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The national productivity recovery depends on getting people back to the office

The national productivity recovery depends on getting people back to the office

Office workers continue to display reluctance to return to their workplaces, despite encouragement from the government for them to head back.

The immediate consequences for the service jobs in cities which depend on people commuting into the office are apparent, hence the government drive. But is office work a good thing for the workers themselves?

An important concept in economics is that of revealed preference. Economists believe that preferences are revealed not in surveys, but by the decisions which people actually make.

So could it be that the Covid crisis has given office workers the chance to reveal their true preferences in terms of work-life balance?

This is almost certainly true for the senior staff who make the decisions. They will typically live in large houses in agreeable surroundings, with space to dedicate a room as an office.

It is much less obviously the case for many younger staff. Working with your laptop on your knees in a bedsit, unable to socialise with colleagues, may lead you to prefer the commute instead. But there are constraints on being able to reveal this preference, such as potentially annoying your boss who enjoys working from home.

Furloughed workers, meanwhile, have merely revealed a preference to be paid a large part of their regular pay and not work at all. This is particularly true of public sector workers, who receive their full salary regardless. They have no incentive to change their work patterns.

An obvious incentive for companies is that, if working from home persists, they can save on office costs. They may even be able to adjust salaries downwards, especially for staff who commuted long distance from cheaper locations.

In the very short term, there will be little, if any, loss of productivity to offset this. Most office jobs consist of performing routine, well understood tasks. Within the discipline of an established framework, some people may even be able to do their jobs more efficiently at home, encountering fewer distractions.

This is true even for jobs which require analytical skills. The business model of a number of large consultancies, for example, can be thought of as follows.

The company hires bright young graduates, who come equipped with a stock of the latest ideas — what economists call human capital.  The short-term pressures in the big consultancies to make money are so intense that they have little chance to refresh this during their careers. Essentially, they run down their human capital. By the time they make partner or director in their forties, they are operating on half-remembered ideas from graduate courses.

This is why the company requires a steady flow of new recruits, to refresh the business. The challenge with remote working over time will of course be to not only integrate new young staff into the organisation, but to ensure that their ideas percolate.

Productivity will grow more slowly over time if extensive homeworking persists. In part, this will be due to factors internal to the firm. The tacit knowledge and creativity sparked by informal exchanges will be lost.

The real loss, though, is through factors external to any individual company. A huge amount of evidence shows that the higher the density of employment in an area, the higher its productivity.

The drive to get people back into their offices, therefore, is about far more than saving city cafes and restaurants. The government should incentivise firms to get staff back to work, in order to avoid lost productivity — for the entire economy.

As published in City AM Wednesday 2nd September 2020
Image: London Underground by via Pikist
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Great expectations: The Darwinian wars of economic and epidemiological forecasting

Great expectations: The Darwinian wars of economic and epidemiological forecasting

A key concept in modern economics is, to use the jargon term, rational expectations.

The idea has dominated orthodox macroeconomics over the past 30 years. Not all economists have been persuaded of its merits by any means, but nevertheless, its influence has extended far beyond academia, into finance ministries and central banks around the world.

The basic idea is simple, even though the maths of the macroeconomic models which use rational expectations can rapidly become hair-raising.

When forming a view about the future, an individual chooses the model which best describes how the economy works. It is then simply a matter of running the model and using the values which it outputs as your expectations.

An obvious criticism seems to be that economic forecasts are very often wrong, but this is easily handled by the rational expectations enthusiasts. Each individual forecast in a sequence of months or years can be wrong. The key thing is that the errors over time cancel out. On average over time, the forecasts are correct.

The idea is not as absurd as it may appear to the layperson. For example, the Federal Reserve Bank of Philadelphia has published the Survey of Professional Forecasters since 1968.

This does what it describes on the label. It takes a wide range of forecasts by academic, commercial, financial and governmental bodies. Information on the average forecast for, say, GDP growth one year ahead is published, as well as details of the spread around the average.

Remarkably — and exactly in line with rational expectations — comparing the predictions with the actual growth over many years, the errors do indeed balance out. Spectacular errors have been made for individual years, but the over and under-predictions cancel out over time.

A more telling attack is that economists themselves do not seem to agree on what constitutes the correct model of the macroeconomy. Different groups have different models.

The standard defence is that the best model will eventually prove its superiority and will drive the others out of existence. But the problem here is that this has just not happened.

The concept of rational expectations can be applied directly to the predictions of the epidemiological models. These purport to describe how a virus spreads. So to form a view about the future, make a set of assumptions about the key inputs, and use the forecasts generated by the model.

It should be much easier in epidemiology for the best model to eliminate its competitors than it is in economics. Economics has a wide range of variables to predict, such as inflation, GDP, unemployment, public borrowing, interest rates. The focus of epidemic predictions is much narrower and their models are in general mathematically simpler than those of economics.

The Covid pandemic set up a competition between epidemiological modelling groups of fierce Darwinian intensity. The efforts of many years of academic debate have been concentrated into a handful of months.

But no group seems to have admitted yet that its model is not up to scratch — and huge differences in forecasts persist.

As published in City AM Wednesday 29th July 2020
Image: Opposites via Pxfuel
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Office clusters are as crucial to productivity as they ever were

Office clusters are as crucial to productivity as they ever were

The Prime Minister is now demanding that offices reopen to revive economic activity in the centres of towns and cities.

But there is not much sign of a return to work.

The preferences of the workforce are an important factor in the very slow pace of return. Fears expressed about the safety of public transport may or may not be genuine, but it is certainly true that many prefer to avoid the time spent commuting and enjoy the extra leisure time this brings.

But why do offices cluster together in urban centres anyway?

It is easy to see that in the old days industries such as steel and coal clustered geographically. One was a key supplier of the other. Being near at hand minimised transport costs.

Today’s offices span a wide range of diverse industries, from consulting to law to oil companies. The reasons why they locate in close proximity are more subtle.

The views of economists on this are still shaped by the writings of Alfred Marshall. He established the faculty of economics at Cambridge in 1903 and was then probably the world’s leading economist.

Marshall described the tendency of businesses to cluster near each other as “agglomeration”. He gave three key reasons why this colocation is observed.

In addition to the savings on the costs of transporting the materials needed in industrial processes, Marshall developed a theory of labour market pooling, in which firms located near one another can share labour.

Further, he believed that “intellectual spillovers” were important. Firms locate near each other in order to learn and speed up the process of innovation. Think of Silicon Valley, formed nearly a century after Marshall wrote.

A large number of detailed studies in recent decades confirm that these are not just mere theories. They have strong empirical support. The Harvard economist Ed Glaeser, for example calculated that in the US in the 2000s each of Marshall’s three reasons were of roughly equal importance.

There have been very distinct benefits to agglomeration. Throughout the developed world, the greater the density of employment in an area, the higher is its productivity. Head offices contain more highly skilled staff and so will be more productive than the average. But in city centres, their productivity is even higher than their skill levels suggest they should be.

Has Covid-19 changed all this? Or more specifically, has the crisis enabled people to see that new technology could overturn two centuries of experience in urban centres in industrialised countries?

Certainly, tech platforms such as LinkedIn offer the potential for efficient hiring of relevant skills and for employees to discover opportunities through their networks. But new recruits need to be integrated. And younger people probably still need a combination of social and remote interaction to develop their own professional networks.

It is less clear that remote working can encourage innovation in the same way. Much of the informal contacts needed for this cannot be captured by video conferences.

Yes, there will be an increase in working from home. But Marshall’s insights into the benefits of agglomeration still hold true.

As published in City AM Wednesday 15th July 2020
Image: The City of London via Wikimedia CC BY-SA
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Innovation is the only way to recover from the Covid crisis

Innovation is the only way to recover from the Covid crisis

One silver lining of the Covid-19 crisis has been a surge in innovation.

Enterprising firms have invented both new products and different ways of delivering existing ones.

Innovation is the life blood of any prosperous economy. Innovation is much more than a scientific invention. It turns inventions into things of practical and affordable use to people.

The ability to deliver innovation in a sustained way is the one single quality which distinguishes capitalism from all other forms of social and economic organisation.

Yet our understanding of it remains imperfect.

MIT Nobel laureate Robert Solow laid the foundations for the modern theory of economic growth over 60 years ago. His neat mathematical model postulated that growth was caused by increases in the amount and quality of both capital and labour used in the productive process, and by innovation.

But when the theoretical model was applied to real world data, it created a problem for economics. The increases in the inputs which could be readily measured — capital and labour — could only explain a small fraction of the growth which had taken place.

By implication, most of the huge growth experienced in the west was due to innovation. But innovation itself was not explained in the Solow model.

Despite various attempts to do better, including an ingenious one which won the Nobel Prize for another MIT economist Paul Romer, economists are still far short of a convincing explanation of innovation.

Matt Ridley, the author and scientific polymath, has made a valuable contribution in his recently published book How Innovation Works.

Ridley describes how major innovations arose in a wide range of sectors, such as energy, public health, food, transport and computing.

From this mass of detailed, empirical description, he synthesises some general principles, the vital ingredients for success.

A classic image of innovation is Archimedes jumping out of his bath shouting “Eureka!” But Ridley makes clear that such moments are exceptionally rare, even if the story is true.  This is for two reasons.

First, innovation is almost always a gradual process. It involves re-combinations of existing ideas and methods of production rather than single revolutionary events.

Second, innovation is, as Ridley puts it, a team sport. The myth of the isolated genius is deeply ingrained, but it is a myth. Innovation requires collaborations and building on what went before. Even Isaac Newton, one of the greatest minds in world history, acknowledged that he “stood on the shoulders of giants”.

Innovation also requires an acceptance of failure.  When Edison perfected the electric light bulb, he had tried 6,000 different materials for the filament before discovering what really worked.

The book ranges far wider than just the science. For example, Ridley argues that the EU has evolved into a system in which innovation simply cannot flourish. Of Europe’s 100 most valuable companies, not a single one was formed in the past 40 years. What a massive contrast with America.

Innovation is key to a successful recovery from the Covid crisis — and Ridley’s book offers excellent insights on how to make it happen.

As published in City AM Wednesday 1st July 2020
Image: Silver Cloud by lfranks via Pixabay
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A tip for Dominic Cummings: Don’t hire anyone who fails to grasp the power of incentives

A tip for Dominic Cummings: Don’t hire anyone who fails to grasp the power of incentives

The job advert issued by Dominic Cummings for people to work in government has attracted a wide range of comments. One particular focus has been on the sorts of skills he is looking for.

Computer science, forecasting, artificial intelligence, causality theory — all these topics excite his interest. Cummings advocates a small selection of scientific papers with which applicants should be familiar. He believes that humanities graduates are unlikely to be aware of them.

The papers are indeed quite challenging mathematically. Even the smartest arts graduate might struggle to cope with their content simply because of the language — maths — in which they are written.

The implication is that those with expertise in the humanities need not apply. Indeed, economics is conspicuous by its absence from the now notorious reading list.

I can empathise with his focus on the hard sciences. But economics does have one very powerful, general insight into behaviour that Cummings should heed. In fact, everyone — whether working in the civil service, think tanks or university social science departments — should be familiar with it.

It is, quite simply, that agents respond to incentives. When the set of incentives faced by an individual, a company, or a government changes, behaviour changes too. Different decisions are made as a result.

Two snippets of recent news, chosen almost at random, can illustrate the power of the concept.

Beggars have started to travel from Glasgow to Carlisle to ply their trade. In Scotland, the penalty for aggressive begging is up to a year in jail and a £5,000 fine. In England, it is only a £1,000 fine. These facts are sufficient to explain why Carlisle has become more attractive.

On a note that will be more relevant to most people, more than a million people a month now fail to turn up for GP appointments. From June to November last year, a record 7.8m patients did not attend.

This bad behaviour imposes extra costs on the NHS and makes it more difficult for people who really need to see a GP to get appointments.

A simple solution is to charge for visits to the GP surgery. It would not eliminate the problem, but it would make a big difference.  Once having paid, people would be much more likely to turn up.

Any proposal to introduce charges in the NHS causes the left to froth at the mouth. The standard argument is that charges would deter poor people from accessing healthcare.

It does not seem to do so in countries such as Ireland and Sweden. Both charge people to see their doctors. The impact is mitigated in the former by an annual cap on charges, and in the latter low-income people can visit for free. Other EU countries have similar schemes — in France, the principle of health services is pay upfront, get reimbursed later.

It is not necessary to believe that people act in a completely rational way all the time. They obviously don’t. But incentives work. Empirical examples of the principle can be found every day, in every situation.

A simple, sensibly designed set of incentives is worth a tonne of regulation. A clear understanding of this principle should be the key thing Cummings considers when hiring a new set of government “weirdos” to shake up the civil service.

As published in City AM Wednesday 15th January 2020
Image: Trending Topics via Flickr licensed for use CC BY 2.0
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Creepy micromanagement won’t drive productivity — try trusting staff instead

Creepy micromanagement won’t drive productivity — try trusting staff instead

Calling all employers: what was in your Christmas stocking? Did you find the latest gadget designed to enhance productivity?

The innovative device, featured in the media during the festive season, is a toilet with a downward sloping seat. The company which makes it, StandardToilet, has conducted extensive tests. A slope of 13 degrees is exactly the right tilt to make workers feel miserable without causing any lasting pain.

This way, it is alleged, staff will spend less time on the lavatory and more on their work. Output per worker will rise.

The very slow growth in productivity, the shorthand word for “output per worker”, was a defining feature of the past decade. Typically, productivity in the UK grows by around two per cent a year. During the latest decade, annual growth was barely above zero, at 0.3 per cent a year.

Higher productivity growth means that real wages can increase faster. Bigger pay packets mean more tax receipts for the government, so spending on public services can also rise.

Clearly, productivity growth needs to be boosted. But contrary to the claims, devices such as the sloping toilet may be one of the problems rather than the solution.

Recent years have seen a surge in technical innovations designed to control in ever more detail the tasks which workers perform. This is particularly the case at the lower end of the pay scale — think of warehouse jobs, delivery services and the like.

This ultra-micromanagement of time is intended to increase productivity. Its side effects include high employee turnover, resentment, and sheer bloody mindedness.

Why bother to make even the slightest bit more effort than your contract specifies under such conditions? Especially when, with the UK at full employment, you can walk into an equally crap job just down the road the very next day.

Nobel laureate George Akerlof addressed these issues in a famous paper 40 years ago entitled “Labor Contracts as Partial Gift Exchange”.

It was stimulated by a study which found that a group of women in a low-level, routine job exceeded the minimum work standards of the firm by an average of 15 per cent. This could not be explained by the standard economic theory of rational behaviour.

A key point for Akerlof was that the women did not work in isolation from each other. They interacted. He argued that, through these interactions, the workers acquired sentiment both for each other and for the firm. As a result, a situation developed which depended on the “norms” of gift exchange.

On the workers’ side, the “gift” given was work in excess of the minimum work standard. On the company’s side, the “gift” was wages in excess of what these women could receive if they left their current jobs.

The new tools of time and task micromanagement do the opposite. They are counter-productive, ensuring that virtually no employee will do more than the absolute minimum required by the contract. Why not try fur-lined, heated lavatory seats instead?

As published in City AM Wednesday 8th January 2020
Image: Bored office workers via Pxhere licensed for use CC0 1.0
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