already presumed to know it.
Less reverently, this view is sometimes referred to as the Groucho Marx theorem. Groucho would never want to be in a club which would have him as a member. And no rational agent would ever want to buy an asset which another rational agent is willing to sell. Both sides of the deal suspect that the other has private information which has yet to hit the market.
The joke is not meant to be taken literally, but like many good jokes it does have a strong element of truth. With economically rational investors, trading volumes would be low. Instead, they are huge. For example, in 2014, the total value of trading in the Standard and Poor’s 500 was $29.5 trillion, nearly double the size of US GDP.
There have been many technical attempts to explain why trading so large. But they all struggle with the sheer scale on which trading takes place. So economists are beginning to come to the view that markets might not be efficient after all. Overconfidence could be an inherent feature of asset markets. Overconfidence simply means having mistaken valuations and believing them too strongly. Investors credit their own talents and abilities for past successes. They blame their failures on bad luck, rather than reducing their level of overconfidence.
A paper in the recent issue of the top Journal of Economic Perspectives by American economists Kent Daniel and David Hirshleifer provides tons of evidence to support this view. For example, stock market trading increases during periods of high returns. It was over 100 per cent of US GDP in the 1920, collapsed in the 1930s and 1940s, and rose dramatically during the 1990s until the crisis.
Much their evidence is on equities, most of which are readily tradeable. So the returns on decisions which people make are obvious, and provide clear feedback. The property market is much less liquid. Overconfidence and mistaken valuations could build up even more. The Bank’s efforts might not be wasted after all.
As published in City AM on Wednesday 11th November 2015
The Prime Minister recently announced that the civil service will now introduce name-blind recruitment. When people apply for public sector jobs, their name will not appear on the documents sent to the appointment panel. Major companies such as HSBC, KPMG, the BBC and the NHS are following suit. Economists have produced a substantial body of evidence which shows that some employers discriminate on the basis of the names of the applicants.
The classic paper was written as long ago as 2003 by two academics at the National Bureau of Economic Research. The title is “Are Emily and Greg more employable than Lakisha and Jamal? A field experiment on labor market discrimination”. The article does what it says on the tin. The answer to the question is ‘yes’. People with names which sound white have a better chance of getting a job than those with names which are obviously black or Muslim. The results have since been replicated in numerous studies.
Perhaps David Cameron’s measures do not go far enough. The ethnic origin of an applicant will, after all, be immediately apparent at the interview. The job seekers should really enter the building covered by a security blanket, sit behind screens, and have their voices distorted by computer so they all sound like Stephen Hawking.
More seriously, the question of discrimination was discussed at length by Milton Friedman in his great book ‘Capitalism and Freedom’. He pointed out that capitalism was by far the most successful form of social and economic organisation for reducing discrimination. We can readily contrast the situation in, say, the UK or Germany with that of the treatment of so-called ‘enemies of the people’ and their families under socialism in the former Soviet Union and China, and the widespread gender, sexual and religious intolerance found in many Muslim countries.
Friedman’s argument was essentially that a market economy separates economic efficiency from irrelevant characteristics of the product or service being offered. So when you buy a shirt, for example, you are not interested in the colour or creed of the person who made it, just in whether it is a nice shirt at the right price.
So far, so good. But Friedman went on to much weaker ground by arguing that the very concept of discrimination did not make sense in a market economy. In particular, employers who discriminated would be making less efficient choices and so would eventually be forced out of business by non-discriminators.
This makes logical sense. But there is the question of the additional costs a company might incur in conducting a more extensive search process. These have to be balanced against the potential loss of efficiency, which might be quite small. A more fundamental point is that markets for goods and services do not usually expose inefficiencies swiftly. Substantial differences in productivity between firms in the same industry can persist for years.
Markets are indeed much more colour, creed and gender blind than any other form of economic structure. But they are not completely perfect, and David Cameron’s initiative is to be welcomed.
As published in City AM on Wednesday 4th November 2015
Government ministers have bowed to pressure. They have published the report by Public Health England (PHE) which calls for a tax of up to 20 per cent on sugary drinks and foods. If the tax reduced sugar intake in line with the recommendations, it is claimed that more than 77,000 deaths could be prevented in the next 25 years. PHE must be gifted with unusual powers of clairvoyance to be able to see the future with such precise accuracy. Better get the staff transferred to the Treasury or the Bank pronto, so they can predict the next economic crisis!
Lurking in all such projections is the little word ‘if’. It is this tiny word which is the downfall of so many grandiose plans of social engineering. The public may simply not believe the message, at least not in sufficient numbers to make much difference. Hardly a week goes by without some academic berk or pompous official proclaiming that something we have enjoyed since time immemorial is a mortal threat to our health. The latest is the pronouncement from the World Health Organisation that bacon sandwiches and sausages are as dangerous as smoking. Such statements are often contradicted at some point in the future. Car owners, for example, were actively encouraged to switch from petrol to diesel, but the latter is now regarded as the devil incarnate.
The fundamental difficulty is that ordinary people are much smarter and more creative in their reactions to changes in incentives than planners give them credit for. During the UN Climate Change conference in Copenhagen in 2009, the city council wanted to curb prostitution. They sent postcards to hotels and delegates urging them not to patronise the city’s sex workers. The members of the Sex Workers Interest Group responded by offering free sex to anyone who could produce both their delegate card and one of the postcards sent by the Mayor. They faced the choice of a much reduced income if the Mayor’s strategy was complied with, or a normal income reduced by the occasional free service.
Taxes on sugar are altogether less exotic. If the price goes up, less will be consumed. That is the opening chapter of many economic textbooks. But reality can be much more complex. Different states in America have different levels of tax on cigarettes. Jerome Adda and Francesca Cornaglia of University College London took advantage of this to examine how smokers responded to different tax rates in a 2006 paper in the American Economic Review. The higher the rate of tax, the fewer cigarettes smoked. So far, so good. But higher rates led smokers to switch to brands with higher tar and nicotine yields. In addition, smokers increased their intensity of smoking by smoking right down to the butt. Such behaviour further increases tar and nicotine consumption, and leads to even more dangerous chemicals being inhaled.
Obesity is undoubtedly a serious problem. But the idea that a simple tax on sugar will solve the problem is a pure fantasy of the mindset of the central planner.
As published in City AM on Wednesday 28th October 2015
The Governor of the Bank of England, Mark Carney, courted the wrath of the fossil fuel industry in a speech at the end of last month. He argued that investors in the sector face ‘potentially huge losses’. Actions by governments to try to head off climate change could make most reserves of coal, oil and gas ‘literally unburnable’.
Tougher rules and regulations on the use of carbon based energy, along with higher taxes, could leave the assets of fossil fuel companies ‘stranded’. ‘Stranded’ is the new buzz word in climate change circles. Assets may be left stranded in the ground because it is no longer practical to extract them at any meaningful rate.
A fascinating and closely argued paper by Ted Nordhaus and Michael Shellenberger of the California-based Breakthrough Institute puts a different perspective on how energy assets become stranded. They give plenty of historical examples. In the middle of the 19th century, Americans used 13 million gallons of whale oil each year, mainly to light their lamps. Within two years of the first oil strike in 1858, the petroleum industry achieved that level. Whalers quit their jobs to work in the oil fields. The asset of whale oil was left ‘stranded’ in the whales in the ocean. From the first stirrings of industry in England several hundred years ago to well into the 19th century, wood was the primary source of energy for our factories and blast furnaces. Coal stranded the wood fuel industry. In 1900, just 2 to 3 percent of England was covered by forests. Today, 10 to 12 percent is.
Nordhaus and Shellenberger argue that large scale asset stranding in the global energy context will remain, as it has always been, primarily driven by technological change. Whether from wood to coal in the nineteenth century or, as is currently underway in the United States, from coal to gas in the twenty-first, the primary driver of wholesale transitions to new sources of energy has been the fact that the new source of energy was cleaner, cheaper and more useful.
This is the classic concept of a disruptive technology put forward by the great Harvard economist Joseph Schumpeter. Such technologies are so superior they simply sweep aside competition. Within a few years of the coming of the railways, the prestige London to Edinburgh stagecoach service disappeared. Humanity’s quest for more heat, light, and power has been the main driver of invention and innovation. Only this month, Bill Gates announced a project to work with the Chinese government to develop a next-generation nuclear reactor that not only cannot melt down but also recycles waste as fuel.
The demand for energy, especially in the developing world and countries like India and China with their massive, aspirant populations, will continue to grow. Carbon pricing, emissions caps, the whole paraphernalia of regulation which Western countries might bring in, will not alter this demand. Fossil fuels may indeed become stranded. This will happen not because of bureaucrats, but because of innovation and breakthroughs in nuclear and alternative energy technologies.
As published in City AM on Wednesday 21st October 2015
Olivier Blanchard, the recently retired Head of Economics at the International Monetary Fund, has something of a track record with his predictions. In 2013, he warned George Osborne that he was “playing with fire” with the UK’s recovery from the financial crisis. Austerity had to be relaxed. We now know that we were actually nowhere near a drop in GDP. Growth has been unequivocally positive in every year since 2009. Compared to the year immediately before the crisis, 2007, GDP is now 6 per cent higher, a recovery of similar strength to that of America, with US GDP being 8 per cent up on its 2007 level.
In August 2008, only a few weeks before the collapse of Lehman Brothers, Blanchard published an MIT Discussion paper on the state of macro-economics. This is the part of economic theory which tries to explain how the economy as a whole moves, why variables such as GDP or unemployment go up or down. The state of macro-economics, Blanchard opined, as the most serious crisis since the 1930s was about to burst upon the world, was “good”.
But his pronouncements this week on the Eurozone deserve to be taken seriously, not merely because a stopped clock occasionally tells the correct time. There is real substance to them. Blanchard warned that the planned moves to closer integration within the Eurozone would not solve its fundamental problems. Very powerful figures such as Mario Draghi, President of the European Central Bank, and Jean-Claude Juncker, head of the European Commission, are heading the drive to full fiscal integration of the Eurozone.
Under the plan, member countries of the Euro would pool funds to a Euro Treasury in Brussels. This outfit would have the ability to transfer funds from strong to weak economies. The UK Treasury has similar powers to move money around within the UK, which is a monetary union based on sterling. Huge amounts have been taken from London and the South East and given to the rest of the UK over a period of decades. But the gap in performance remains.
The relative performance of the Eurozone economies in recent years highlights the problems faced by the zone. German GDP is now 6 per cent higher than it was in the year just before the crash, 2007. Positive gains have been registered in countries like Austria, Belgium. France, too, is up, though here growth has more or less stalled since 2011. Even Ireland, which was very badly hit, is now registering strong growth and the economy is larger than it was in 2007.
But there is another group where growth has been disastrously bad. The Italian economy has shrunk by 9 per cent since 2007, Portugal by 7 per cent and Spain by 5 per cent. These economies just do not seem to have the enterprise and the resilience to bounce back in the way in which Germany and its immediate economic satellites have done. Closer integration may make sense for the successful countries in the Eurozone, but not for the rest.
As published in City AM on Wednesday 14th October 2015
David Cameron’s visit to Jamaica last week led to vociferous demands for the UK to pay the Caribbean island billions of pounds in reparations for slavery. Most people here reacted with predictable eye-rolls and sighs. Slavery was abolished throughout the British Empire in 1833, nearly two centuries ago. Jamaica has been independent since 1962, over fifty years ago. Surely they have had time to sort themselves out and get a decent economy?
There is much to be said for these arguments. In the early 1960s, for example, South Korea was essentially a poor, agricultural society, only one step up the ladder from subsistence level incomes. Now, it has a dynamic, modern economy with living standards similar to those of the West. Countries such as Singapore have followed similar trajectories.
The demands for payment are a classic example of what economists call “rent seeking” activity. The word “rent” here does not mean what you pay on your apartment to live in it. The concept goes all the way back to Adam Smith himself, though the phrase was only coined in the late 20th century. Rent seeking means trying to increase your share of existing wealth without creating any new wealth.
But we should not feel too much moral superiority over the Jamaicans. Rent seeking has proliferated in Western society in the last couple of decades. The US economy has performed well over this period. Its success is reflected in the amounts paid to CEOs, with the average compensation in the top 350 firms being around $15 million a year. This enormous sum is some 300 times higher than the amount the companies pay to the typical worker. In the mid-1970s, the ratio was not 300:1 but only 30:1. Even in the mid 1990s it was around 100:1. This later figure would still hand the average CEO some $5 million today, not a bad sum to have. It is hard to justify these payments in terms of the contribution the individuals are making to creating new wealth. Some of it, yes, but essentially these pillars of our society have been rent seeking on a grand scale.
Rent seeking by the public sector characterised Gordon Brown’s long period as Chancellor. Public spending rose dramatically. But much of the increase did not go to provide better public services. Instead, it paid for the private consumption of those employed in the public sector. Some graduates in Hollande’s France flee abroad. Most of the rest aspire to become a fonctionnaire. Good pay, virtually unsackable, and with a gold plated pension at the end, it is a much sought after position. Little wonder that France has essentially registered no economic growth since 2011. Jeremy Corbyn eulogised the Italians for subsidising a steel plant rather than letting it go under like Redcar. But rent seeking proliferates in Italy, and their living standards are now back to those of the late 1990s.
Economists disagree about many things, but they are united in their opposition to rent seeking, an unequivocally Bad Thing.
As published in City AM on Wednesday 7th October 2015
Image: “Street in Montigo Bay Jamaica Photo D Ramey Logan” by WPPilot – Own work. Licensed under CC BY-SA 3.0 via Wikimedia Commons.
Readers who either had young children or were children themselves in the 1980s will recall the Um Bongo jingle. The advert assured us it was drunk in the Congo. A survey published last week to mark the 60th anniversary of British television advertising showed that no fewer than 32 per cent of the total sample of 2,000 people remembered the tune. This compared to only 20 per cent who identified Mozart’s Eine Kleine Nachtmusik.
We might attribute this to the failures of our educational system to promote grand culture. But despite Justin Bieber selling more than 15 million albums and having almost 70 million Twitter followers, only 19 per cent of those polled could name his recent number one hit. In contrast to both high and low music culture, Um Bongo has seared itself into the brain cells. The failure of four out of five people to remember even the name of the Bieber song could perhaps be due to the age profile of his target audience. But their parents can hardly fail to be aware of him, in the same way that they knew of a drink which few of them actually consumed.
A potential reason for the differences is that the turnover in popular cultural markets has speeded up decisively in recent years. Attention spans have shortened. The changes in technology have made it very hard to make direct comparisons over the history of popular music charts since the early 1950s. But the trend was already apparent when the New Musical Express charts, introduced in 1952, were discontinued in 2006. The early and mid 1960s were a highly innovative period, with the emergence of for example the Beatles and the Rolling Stones. There were also many one-hit wonders seeking to emulate their success. At this time, in terms of the Top 75 in the NME charts, around 300 songs featured during the course of each year. By the mid-1980s, this figure has doubled to some 600, and in the mid-2000s it was around 1,000. So the turnover had risen sharply even a decade ago. Songs were getting less and less time to imprint themselves on memories. And there were many more of them which did become popular, even for a short time, so the competition to capture memory intensified.
A dramatic rise in ‘churn’, the speed at which relative popularity changes, can also been seen since 2000 in the choice of baby names, both here and in the United States. Baby names may seem frivolous, but the polymath American psychologist Stephen Pinker emphasises their cultural importance. The choice of name “encapsulates the great contradiction in human life: between the desire to fit in and the desire to be unique”. In the last decade or so, the latter has strengthened dramatically. The Houston anthropologist Alex Bentley and I have published papers showing that turnover in popularity was steady for most of the 20th century, but has since risen fivefold.
Attention spans have shortened, with important consequences for our society and economy. But, for some at least, Um Bongo lives forever.
As published in City AM on Wednesday 30th September
Imagine you are relaxing at a bar enjoying a drink after a hard day’s work. The person next to you strikes up a conversation. Initially he seems reasonable. But soon he begins to go on at length about how the Earth is flat and how a misguided cabal of scientists hides this truth from us. You could try and persuade him of the error of his ways. But the most sensible course of action is to make your excuses and leave.
Economists face the same dilemma in commenting on the policies of John McDonnell, Jeremy Corbyn’s new Shadow Chancellor. They are bonkers. For example, McDonnell believes that the problem of the public sector deficit can be solved by extracting an additional £93 billion a year from companies. He claimed in the Guardian this is the total amount of subsidies which the corporate sector receives from the taxpayer. The source of the calculation is apparently a report published by the University of Sheffield, with the same newspaper bemoaning the fact that no-one bothers to read it. Could there be a reason?
Suppose, purely for the sake of argument, that the £93 billion figure is correct. What might be expected to happen if companies are suddenly deprived of this vast amount of money? They might slash dividends, an action with which McDonnell would almost certainly approve. This would of course harm pensions, but perhaps this is the price to be paid. But firms might equally well make major savings by getting rid of workers, by reducing wages, or by drastic cuts in investment and research and development expenditure. Ultimately, only individuals and not companies can bear the cost of taxation, a profound insight of economics which many, especially on the Left, find hard to grasp.
By comparison, the economic wish list set out by Corbyn himself during his leadership campaign gives the impression he retains some residual connection with reality. But is a Flat Earther more or less balanced than someone who, say, believes that the dimensions of the Great Pyramid reveal the hidden secrets of the universe, a quite popular internet delusion?
Corbyn argues that there is no need to place limits on the amount of welfare benefits which an individual or family can receive. Economic growth will revive the economy to such an extent that employment will boom, and many people will be removed from welfare as a result. In turn, growth will be generated by the activities of a new National Investment Bank. But this is pie in the sky. The failure of planned economies such as the Soviet Union, the failure of the National Plan of the 1964 Labour government, the failure of the Regional Development Agencies, none of this evidence shakes Corbyn’s faith in the inherent superiority of economic planning and dirigisme.
No doubt these policies will have some popularity in the regions which are already heavily subsidised. But it is hard to see them striking a chord in the wealth generating parts of London and the South East.
As published in City AM on Wednesday 23rd September