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Don’t believe the myths: Capitalism has performed well since the financial crisis

Don’t believe the myths: Capitalism has performed well since the financial crisis

Ten years ago, the financial crisis began to grip the Western economies. During the course of 2007, GDP growth slowed markedly everywhere. By the end of 2008, output was in free fall.

A key theme in economic commentary is the sluggishness of the subsequent recovery of the developed economies.

The picture is not quite as bad as it is usually painted. True, last week the Office for National Statistics announced a dip in UK growth in the first quarter of this year. But from 2009, the trough of the recession, to 2016, GDP growth averaged 2.0 per cent a year.  Not exactly a stellar performance. But from 1973, the year prior to the major oil price shock, to 2007, the British economy expanded by just 2.3 per cent a year on average. The contrast between the two periods in the US is slightly greater. From 1973 to 2007, growth averaged 3.0 per cent a year, and since 2009 it has been 2.1 per cent.

There is a very stark contrast with the experience of the 1930s, the last time there was a global financial crisis. This time is different, things have only got better. The recovery may be slower than desirable, but it has been much more widespread than in the years following the Great Depression of the 1930s.

A decisive indicator is the length of time it took not just for growth to resume, but for the previous peak level of GDP to be regained.  So in the UK, for example, the economy started to grow again in 2010. But it was not until 2013 that there had been enough growth for the economy to get back to its 2007 size.

Looking at a group of 18 developed economies, which includes all the main and medium sized ones, GDP had regained its previous peak within 3 years in no fewer than 8 of them. By 2016, everyone in the group except Finland, Italy and Spain had a GDP which exceeded its previous peak.

Three years after output began to fall in 1930, not a single economy had managed to regain its 1929 level of output. Even by 1938, output was below its 1929 level in Austria, Canada, France, the Netherlands, Switzerland and Spain.

Perhaps Keynes’ most powerful insight was why the slump was so prolonged. He developed the concept of “animal spirits”, which are not a mathematically based prediction of the future, but the sentiment of the narratives which companies form about the future. He wrote: “the essence of the situation is to be found in the collapse of animal spirits…. this may be so complete that no practicable reduction in the rate of interest will be enough.”

Zero interest rates and low growth! Keynes got there before us.

Still, capitalism has performed much better in the aftermath of the financial crisis of the late 2000s than it did in the crisis of the early 1930s. Animal spirits may not be buoyant, but they are in much better shape than in the 1930s.

As published in City AM Wednesday 2nd May 2017

Image: Day 20 Occupy Wall Street by David Shankbone is licensed under CC by 2.0
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Do markets solve the problem of discrimination?

Do markets solve the problem of discrimination?

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

Image: London by Olivier Bacquet licensed under CC BY 2.0

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Technology is replacing school ties in companies’ battle to keep their employees honest

Technology is replacing school ties in companies’ battle to keep their employees honest

The activities of the House of Lords are very much in the news at the moment.  But the members do carry out serious work, not least on the economic affairs committee.  Last week, Lord Green, former chairman and chief executive of HSBC, appeared before them.  Yes, the noble Lord admitted, the bank had not got everything right. “There were things we should have done differently with the benefit of hindsight”, he told the committee.

This sort of apology has become routine from those who led banks in the run up to the financial crisis.  What was certainly not routine was Lord Green’s view on how the board could obtain reliable information about what was really going on inside the bank.  He was nostalgic for what he called the ‘old’ HSBC before the takeover of the Midland in 1992.  Then, he said, “you could rely on the people on the spot because you knew them, and had probably been to school with them”.   Rather disappointingly, at a time when the Prime Minister likes to surround himself with old school chums, Lord Green himself only went to Lancing rather than to Eton.

But his rather throwaway remark does raise an issue of fundamental importance for all large organisations like HSBC.  Just how does the board find out whether managers are cutting corners in order to meet profit targets?  Indeed, are the profits which are being reported fair and true?  The directors of Barings were certainly duped by Nick Leeson and lost their bank as a result.

Lord Green longed for the days when he had been to school with key people reporting to the board.  That is certainly one approach to obtaining sound information.  Stalin adopted a similar method in order to know what was actually being produced in the Five Year plans of the old Soviet Union.  He believed Nikolai Voznesensky to be completely reliable and promoted him to run the entire Soviet economy when still in his thirties.  Voznesensky did indeed provide years of loyal service, though his first slip up was his last.  He was shot in 1950.

Boards can’t liquidate employees who distort the information which flows up to them.  Yet even this measure, which an economist might regard as providing the ultimate incentive to behave properly, does not seem to have worked.  So much depends upon the internal culture of an organisation, as the long and interesting discussion between Lord Green and the members of the economic committee makes clear.

Recent innovations using modern computer science might help.  For example, the emotional content of internal emails and communications can be extracted using advance textual analysis.  Potentially risky attitudes might be detected, even though the reported numbers tell a different story.  Perhaps even more powerfully, by the use of network theory, the patterns themselves can reveal anomalies, regardless of the content of the messages.   The Enron internal email traffic has been dissected in a number of academic papers, and the problems were certainly identifiable in advance.  At heart, however, it is the culture, the human factor which matters, and it is here where many banks have yet to clean up their acts.

As published in City AM on Wednesday 29th July 2015

Image: “Bank Vaults under Hotels in Toronto, Ontario” by Jason Baker licensed under CC BY 2.0

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Day care for dogs and the output gap

Day care for dogs and the output gap

I am keen on dogs. Recently, I have seen an advert for a special canine toothbrush designed to get rid of the pet’s bad breath, surely a difficult challenge given what dogs get up to. Vans promoting home beauty visits for dogs have proliferated for some time now. A new service being promoted is day care for dogs, similar, one might think, to child care. The dog is deposited and entertained for the day while you go off to your meeting or out to lunch.

At one level, these stories are mere trivia. At another, they are a tribute to the continuing inventiveness of capitalism. The role of the entrepreneur is to imagine a product or service which no one, until then, realises they want, and to make a successful business out of selling it. But they are also relevant to the important policy concept of the output gap.  This is defined very simply as the difference between the actual and potential levels of GDP.

Describing the output gap is one thing, measuring it in practice is quite another. The Office for Budget Responsibility (OBR) is required to provide an estimate. A key reason is that the output gap plays an important role in assessing the government’s financial deficit, once cyclical factors are taken into account. In recessions, tax receipts drop, so the deficit rises. A measure is needed which allows for this, and this is the so-called cyclically-adjusted deficit, what the deficit would be if the output gap were zero. The output gap is also crucial to central banks in judging whether inflation is likely to be a problem as the economy expands. During the past year, there has been a flurry of publications from the various Federal Reserve banks in America on the output gap.

What is the potential level of output of the various dog services described above? Dogs, of course, are just one illustration of a proliferation of inventive offers which are available in the modern service economy. Personal trainers and lifestyle coaches are other obvious examples.  There is obviously a limit to the number of dogs for which any one person can provide day care.  But from the point of view of measuring the value of the output of a dog caring business, a great deal depends upon what price the market will bear.

Part of the problem is that such services are not commodities like, say, gold bars, which are the same everywhere. They all have their own features, their own specialities. This introduces an inherent indeterminacy into the price, which is essentially a bargain between the seller and each individual buyer. If I can double my price, I can double the value of my output, with nothing else changing at all. And, as the economy expands, the easier I will find it to put my price up. Potential output in the personalised service sector of the economy is a very flexible and elusive concept. The idea of the output gap belongs to an economy which made steel bars and dug coal, not one which provides day care for dogs.

As published in City Am on Wednesday 29th April

Image: Poodle Gothic by Amanda Wray under license CC BY 2.0 

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Capitalism is stable and resilient

Capitalism is stable and resilient

The financial crisis did succeed in creating one dynamic new industry.  Since the late 2000s, there has been a massive upsurge in op-ed pieces, books and even artistic performances offering a critique of capitalism. A founder member of the Monty Python team, Terry Jones, is the latest to get in on the act with his documentary Boom, Bust, Boom. The film makes use of puppetry and animation to argue that market-based economies are inherently unstable.

In the opening scene, Jones appears on Wall Street. ‘This film is about the Achilles heel of capitalism’, the ex-Python solemnly proclaims, ‘how human nature drives the economy to crisis after crisis time and time again’. The intellectual underpinnings of the movie are the theories of the American economist Hyman Minsky. Minsky argued that a key mechanism that pushes an economy towards a crisis is the accumulation of debt by the private sector. Although he never constructed a formal model, Minsky’s ideas are clearly relevant to the run up to the crash in 2008. They at least deserve to be taken seriously.

But does life really imitate art? Is capitalism genuinely unstable in the way in which Jones alleges in the film?  An immediate problem for this view is that there have only been two global financial crashes in the past 150 years. The early 1930s and the late 2000s are the only periods in which these were experienced. So an event which takes place approximately once every 75 years is hardly convincing evidence with which to indict an entire system with the charge of instability.

One way of looking at the stability of capitalism is through the labour market. If the system experiences frequent crises, the average rate of unemployment will be high. But this does not seem to be the case. From the end of the Second World War until the oil price crisis of the mid-1970s, unemployment averaged just under 5 per cent in America and was less than 3 per cent in the UK and Germany. Even during the more turbulent times since the 1970s, prior to the 2008/09 crisis, the unemployment rate averaged 6 – 7 per cent in the three economies. Higher, but by no means catastrophic given that Keynes himself thought it was very unlikely that the rate could be much less than 3 per cent over long periods of time.

It could be argued that since 1945, the state has intervened much more in the economy, and it is this which has kept unemployment low. But over the 1870-1938 period, the numbers are very similar to those seen post-war. In the United States, it is 7 per cent, 5.5 per cent in Britain, and under 4 per cent in Germany.

Most recessions are in fact very short lived. Since the late 19th century, 70 per cent of all recessions lasted just a single year. The distinguishing feature of capitalism is not its instability, but its resilience. Markets are not perfect, but unemployment is usually low. Crises happen, but the system bounces back.

As published in City Am on Wednesday 8th April

Image: Enjoy Capitalism by Pimkie under license CC BY 2.0

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Why are crime rates falling?

Why are crime rates falling?

Economic statistics are the bane of forecasters’ lives. Cynics might say that this is because the data reveal how bad their predictions are. But a big practical problem is that initial estimates of the state of the economy can be revised substantially.

These issues are as nothing compared to statistics on crime. The Crime Survey of England and Wales shows that crime fell by 11 per cent in the year to September 2014, and was at its lowest level since the survey began in 1981. In contrast, police recorded crimes show no change at all during 2014. The ONS does point out that there had been a “renewed focus on the quality of crime recording”. In plain English, the police were starting to do their jobs properly and actually record the crimes reported to them. Even the police figures, however, suggest a drop in every previous year as far back as 2003.

So we do know that crime is much lower than it was 10 years ago, and probably less than it was in the 1990s. Why is this? A few years ago, I was at a seminar where a professor from a criminology department at a former polytechnic in North London claimed he knew why crime took place. It was, he pronounced, the fault of capitalism. Well, capitalism seems to have become even more capitalist in recent decades, yet crime has fallen. So this particular Dave Spart idea can be kicked into touch, though taxpayer funding for similar rubbish continues.

In recent years, the success of the UK labour market in creating jobs has undoubtedly been a factor in helping to reduce crime. The plain fact is that most crime does not pay. The rewards are often meagre, and persistent petty criminals face constant pressure from their local police. It might be thought implausible that semi-literate low skilled young men, the group which commits most crime, are capable of such rational analysis. But the evidence is pretty convincing. Stephen Machin at University College London, for example, did a very sophisticated statistical analysis of crime in the police areas of England and Wales when the minimum wage was introduced in the late 1990s. He found that it had a clear impact on cutting crime.

Another factor is the complex evolutionary game played between criminals and respectable citizens. Cars get broken into and stolen, so technology which makes this more difficult is gradually discovered. People become more security conscious about their homes, making burglaries more problematic.

A recent survey of 500 police officers claimed “there are just not enough of us to cope”. But despite this moaning, a constant theme in recent years, crime has fallen. Some increases in the efficiency and productivity of the police force have taken place, but there is a long way to go. And the culture is still too focused on the political correctness inherited from the Blairite era.

Sharp reductions in crime have been experienced in America and elsewhere in Europe as well as the UK. The explanation remains a key challenge for serious social science.

As published in City AM on Thursday 26th March 2015

Image: “Police Line /Police Tape” by Tony Webster under license CC BY 2.0

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