Most of us don’t love our banks. We have all experienced the unanswered letter, the seemingly interminable waits on hold before being put through to someone who gives the impression of auditioning for the infamous “computer says no” television sketch. Yet we are surprisingly loyal to our current accounts. Figures from Bacs suggest that around 1m people a year switch their banks. It seems a lot, but that is less than 2 per cent of the total number of personal current accounts in the UK.
This puzzle currently preoccupies the Competition and Markets Authority (CMA), which published its provisional findings on retail banking competition in the UK last October. One problem was that the lower the quality of the service which a bank provides, the higher its market share tends to be. The CMA used several standard survey-based market research measures to estimate quality, so perhaps these surveys do not measure quality well. Even so, the result was a paradox.
The regulators have tried hard over the years to promote switching. The standard economists’ response of giving people more information has been used. Then, in September 2013, the Current Account Switch Service (CASS) was introduced. The idea is great. It is free to use, and really does seem to make switching easier. Yet the FCA found last year that not only had just 41 per cent of consumers heard of it but, more tellingly, over 50 per cent thought that this smart new technology might make an error in switching their account.
In short, not enough consumers trust a system which looks fantastic in theory. Exactly the same problem is reported in an article in the latest American Economic Review, by Esther Duflo and colleagues at MIT. The context is completely different. The World Health Organization estimates that primitive indoor cooking causes 4.3m deaths a year, as many as malaria and tuberculosis combined. Duflo, a rapidly rising star, provides evidence, from a large-scale randomised trial in India, on the benefits of a common, improved cooking stove.
The idea had backing even more powerful than the CMA. In 2010, Hillary Clinton formed the Global Alliance for Clean Cookstoves, calling for 100m homes to adopt them by 2020. In the laboratory, just like CASS, the scheme looked impressive. In tests, improved cooking stoves reduced indoor air pollution, improved health, and decreased greenhouse gas emissions. But as Duflo notes, Clinton’s policy initiative was launched despite “surprisingly little rigorous evidence on the stoves’ efficacy on health and fuel use in real-life settings”. In practice, the policy did not work because people either did not understand or did not trust the new stove.
From bank users in the UK to peasants cooking in their huts in India, the problem for policy-makers is the same: many people just do not trust new technology. Duflo proposes that people should pay to take part in an experiment, which they would then take more seriously. In the same way, perhaps CASS should have a price. It is the old story. If it costs nothing, maybe it is worth nothing.
As published in CITY AM on Wednesday 3rd February
The opening month of 2016 has been marked by sharp falls in asset prices, not just in financial markets but in commodities such as oil. The conventional wisdom is that the markets form a rational assessment of future prospects for the economy, and set prices accordingly. So if prices fall, we should be downgrading our forecasts for economic growth.
The underlying theory is that shares in any particular company only have value because of the future stream of dividends which the owner of the share will receive. If the outlook for the economy becomes gloomier, the expectation becomes that firms will not make as much profits, and dividend payments will be reduced. So share prices fall.
It sounds plausible. But in recent years, developments within economics have cast serious doubt on whether financial markets are rational in this way. A key player has been Robert Shiller, professor at Yale and winner of the Nobel Prize in 2013. The title of his first paper on the topic, published as long ago as 1981, summarises his argument: “Do stock prices move too much to be justified by subsequent changes in dividends?”
Shiller looked at data from the 1920s onwards, and showed that stock prices moved up and down to a much greater extent than did dividends. This excess volatility, as he called it, was confirmed when evidence going back into the 19th century was examined. If dividends are meant to determine prices, yet shares fluctuate much more, there is clearly something wrong with the theory. Although his article was published in the top ranked American Economic Review, it was originally widely regarded as a bit weird. Gradually, however, as events unfolded like the 20 per cent crash in share prices in a single day in 1987, his arguments became more persuasive.
Recent years have seen developments which reinforce Shiller’s point. In February 2015, for example, Brad Jones published an IMF Working Paper on asset bubbles. He points out that the value of globally traded financial assets increased from some $7 trillion in 1980 to around $200 trillion now. Even more importantly, banks no longer dominate the market. The value of assets under management of investment firms is now nearly as large as that held by the large global banks. People have become richer, are saving more, and look for companies to manage their money.
Jones argues that the incentives facing asset managers lends itself to herding behaviour and excess volatility in the markets. The tyranny of the quarterly report drives decisions. A fund simply cannot risk taking a view which is too contrary to that of the consensus. A manager may eventually be proved correct, but if in the short term loses money, investors will simply pile out of his or her fund.
Ironically, of course, large falls in markets still have the capacity to be self-fulfilling. By destroying the value of wealth, they reduce future spending. Still, it was another Nobel Laureate, Paul Samuelson, who famously remarked that “the stock market has forecast nine of the last five recessions.”
As Published in CITY AM on Wednesday 27th January 2016
The eyes of the financial and economics worlds are now fixed on China, with focus predominantly on Chinese stock markets and the country’s GDP figures. A fascinating perspective was provided last week in the leafy borough of Kingston upon Thames. The university has recruited the Australian Steve Keen as head of its economics department, and it was the occasion of his inaugural lecture. Keen was one of the few economists to highlight the importance of private sector debt before the financial crisis began in 2008.
The title itself was exciting: ‘Is capitalism doomed to have crises?’ Judging by the beards and dress style of the audience, many may have expected a Corbynesque rant. Instead, we heard an elegant exposition based on a set of non-linear differential equations.
Private sector debt is the sum of the debts held by individuals and the debts of companies, excluding financial sector ones like banks. He pointed out that in the decade prior to the massive crash of 1929, the size of private debt relative to the output of the economy as a whole (GDP) rose by well over 50 per cent.
The increase from the late 1990s onwards meant that debt once again reached dizzy heights. In ten years, it rose from being around 1.2 times as big as the economy to being 1.7 times larger. This may seem small. But American GDP in 2007 was over $14 trillion. If debt had risen in line with the economy, it would have been about $17 trillion. Instead, it was $24 trillion, an extra $7 trillion of debt to worry about.
Japan experienced a huge financial crash at the end of the 1980s. The Nikkei share index lost no less than 80 per cent of its peak value, and land values in Tokyo fell by 90 per cent. During the 1980s, private sector debt rose from being some 1.4 times as big as the economy to 2.1 times the size.
In China, in 2005, the value of private debt was around 1.2 times GDP. It is now around twice the size. Drawing parallels with the previous experiences of America and Japan, a major financial crisis is not only overdue, it is actually happening. And Keen suggests there is still some way to go.
So is it all doom and gloom? Up to a point, Lord Copper. High levels of private sector debt relative to the size of the economy do indeed seem to precede crises. But there is no hard and fast rule on the subsequent fall in share prices.
Japanese shares fell 80 per cent and have not yet recovered their late 1980s levels. In the 1930s, US equities fell 75 per cent, and took until 1952 to bounce back. This time round, they fell by 50 per cent, but are even now above their 2007 high. Equally, output responds to these falls in completely different ways. In the 1930s, American GDP fell by 25 per cent, compared to just 3 per cent in the late 2000s. Japan has struggled, but never experienced a major recession. Still, Keen’s arguments leave much food for thought.
As Published in CITY AM on Wednesday 20th January 2016.
The story of the week for many people was the new alcohol guidelines issued by the UK’s chief medical officers. In 1995, the recommended weekly upper limit for men was set at 21 units, or around eight pints. This has now been slashed to only 14 units.
We might imagine that this drastic reduction is based upon some important advance in medical knowledge. But our cultural cousins in Ireland, Australia and New Zealand do not seem to have noticed it. They still have recommended limits very close to our 1995 one. Large swathes of America retain a puritanical mistrust of alcohol, and even pensioners are required to certify their age in many states before they can order a drink. But the “health limit” for men in the United States is 25 units. In Spain it is 35.
The methodology of science may seem an abstract subject, but it has important practical implications. The point in question is: can your conclusions be replicated by other scientists? Medical officers in the UK have used scientific evidence to pronounce about “safe” alcohol limits. Their Spanish counterparts have done the same, and have come up with a number two and a half times as large. The conclusions are completely different in the two cases.
Replicability is currently a hot topic in science. For example, there is a serious crisis in psychology. It seems that most of the conclusions they draw from their experiments cannot be reproduced when the tests are repeated. We have all read media features under the headline “six steps to happiness”, or some such compelling title, based on academic psychology. But we need to take them even less seriously in future.
Science and Nature are the top two scientific journals in the world. Last August, Science had an article which attempted to reproduce the results of 100 experiments published in leading psychology journals. The original teams collaborated with the replicators, a fact which should enhance the rate of replicability. In fact, only 36 per cent of the attempted replications led to results which were statistically significant. Further, the average size of the effects found in the new studies was only half that reported in the original studies. The lead author, Brian Nosek, commenting on the paper in Nature, said that there is no way of knowing whether any individual paper is true or false from this work!
Economics has made progress in facing up to this crucial issue. Can your result be repeated by someone else? Many leading journals now insist that the data sets and even the code used to generate findings are posted on line. But there is still a long way to go to get economists to take replication as seriously as do physicists. A few years ago, my own company created a competition, with a decent prize, for the best paper on replicating an article already published. In the first year we got five entrants, the second just two, and in the third only one. Economics must avoid the current pitfalls in medicine and psychology.
As Published in CITY AM on Wednesday 13th January 2015
Last month saw some very positive economic news. The US Federal Reserve raised interest rates for the first time in over seven years. The Bank of England reported on the major stress test of UK banks which it launched in March 2015. It concluded that “the banking system is capitalised to support the real economy in a severe global stress scenario”.
Yet much of the discussion on the economy remains tinged with various hues of gloom. We expect John McDonnell, the Shadow Chancellor, to be living in the past. So it is not surprising that he has launched a “fight against austerity” with Yanis Varoufakis, the former Greek finance minister. But many commentators seem to find it hard to believe that the recession in the UK is well and truly over.
Some argue that the recovery has taken place, but that it is somehow “unbalanced”. True, manufacturing is struggling, with highly publicised plant closures in what have become effectively commodity industries, like steel. But the data from the Office for National Statistics suggests a virtually textbook example of a sustainable recovery.
The depth of the crisis was reached in the spring and summer of 2009, and we now have the initial estimates for the economy for the same period in 2015. GDP as a whole increased by £100 billion, after allowing for inflation, a rise of nearly 13 per cent. Companies spent an additional £32 billion on new investment in 2015 compare to the same period six years ago. In percentage terms, this was by far the fastest growing sector of the economy, up by 26 per cent. In contrast, consumer spending grew by only 10 per cent, less than the economy as a whole. It has been an investment-led recovery, with the role of public spending being negligible.
From a historical perspective, the recovery profile is better than it was in the 1930s, the previous time there was a major financial crisis on a world scale. The economic historian Angus Maddison devoted his life to constructing the annual national accounts of the developed economies going back to the late 19th century, and his work has widespread academic credibility. Peak output prior to the Great Depression was in 1929. In his sample of countries, only just over a half had regained this level by 1937. This time round, taking the same group of economies, 80 per cent of them had a higher GDP than in 2007.
The only area which really continues to struggle is the Mediterranean economies in the EU. In Spain, output is 4 per cent lower than in 2007, in Portugal it is 6 per cent down, in Italy 9 per cent and Greece has seen a drop of no less than 26 per cent. The crisis exposed deep structural problems with these economies.
In contrast, GDP in the G20 economies has risen by 24 per cent since 2007, the last year before the recession began. And they account around 85 per cent of world output. The economic discourse has become disconnected from reality.
As published in CITY AM on Wednesday 6th January
… and the chance to win a bottle of champagne.
For the prolonged holiday break, a quiz is appropriate. But one with a difference: not just questions, but comments to go with them. A prize of a bottle of champagne to the best answers – just email them to me.
The last couple of years have seen the rise of populist left-wing movements. Syriza in Greece is the most prominent example. Podemos in Spain polled well in the general election in that country on Sunday, securing just over 20 per cent of the vote. In neighbouring Portugal, the ruling conservatives were displaced this year after internal constitutional wrangles involving a motley alliance of leftists. Even in the United States, Bernie Sanders, the senator who openly proclaims himself a socialist, is attracting support in the Democratic primaries. Socialist incumbents were re-elected last month in Seattle, the home of Microsoft.
Many people have serious doubts about the practical viability of the programmes of these parties. But criticism is not limited to the right. The Labour Prime Minister James Callaghan notoriously pronounced at the height of the economic crisis of the 1970s that “we used to think that you could spend your way out of a recession and increase employment by cutting taxes and boosting government spending. I tell you in all candour that that option no longer exists, in so far as it ever did exist”. But which famous socialist went even further and once said, and where: “certain comrades deny the objective validity of the laws of political economy under socialism. These comrades are profoundly mistaken”?
Thinking of workers’ rights, Sports Direct has come under intense criticism this month for the alleged way in which it treats its staff. The chairman of the Public Accounts Committee, Meg Hillier MP, has called for an HMRC investigation into low pay and the “humiliating and demeaning” working conditions at the company. Whatever the truth of the allegations (and Sports Direct has insisted that it is acting within the law), working in a warehouse on low pay isn’t much fun at the best of times. But things could be worse. Where and when could workers be sent to jail for being late for work twice within a single year and with what offence were they charged?
On a lighter note, England is in action in the first Test against South Africa in Durban beginning on Boxing Day. Brian Statham, the great England fast bowler (and great Lancastrian) wrote over 50 years ago that he expected all the batting records to end up eventually in Asia. It looks like a good prediction. The highest all-time partnerships for the first five wickets are now held by Indians, Pakistanis and Sri Lankans, including the highest of all, the 624 for Sri Lanka’s third wicket against South Africa in 2006.
But our boys still hold one truly outstanding record. Jim Laker’s match statistics of 19 wickets for 90 runs against Australia in 1956 is still by far the best bowling return, not just in Tests but in any first class match. As an approximation, what is the probability that this will be beaten in 2016? Extra marks for your reasons why. Happy Christmas.
As published in City AM on Wednesday 23rd December
Image: Champagne by Sam Howzit licensed under CC BY 2.0
What would you buy Jeremy Corbyn for Christmas? Printable answers only, please. But somehow, a Christmas jumper seems appropriate. It would match the 1980s-style shell suit he wore the other day. Perhaps one with a portrait of Stalin and the slogan ‘Teacher, Leader, Friend’, a phrase in widespread use in the old Soviet Union, a country he seems to admire. The purchase would help to prop up a declining industry, something which the Labour leader seems keen to do in general.
For the sales of Christmas jerseys have peaked. In 2013, they rose by no less than 450 per cent compared to a year earlier, and this was followed by a further doubling in 2014. This year, according to analysts at WGSN’s INstock service, retailers bought in 10 per cent fewer Christmas woollies than last year. There does seem to be some rational reasons for this decision. A key one is the view taken that the market for these Christmas-themed jerseys was approaching saturation. Outside the festive season, most people shy away from wearing an item of clothing featuring red nosed reindeers or sparkly snowmen. So the old jumper appears from the bottom drawer for its annual outing.
Even so, demand seems to have been even less than anticipated. Some outlets were already marking them down to half price a week ago. It is always easy to be wise after the event. So it was obvious, was it not, that the game was up for these jerseys when Nick Clegg, still then the Deputy Prime Minister, appeared in support of Save the Children sporting a blue number adorned with Christmas puddings. He was, he pronounced on Twitter, ‘hoping to win the office’s most garish jumper competition’. Still, that was possibly one thing he did win.
Many fashion items themselves may be rather trivial, but anticipating tipping points in their life spans is a very demanding intellectual task. How early can we say that a product has reached lift off, and is going to be really popular? Exactly when are we able to pronounce that it is on its way down? Frank Bass, a larger than life Texan professor who used to smoke foot-long cigars, scribbled a few lines of maths down in the early 1960s. He distilled these into a simple non-linear equation – well, simple as far as these things go – and the resulting paper became possibly the most cited in the whole history of marketing science. Bass made a fortune in consultancy fees on the back of it.
Bass relied on dividing consumers into two types, innovators and imitators. His equation described the complex interactions between their behaviours, and tried to estimate their relative importance. This division remains the basis for the even more complicated maths that appears in papers on the topic posted on Cornell’s e-print repository for physics and maths. As a holiday diversion, forget about trying to solve the puzzle which GCHQ released on their Xmas card. Just try and predict the fashion product for next Christmas.
As published in City AM on Wednesday 16th December
The two week long Paris conference on climate change seems to drag on interminably. There are obviously many reasons why such summits find it difficult to reach meaningful agreements. But a fundamental one is that the electorates of the West are being asked to bear substantial costs right here and now, in return for a stream of benefits which will only become apparent well into the future. Closer to home, we see similar issues with major infrastructure projects such as the new airport runway in London and the high speed rail project HS2. We pay for them upfront, and the gains appear later.
Economists have a way of analysing this problem. They even, as usual, have their own special phrase to describe it, namely ‘social time preference’. The Treasury publishes the Green Book, which describes the methodology to be used in the appraisal and evaluation of the use of public funds in investment projects. A substantial part of it is devoted to how to compare the value of costs incurred now and benefits received in the future. If you are offered the choice between being given £100 today or £100 next year (inflation adjusted), you will naturally prefer to have the money in your hand immediately. But how much more would you need to be offered to persuade you to wait?
The Treasury calculates, citing some impressive academic work, that the rate to be used on public projects is 3.5 per cent a year. So if an investment yields a benefit of £103.50 next year, this is essentially the equivalent of receiving £100 today. The impact cumulates strongly, so that a benefit of £100 in twenty years’ time is only the same as £50 today. The numbers for Crossrail, for example, were ground through the same process, and came out positive. The scheme was calculated to be worth building despite the high initial costs involved in money and disruption.
In the case of climate change, the predicted benefits of taking action now stretch hundreds of years into the future. But the impact of the social time preference rate is ruthless. Very long term benefits become worth more or less nothing when translated into today’s value. Yet people in the West are being asked to bear the costs now.
This was the problem faced by Lord Nicholas Stern in his famous review written for Gordon Brown in 2006, the Economics of Climate Change. His advocacy of spending 1 per cent of the world’s GDP immediately to combat climate change has been very influential. But to get the numbers to stack up, he had to set the rate of social time preference close to zero.
Martin Weitzman of Harvard wrote an important paper nearly 20 years ago arguing that the discount rate should be reduced for the ‘far distant’ future. The Treasury do acknowledge this, and their 3.5 per cent rate only applies for the next 30 years. Even so the basic dilemma remains. Pay now, and your grandchildren might benefit. No wonder democratic politicians struggle to sell the idea.
As published in City AM on Wednesday 9th December
Black Friday has come and gone. The massive surge into the shops which was anticipated in much of the media failed to materialise. Many retail outlets were quieter than a normal Friday. In contrast, internet shopping went wild. Amazon had its biggest ever day in the UK, selling over 7 million items. Argos and John Lewis experienced problems with their websites because of the huge number of visitors. For the first time ever, online sales are believed to have exceeded £1 billion in a single day.
Experiences such as this raise fundamental questions about the predictability of many social and economic events. The Office for Budget Responsibility handed George Osborne an extra £27 billion to play with in his Autumn Statement by revising its forecasts through to 2020. Many commentators have pointed to the large amount of uncertainty which surrounds them. But these are predictions over a five year horizon. Even just a week ago, many believed that the shops would be packed on Friday. The retailers themselves geared up for the crush. But it did not happen.
It is always possible after an event to rationalise it. On Black Friday 2014, in an Asda store, shoppers trampled each other and fights broke out as they attempted to grab bargains. This mayhem was publicised widely. Looking back surely it is obvious that this is why people went online rather than risk a repeat of last year’s chaos? In fact, so-called hindsight bias appears to be deeply rooted in our individual psychologies. Something happens, and we often come to believe that it was inevitable. But this is not what the retailers and the media thought in advance of last Friday. We conveniently forget that we failed to predict it even the day before.
Approaching last Friday, consumers were essentially playing something called the Minority Game. You want to go shopping, but not if there will be huge crowds. If the shops are empty, it is not enjoyable. Like baby bear’s porridge, you want it just right, not too many, and not too few. Parisians leaving the city for their annual month off in August face a similar problem. Giant traffic jams have been experienced at 3am in the morning, as everyone came to the view that the roads would be quiet at that time. In stock markets, the ideal time to sell is just before the cusp when majority opinion shifts from being bullish to bearish. You are in exactly the right size of minority.
Two Swiss physicists, Damien Challet and Yi-Cheng Zhang, formalised the structure of the game about ten years ago. Since then literally thousands of scientific papers have been written about it. The problem can be stated in words very simply, and it is one with many practical applications. But even using hair raising maths, it turns out to be fiendishly difficult to solve. In general, there is no strictly rational way to play. To succeed you need to adapt your strategy constantly. The overall outcome is highly uncertain, just like Black Friday.
As published in City AM on Wednesday 2nd December
Image: dice another day by topher76 licensed under CC BY 2.0
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