The government is relaxed about people cashing in their pension schemes to buy a Lamborghini. But the left-leaning liberal commentariat is certainly not. Abuse has been heaped onto George Osborne’s Budget measure of removing the requirement for people to buy an annuity. The main thrust of the attacks is that individuals may act irresponsibly. They may take financial decisions that are not in their best interests.
This is certainly true. People do make mistakes. The 1945 Labour government used the infamous phrase ‘The gentleman in Whitehall knows best’. The concept has since been extended to include ladies, and, despite its antiquity, is still very much alive and kicking. This view of the world lies at the heart of the criticisms of Osborne’s innovation. But does the state itself have a better track record when it comes to questions of finance? The answer is plain. An entire issue of this newspaper could be filled with shocking decisions. So just a few recent examples will suffice.
The issue of Gordon Brown’s disastrous sale of half the UK’s gold reserves over the 1999-2002 period was raised last week at Prime Minister’s questions. The average price of our gold was $275 an ounce, and of course the price now stands at some $1,300. Hindsight can make geniuses of us all. But the ineptitude of the process itself was breathtaking. The large sale was announced in advance, on 7 May 1999. This public declaration of a large increase in supply coming on to the market was sufficient to drive the price down 10 per cent by the time the first tranche was auctioned two months later.
The Private Finance Initiative is placing major strains on the finances of the NHS. The concept was created under John Major, but Gordon Brown really loved it. PFIs allowed ministers to secure large sums to invest in popular projects, such as new schools and hospitals, without paying any money up front. The insane financing structure places a debt on the taxpayer which is roughly double the value of the infrastructure which the framework helped to build.
Not everything is Gordon Brown’s fault. In the 2010 Strategic Defence Review, the new government announced that they would adopt the aircraft carrier version of the American F35 fighter, rather than the ‘jump jet’ favoured by the previous Labour administration. But the costs of adapting the design for use on carriers spiralled out of control, and two years later, it was abandoned and the jump jet reinstated.
But who can forget that Brown boasted that he had ‘abolished boom and bust’? The Treasury and the thousands of officials in regulatory bodies such as the Financial Services Authority thought they were so clever that they had designed a system in which recessions would never happen. The cost of the crisis can be reckoned not in billions but trillions.
Hayek won the Nobel Prise for his work on the inherent limits to knowledge of economic systems. Individuals, governments, central banks all face these limits. Osborne is right to trust the people.
As Published in City AM on Wednesday 9th April
The Premier League season draws to an exciting close. It is by no means clear who will be champions, or who will gain the coveted top five European qualifying spots. There could even be a surprise. If Liverpool win, for the first time since 1995 a team from outside Manchester and North London will be crowned. Even then it was Blackburn. In the previous 21 seasons of the Premier League, all the winners have come from either the North West or London. So a Scouse victory would not alter this.
These regions are important, with around 20 per cent of the UK’s population and 30 per cent of its income. But their lock on the Premier League seems absolute. Yorkshire and the West Midlands have big populations, but have not experienced football success, especially teams from the White Rose county. It is not just a matter of the champions. No team from outside the Lancashire/London strongholds has been in the top five since Newcastle in 2004, and none have been in the Champions’ League top four qualifying spots since Newcastle the season before that. Aggregating all the results over the last ten years, only Aston Villa and Newcastle are in the top ten from outside, at eighth and tenth respectively.
In its first few seasons, the Premier League had more democratic outcomes. In 1992/93, not only were Aston Villa second, but Norwich were third and QPR fifth. The next season, Newcastle were second, and Leeds and Wimbledon fifth and sixth respectively.
Looking back, it seems easy to rationalise the growing concentration of success amongst a handful of teams in a couple of areas. The creation of the Premier League injected increasing amounts of money into the game. The value of TV rights has soared. The bigger names have cashed in on income streams such as sponsorship and shirt sales. In the jargon, positive feedback has been in operation. Unto him that hath, more shall be given. And as Kuper and Szymanski show in their book Soccernomics, the size of their wage bills explains no less than 92 per cent of the variation in the clubs’ league positions over a ten year period.
Despite all this, change is possible. Even giant clubs can falter and fail. Much of the regional monopoly of the Champions is due to Manchester United winning 13 titles, yet this season, even given all their money, they seem destined to finish outside the top five. The decade before the Premier League, football was dominated by Liverpool, yet until very recently they have hardly threatened to win the League again. The same principle operates at all levels. Leeds and Wimbledon, top boys 20 years ago, now languish in obscurity.
For all their peculiarities, football clubs are companies. They share the fundamental dynamics which explain the success and failure of all companies over time. Yes, success does tend to reinforce success. But a myriad of factors, very hard to identify in advance, can upset this process and send the feedback into reverse.
As Published in City AM on Wednesday 2nd April
The improvement in the economy has seen a narrowing of the gap in the opinion polls between the Conservatives and Labour. In the key marginal seat of Bury North, a Tory gain in 2010 by just 2,200 votes, they recently took a council seat from Labour. Bill Clinton famously said about elections “It’s the economy, stupid!” So, if the consensus economic forecasts are to be believed, is David Cameron home and dry in 2015?
A pinch of salt is always the appropriate condiment with which to digest economic forecasts. As the events in the Ukraine show, unexpected things happen all the time. But the changes to forecasts for GDP growth in the UK have all been upwards this year. Certainly, by 2016, on the forecasts, and going along with Clinton’s phrase for the moment, the Conservatives should be well in front. 2015 may be a little too early for them to establish a decisive lead, but the omens look good for the Tories.
The problem they face is that the economy is often by no means the decisive factor in elections. Clinton used the phrase to defeat George Bush Senior in 1992. But the Democrats lost in 2000 when Clinton had completed his two permitted terms, despite the fact that the American economy had performed well under his Presidency. Mrs Thatcher increased her majority in 1983, even though unemployment had risen by 2 million since her victory in 1979. The economic boom of the late 1980s collapsed, and house prices slumped. But John Major won unexpectedly in 1992, amidst doubts about Neil Kinnock’s competence. Under Chancellor Ken Clarke, the economy recovered very strongly. The 1993-97 was possibly the best four year period in British economic history for over a century. Yet Tony Blair swept to power in 1997, with the Conservatives mired in allegations of sleaze and corruption.
A narrative in which people believe is the key to electoral success, much more so than the objective economic facts. During the long period of Conservative rule from 1951-64, for example, people genuinely ‘never had it so good’, in Harold Macmillan’s famous phrase. But the Labour leader, Harold Wilson, was able to convince the nation that the Tories were decrepit, and what Britain needed was the ‘white heat of the technological revolution’.
Ed Miliband has a narrative. It does not resonate much in London and the South East, but it is carefully constructed. Many people, especially in the rest of the UK, are frightened of the modern, globalised market economy. Its dynamism and its pace of change are unsettling. In contrast to Wilson’s and Blair’s, Miliband’s narrative is limp. It is the comforting arm around the shoulder, a reassurance that people can be protected from the outside world. It has little objective validity, as President Hollande is demonstrating so clearly in France. But this narrative is seductive. Given the massive pro-Labour bias in the constituency boundaries, Miliband may still sneak in. For the first time in years, the 2015 election will see a real clash of dramatically different narratives.
As published in City AM on Wednesday 26th March
Concern about inequalities of income and wealth is now a fashionable topic. It featured strongly in the gathering of the world’s top brass at Davos earlier this year. Much of the popular coverage of the topic gives the impression that not only is inequality at record highs, but that it is confined to the wicked Anglo-Saxon economies. A recent paper published by authors linked to the George Soros-funded Institute for New Economic Thinking shows very decisively that neither of these points is true.
Tony Atkinson, former Warden of Nuffield College Oxford, and Salvatore Morelli examine trends in both income and wealth inequalities in 25 countries since 1900. Their work is a very impressive piece of scholarship, requiring detailed examination of a wide range of data sources. Even so, there are often historical gaps where no information is available. Regrettably, too, the study includes neither Russia nor China, socialist societies characterised by massive inequalities. In the old Soviet Union, for example, in the early 1950s the diet on offer to the general population was no better than that in the labour camps, whilst the Party elite luxuriated.
It is certainly the case that inequalities have increased in the UK and the US in recent decades. A crude but widely used measure of inequalities in inco
me and wealth is the so-called Gini coefficient. Theoretically, this can range between 0 and 100. If it is zero, everyone has literally the same amount. If it is 100, one person has all the income or wealth and no-one else has anything. Obviously, these theoretical extremes can never be observed in practice. The key point is that the higher is the GIni, the greater is inequality. Looking at the distribution of income, in Britain in the 1950s and 1960s, the Gini was approximately 30.
Atkinson and Morelli estimate that in America the Gini coefficient was 7 percentage points higher in 2012 than it was in 1980. For the UK, the increase was even higher, at 10 percentage points, though they note that much of this increase took place during the 1980s. Contrary to popular perception, it has not risen sharply since then. The authors also have a measure of ‘relative poverty’, which is even more interesting. The relative poverty rate in 1990 was twice that of 1977, but “overall the poverty rate has been falling since the 1990s”. In America, it has been “constant since about 1970”, although with cyclical variations around this level.
Strikingly, in the Scandinavian countries, often held up as exemplars of ‘fair’ societies, inequality has risen. In Norway, the Gini coefficient for income is 4 percentage points higher than it was in 1986. In Finland, it is 6 percentage points up on its 1990 level. And in Sweden, since the early 1980s, the Gini has increased by no less than 10 percentage points, just the same as the UK.
Atkinson and Morelli do not offer explanations of movements in inequality, but they provide an excellent example of the value of meticulous empirical analysis in economics.
As published in City AM on Wednesday 19th March 2014
On 31 January 1990, a great event took place in Pushkin Square, Moscow. A branch of MacDonald’s was opened. The same excitement was generated in Kiev on 24 May 1997, when the MacDonald’s franchise was extended to the Ukraine. The American author Thomas Friedman wrote in 1999 that no two countries with such a franchise had ever gone to war with each other. It is a striking and imaginative image, which rapidly spread to become part of the received wisdom of the chattering classes. If economic prosperity could become spread more widely across the world, liberalism and tolerance would follow.
This relationship has been dramatically overturned by the events in the Ukraine. Semantic quibbles aside, a state of war exists between Russia and the Ukraine. It shows the dangers of relying upon relationships which seemed valid in the past to try and predict the future – especially with no understanding of the underlying reasons why a relationship might have existed.
Friedman was aware of this problem. In his 2005 book The World is Flat, he developed the MacDonald’s observation into his Dell Theory of Conflict Prevention. Friedman proclaimed that “The Dell Theory stipulates: No two countries that are both part of a major global supply chain, like Dell’s, will ever fight a war against each other as long as they are both part of the same global supply chain.” He reasoned that countries do not just want to be better off, but they want part of the action of globalisation for themselves. They want multi-nationals to locate part of the global supply chain in their own countries, rather than just sell them things. If they go to war, large foreign companies are unlikely to want to base part of their operations there.
The trouble with this view is that for many people, the possibility of dramatic change is very scary. The past is no longer a reasonable guide to the future. An alternative which may eventually prove to be very much superior can be rejected in favour of the old familiar routines. Russia and the Ukraine are victims of this attitude. Neither country has really embraced Western market-oriented economic structures since the fall of the Berlin Wall. Bits of them have, hence the tension between the western and eastern parts of Ukraine. But overall, they prefer what they know to what they could be.
The costs have been huge. In Poland, income per head is now more than double what it was in 1990. In the Ukraine, it has now just about struggled back to the level of 1990. Two decades with virtually no overall growth! Yet many people in that country seem to prefer this outcome, with its security blanket, to the much more frightening world which the Poles embraced successfully.
A longstanding assumption in Western views of international relations is that economic growth will encourage the spread of liberal values. Events in the Ukraine show that many people may not even want the prosperity if it means they have to embrace uncertainty.
As published in City AM on Wednesday 12th March
Pimlico Plumbers will be a familiar brand to many readers – it has a prominent advert on the approach into Waterloo station. But the company is now calling for plumbers who are fluent in both English and French, and says applicants will be interviewed by a native French speaker. This is just the tip of the iceberg. The original French school in London, the Lycée Français Charles de Gaulle in South Kensington, has been around for many years. Recently, however, it has opened new outposts to meet rapidly rising demand. Entirely new French schools are springing up across the capital.
London is now on the verge of becoming the fifth largest French city, measured in terms of the number of native speakers of the language. To all intents and purposes, London elects a member of the French National Assembly. The constituency covers the whole of the UK, Ireland, and parts of Scandinavia, but the bulk of its electorate lives in London.
Intriguingly, the French MP is a member of the Socialist Party, although she admittedly won by a fairly narrow margin. Cynics may say that it is easy to vote for a tax and spend policy when you do not have to pay. Large parts of the UK have conformed to this model for many years. But the election result suggests that London attracts two distinct groups from France. The sudden surge of French interest in London is undoubtedly in part due to President Hollande’s punitive tax regime on those who are already successful. Equally, however, there has been an influx of young people, who still retain what some would call political idealism and others naivety. Yet the fact that they are here, improving their English, making themselves marketable on an international scale, means that they are the tax base of the future, a dynamic element of society.
The key point is that talent, whether realised or still just potential, is now mobile on a scale unimaginable to previous generations. Combine this with another fact. HMRC now estimates that 30 per cent of all income tax is paid by just 300,000 people, less than 1 per cent of all taxpayers. The premium now placed on skill, and the resulting widening of the income distribution, is a key driver of this outcome. Rising income inequality is not just a feature of Anglo-Saxon economies, but a worldwide phenomenon.
These two developments call into question the long-term viability of the post-Second World War social and political model in Western Europe, based as it is on a state which actively redistributes resources on a large scale.
There is a tremendous ongoing furore about multinational firms avoiding tax, even though for the most part this is perfectly legal. But if governments are sufficiently resolute and willing to act in concert – a big “if” – something could be done about it. Short of building barbed wire fences on borders and bringing in the old Soviet system of internal passports, however, people can always move. And it is the taxpaying base, the dynamic and the successful, that has the greatest ability to do so.
Most of the commentary on the UK’s economic recovery focuses on consumers. Are they taking on too much debt again to finance their spending? Is there a bubble in house prices, as people get excited about bricks and mortar again? Certainly, in terms of its sheer size, spending by consumers is by far the biggest component of GDP, making up around 60 per cent of total domestic expenditure.
But it is much less variable than spending on new equipment, buildings and inventories by companies, which in total is less than a quarter the amount of consumer spending. It is companies who are the main drivers of the business cycle, the expansions and recession which we observe in the Western economies.
So, for example, GDP in the 17 country Euro zone reached a peak in the first quarter of 2008. It stopped falling in the third quarter of 2009, and has grown slightly since then to the most recent date for which complete data is available, the third quarter of 2013. In real terms, it is still some 3 per cent below its 2008 peak. But in each of the three quarters just mentioned, the peak, the trough and the latest period in the recovery, the level of consumer spending in the Euro zone was virtually the same. In contrast, corporate investment fell by 19 per cent during the recession. A key reason why the Euro zone as a whole has not recovered is that it has continued to fall, though at a much slower rate, to the present date.
The UK and the US tell the same story. The pre-crisis peak level of GDP in the UK was in the first quarter of 2008, and it fell until the fourth quarter of 2009. In terms of the amounts of money involved, corporate investment fell by more than twice as much as spending by individuals. In America, almost the whole of the fall in spending during the recession is accounted for by companies carrying out less investment, and it is companies which have driven the recovery.
When Keynes was contemplating the massive collapses of output which took place in the 1930s, he constructed his famous theories on the assumption that the booms and busts of the economic cycle were primarily driven by spending on investment by companies. Of course, in the Great Recession, when the unemployment rate in America reached 25 per cent, consumer spending did eventually fall sharply, but the main driver again was investment.
Keynes recognised that economic fundamentals such as profits and interest rates influence firms’ investment decisions. But he overlaid this with psychology. The same set of fundamentals are capable of more than one interpretation, more than one narrative can be constructed about them. It is this psychological factor which is the key. The Bank of England at the moment tries to give forward guidance on interest rates to reassure consumers. A much more effective target is companies. If an optimistic narrative in boardrooms is encouraged, we will see a sustainable economic boom.
As published in City AM Wednesday 26th February 2014
In the 1990s and early 2000s, Germany was seen by many as the new ‘Sick Man of Europe’. Between 1991 and 2005, GDP growth averaged only 1.2 per cent a year, compared to 3.3 per cent in the UK. Since then, the German economy has revived dramatically. The recovery in the German cluster of economies from the financial crisis has been as strong as in the United States, with the previous peak level of output being regained in 2011. Germany itself experienced virtually no increase in unemployment in 2008 and 2009, its exports are at record levels, and even the crisis in the Euro area has not prevented expansion in both output and employment.
There are two reasons which are frequently given for this. The first relates to the favourable exchange rate at which the German mark entered the Euro, giving an initial competitive edge to the economy. The second is the so-called ‘Hartz reforms’, a series of legislative labour market reforms which began in the mid-2000s. Both have validity.
There is a deeper reason for the recent turn-round in the performance of the German economy, which is rooted in institutional structures. In an article in the most recent Journal of Economic Perspectives – one of the world’s top academic journals – Christian Dustmann and colleagues agree with the general view that the evolution of unit labour costs has played a key role in the favourable performance of German tradable goods. But the main reason for this is in fact ‘the specific governance structure of German labor market institutions which allowed them to react flexibly in a time of extraordinary economic circumstances’.
German labour market flexibility is not based on legislation, but is laid out in contracts and mutual agreements between the three main actors in Germany: employer associations, trade unions, works councils. The formal institutional structure has remained unchanged, but there have been major changes in recent years in the way in which it works in practice. In particular, there has been a massive decentralisation of the wage-setting process from the industry level to the firm level, with a sharp fall in the proportion of workers covered by union agreements.
The fall of the Berlin Wall created opportunities for German industry to both source from, and relocate to, countries such as Poland and the Czech Republic which had stable political structures and skilled labour forces. Gradually, the German labour force appreciated that these developments required it to operate in a considerably more flexible way than it had previously. This has led to a rise in wage inequality within Germany, but the benefits have been a strong employment and output performance.
This decentralisation is in sharp contrast to economies such as Italy and France, where union wages and work hour agreements apply to all firms within an industry, or are subject to legal limits. These countries lack the flexibility and resilience which are required in a globalised economy. The structural problems of the EU run much deeper than the public debt issues revealed by the financial crisis.
As published in City AM on Wednesday 19th February 2013
There is something about onions which brings out the worst in bureaucrats. Orlando Figes’ A People’s Tragedy chronicles the early years of the Russian revolution. Under war communism, the Bolsheviks attempted to exert state control over the entire economy. A long list of vegetables was drawn up, specifying the prices at which they could be traded. Through incompetence, onions were omitted. The result was a huge glut of onions, as everyone rushed to take part in one of the very few areas of private enterprise left to them.
Congressman Gerald Ford, the future American President, made no such mistake. In the late 1950s, he promoted the Onion Futures Act, which means that onions are the only commodity in which futures trading is banned in the United States. This was in response to a massive coup in which two traders literally cornered the market in onions. But in general, futures markets helped rather than hindered producers by providing a guaranteed price and protection from price fluctuations.
The temptation for bureaucrats to imagine they have special knowledge, that they can intervene and make things better, is irresistible. The European Union is getting in on the act. A revised Markets in Financial Instruments Directive provides for regulators to impose limits on the size of the bets which dealers in commodity futures can place. Time will tell how successful this will be, though recent academic work suggests that interventions such as this, or the Tobin tax, may actually increase rather than reduce price volatility. The Taiwan stock market, for example, has a tax on most transactions, yet it is one of the most volatile. The UK housing market has a very large tax on transactions – stamp duty – but this has not prevented the development of speculative bubbles and huge swings in prices.
We might perhaps think of the bureaucrats at the Environment Agency as a bunch of onions. Rather, as a group of people who imagine they can improve the outcomes for onions. Of course, their concern is the environment rather than markets, but the mentality is the same. It is not that bureaucrats lack imagination. Whether it is the Soviets believing they could control vegetable prices, of the denizens of Brussels who think they know the maximum amount of speculation which is to be allowed, a future which is different to the past has to be imagined. And this vision has to be held with conviction
This conviction is often the root of the problem. A narrative emerges within a bureaucracy that there is a correct line, one best way of doing things. The Environment Agency came to believe that flora and fauna were more important than humans, and everything became subordinated to this narrative.
It is when a dominant narrative emerges within an organisation, when dissent is not tolerated, that the chances of making bad decisions rise sharply. Recent developments in algorithmic text analysis enable such situations to be detected from internal memos and emails. The first task of a regulator should be to monitor itself against this danger.
As Published in City AM on Wednesday 12th February 2013
Valentine’s Day is almost upon us. Many readers may recall a time when its main purpose was for love-struck teenagers to communicate, anonymously or otherwise, with the objects of their desire. Now, it is big business. It is hardly possible to enter a pub or restaurant without being exhorted to publicly display fidelity and love over extravagant drinks and luxury menus.
Paradoxically, during the decades in which this shift has taken place, personal relationships have become much less durable, much more temporary. Forty years ago, for example, each year there were eight times as many marriages as divorces and now there are less than twice as many. According to the Office for National Statistics, 42 per cent of all marriages end in divorce. The average period a cohabiting couple live together is less than four years.
Valentine’s Day is by no means the only ceremonial day whose significance has increased enormously. Mother’s Day, for example, appears to be a pure commercial invention, with no prior cultural roots, yet is now observed devotedly by millions. Celebrations of Hogmanay have been an integral part of Scottish culture for many generations. The English equivalent, New Year’s Eve, tended to be a much more restrained event. Now, it almost rivals Christmas Day itself. The American concept of Halloween was always present in a very limited way in British culture, but was overshadowed completely by our home grown ceremony of Bonfire Night. In the past decade, it has become of at least equal importance.
Economics is not really much use in trying to understand this phenomenon. One of the key assumptions of mainstream economic theory is that people’s tastes are stable. This postulate makes the maths of economics, impenetrable though it may seem to outsiders, much more tractable. Yet these various occasions of celebration show a very marked shift in preferences over time.
Anthropology offers more insight into these cultural events. The concept of conspicuous consumption has been around for a long time, even prior to Thorsten Veblen’s classic account of it written over a century ago. But the distinctive feature here is that the individual acts of consumption are performed simultaneously with millions of others.
A great deal has been written over the past decade or so about the loss of a common British identity, of a weakening of the cultural bonds of the country. This is about far more than the massive wave of immigration which New Labour cynically encouraged. A generation ago, it would have been inconceivable for Scotland to want to secede. Society in general has become much more fragmented. Yet it seems that people yearn for a common identity. The celebration, at the same time both individual and collective, of what have become these special Days is one way of expressing this.
The next marketing opportunity might be to try and import Thanksgiving, though my personal preference would be the Viking ceremony of Up Helly Aa, performed in Shetland in late January. There is a massive demand for these shared events.
As published in City AM on Wednesday 5th February 2013