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Will the internet lower long-term growth – or do we need to embrace change?

Will the internet lower long-term growth – or do we need to embrace change?

Are we doomed to secular stagnation, to permanently lower rates of economic growth? The debate was sparked off nearly a decade before the financial crisis by the top US economist Robert J Gordon. He took a pessimistic view of the impact of the new wave of technology on productivity and economic growth.

The latest contribution is from the Bank of England’s chief economist Andy Haldane. In a characteristically wide-ranging and thought-provoking speech, Haldane argued a couple of weeks ago that internet technology, far from being a stimulant, may be lowering the rate of long-term growth. He points out that, almost incredibly, 99 per cent of all the information ever created has been generated this century. Haldane suggests that this reduces our attention spans, which in turn leads to short-term thinking and decision-making becoming dominant. But growth requires commitment and patience. Human creativity, the ultimate foundation of all advances in living standards, demands time for reflection. Innovation and research are casualties of these trends.

Long-term growth rates reflect the underlying productive potential of the economy. Actual year-to-year growth rates may be above or below the trend, reflecting short-term influences. But there is a strong consensus among economists that, over the long term, growth is determined by deeper factors, such as innovation and the gradual accumulation of human and social capital.

The experience of the EU economies, or more precisely the economies of continental Europe, seems at first sight to support the Haldane thesis. Output in many countries, especially in southern Europe, remains well below the pre-crisis levels of 2007, almost a decade ago. Much more importantly, long-term growth rates have been in decline for half a century. The 1950s saw historically high growth rates, during the “catch-up” period after the Second World War. Essentially, there was an investment boom. The labour forces of these countries remained largely intact, despite war losses, but much of the capital stock had been destroyed. Since then, however, the underlying 20-year growth rate of the EU as a whole has fallen almost continuously. The financial crisis of the late 2000s was simply an overlay of an already firmly-established downwards trend.

But it does not have to be like this. Capitalism is a dynamic, evolving system which responds to circumstances. In the 1970s and early 1980s, the UK floundered and our prospects were gloomy. The supply-side changes of the 1980s, embracing labour market reforms and deregulation, transformed the economy. In the 1990s and early 2000s, Germany inherited our title as the Sick Man of Europe. But, again, major supply-side changes revitalised the country.

The rate of innovation is by no means fixed. Innovation is by definition disruptive. It creates new companies and industries, while destroying existing ones. The willingness of a country to embrace, rather than resist, change is crucial. Jobs for life in a cushioned public sector with gold plated pensions look attractive. But it is this which has crushed the Greeks, and France under Hollande is heading the same way.

Paul Ormerod

As Published in City AM, Wednesday 4th March 2015

Image: “Internet! 243/365” by Dennis Skley licensed under CC BY 2.0

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Popular culture is the driving force of inequality

Popular culture is the driving force of inequality

The Oscars have come and gone for another year. Winning an Oscar is very often the basis for either making a fortune, or turning an existing one into mega riches. Jack Nicholson has an estimated worth of over $400 million, and stars like Tom Hanks and Robert de Niro are not far behind.

Even winners who lack the instant recognition of these stars do not do too badly. Cuba Gooding Jnr has recently starred in the American civil rights film Selma. But after his 1996 Oscar for a supporting role in Jerry Maguire, he became notorious amongst film buffs for appearing in movies which were panned by critics and which tanked commercially. This has not stopped his wealth rising to an estimated $40 million.

The Premier League has provided us with another example of success apparently reinforcing success. Its recent TV deal with Sky and BT Sports is worth over £5 billion. Along with investment banking, soccer is one of the few industries which practices socialism, with almost all the income of the companies eventually ending up in the hands of what we might call the workers. The year immediately prior to the financial crisis, 2007, still represents a high point in the annual earnings of many people. But the average salary of a Premier League player has risen over this period from some £750,000 to almost £2.5 million.

At one level, films and football seem to provide ammunition for the sub-Marxist arguments of people like Thomas Piketty, arguing that capitalism inevitably leads to greater inequality. The rich simply get richer. This conveniently ignores the fact that over the fifty years between around 1920 and 1970, there was a massive movement towards great equality in the West, in both income and wealth.

During the second half of the 20th century, a profound difference in communications technology opened up between the world as it is now and all previous human history. Television by the 1960s had become more or less ubiquitous in the West. Vast numbers of people could access the same visual information at the same time. The internet has of course enormously increased the connectivity of virtually the whole world.

These advances in technology have altered the way in which people respond to information. The importance of social networks in influencing the choices made by individuals has risen sharply. The economic model of choice in which rational individuals carefully sift all the available information is no longer even feasible in many situations. Almost all click throughs on Google searches, for example, are on the first three sites which come up. It is simply not possible to work through the thousands, or even millions, of sites which are offered.

This means that self-reinforcing processes are set up. Things which become popular become even more popular, simply because they are popular. And because of communications technology, we know what is popular. In popular culture, a rapidly growing sector of the economy embracing both films and soccer, high levels of inequality of income are inevitable

As Published in City AM on Wednesday 25th February 2015

Image: Academy Award Winner by Davidlohr Bueso licensed under CC BY 2.0

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Shouting at the supply-chain: is there a better way?

Shouting at the supply-chain: is there a better way?

EVERY year, the supermarkets hire substantial batches of high-flying graduates to work in their buying departments. The urban mythology is that these expensively-educated young people are paid to shout down the phone, browbeating suppliers to offer yet more discounts.
This hectoring seems to be at the heart of the recent decision of the Groceries Code Adjudicator to investigate Tesco, following allegations that the company delayed payments to suppliers and unfairly handled payments for shelf promotions. These particular complaints may prove groundless. Yet they don’t exactly serve to diminish sentiment that Britain’s large firms can act as ruthless short-term profit maximisers, squeezing their supply chain for every penny. Of course, even if that is the case, we could simply see it as being part of the workings of the free market, in which the most efficient survive. But given the relative sizes of our corporate giants and most of their suppliers, there is an inherent imbalance of power at play.

So how else could these supply chains be managed? Milk is a topical example, in which the much-maligned Tesco, along with Marks and Spencer and Waitrose, is cast as the good guy. It established long-term contracts with suppliers, in which the dairy farmers are probably getting around 30p a litre for milk. Amid allegations that supermarkets are using milk as a loss leader in price wars, other farmers are believed to be receiving as little as 20p a litre – below the cost of production. The National Farmers Union warns that many will be driven out of business; over the past decade, nearly 10,000 dairy farmers have left the industry.

Another answer can be found in many extant markets that function in more sophisticated ways, flying in the face of the simple economic textbook injunction of “slash costs and maximise profit”.

A 2012 paper by Alan Kirman of the University of Marseilles and Nick Vriend of Queen Mary, London, demonstrated this by studying Marseilles’ wholesale fish market. They obtained a data set documenting every single transaction that took place in the market, across a number of years. At the time, there were about 40 registered sellers, and around 400 regular buyers. The prospective buyer approaches a seller and says what he or she wants, and is quoted a price – crucially, no prices are advertised. The price quoted is on a take it or leave it basis, and there is no bargaining.

You would be forgiven for wondering how these non-conventional features translate into business. But for every type of fish, and across the market as a whole, the classic downward sloping demand curve is seen. A higher average price means less is bought. And in a reciprocal process, buyers become loyal to the sellers who offer them the highest utility. In turn, sellers tailor their products and services to these loyal buyers, who prompt higher gross revenues.

There is a lesson here for larger companies. Developing such longer term relationships may enable value to be created in the supply chain – in contrast to the conventional model, in which it is well and truly squeezed out.

As published in City AM on Wednesday 11th February 2015

Image: Milk Family by Solveig Osk licensed under CC BY 2.0

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Bring Back Cedric the Pig!

Bring Back Cedric the Pig!

Executive bonuses are back in the news. The Goldman Sachs pot of £8.3 billion has been prominent. German executive pay has overtaken that in the UK for the first time. Top management seems to have no shame. Some bad publicity today, but the fat cheque remains safely in the bank account.

How one longs for the days of Cedric the Pig! This was the unfortunate nickname bestowed upon Cedric Brown, the Chief Executive of British Gas whose salary was increased by 75 per cent to £475,000 at the end of 1994, at a time when the company was making staff redundant. This works out at just over £700,000 at today’s prices. We can usefully contrast this with the remuneration package of Iain Conn, the newly installed Chief Executive of Centrica, parent company of British Gas. We read on the Centrica website that his basic salary is £925,000. Well, perhaps not an indecent amount more than poor Cedric. But the text goes on ‘to provide continuity of incentive opportunity prior to new arrangements being established two transitional awards will be made’. ‘Continuity of incentive opportunity’ means he could be in line for share awards of up to three times his base salary, plus pension contributions and ‘other benefits’.

Compared to many leading companies nowadays, the remuneration committee of Centrica has acted with a certain amount of restraint. Last year, the average FTSE Chief Executive was paid 143 times the salary of their average workers.

Perhaps economic theory can be used to justify these various payments? An essential component of any basic course in economic principles is the so-called marginal productivity theory of wages. ‘Marginal’ here does not have its everyday meaning in English, but is a piece of scientific jargon. It means the additional value contributed to the firm by a particular worker. According to the theory, the massive increases in executive remuneration over the past two decades or so are entirely justified. People are paid what they are worth. Certainly, this sentiment is prominent in corporate justifications for pay packages. World class individuals are needed, who can deliver world class performances.

There are many practical criticisms of this description of how pay is determined. Yet even within the abstract confines of economic theory itself, it cannot be justified. Economics has no theory with which to explain the distribution of income. This result, which required many pages of maths to prove, was established as long ago as the early 1970s. The lineage is impeccable. Gerard Debreu received the Nobel Prize for his work on equilibrium theory, and Hugo Sonnenschein went on to become President of the free-market oriented University of Chicago. But only high level graduate students, once they have been thoroughly socialised as economists, are taught these theorems.

The simple fact is that executive pay is almost entirely determined by social values and norms. The sense of restraint, of noblesse oblige, which characterised much of Britain’s post-war history, has vanished. Until top management learns to behave respectably again, the problem will remain.

Paul Ormerod

As published in City AM on Wednesday 21st January

Image: Piggy Bank by Pictures of Money licensed under CC BY 2.0 

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Corporate tax is getting easier to avoid. Time to abolish it.

Corporate tax avoidance is once again prominent in the news. When Jean-Claude Juncker, the new European Commission president, was prime minister of Luxembourg, the country seems to have operated as a vast tax shelter. Leaked documents have revealed that special tax arrangements were agreed by his country with over 300 multi-national companies.

 

Getting a handle on the scale of corporate tax avoidance across the world is tricky. A detailed study has just come out in the latest issue of the top ranked Journal of Economic Perspectives, by Gabriel Zucman of the London School of Economics. His focus is on American companies. Zucman’s thorough analysis of balance of payments statistics and corporate filings shows that US companies are moving profits to Bermuda, Luxembourg, and similar countries on a large and growing scale. About 20 percent of all US corporate profits are now booked in such havens, a tenfold increase since the 1980s. Over the most recent 15 years, the effective rate of tax on the profits of US firms has fallen by one-third, from around 30 per cent down to 20 per cent. And about two-thirds of this can be attributed to an increase in shifting profits to low-tax jurisdictions. In money terms, the loss in revenue is some $175 billion, over 1 per cent of the total size of the American economy.

 

It is of course the most dramatic examples which hit the headlines. But if the effective rate is some 20 per cent, and a few massive companies are paying very little tax at all, many American companies must in fact paying tax rates on profits which are close to the nominal rate of 35 per cent. Although Zucman does not repeat his detailed exercise for the UK and Europe, a clear implication of the paper is that a qualitatively similar outcome obtains here. In other words, most firms operate in a way which most people would regard as being fair and reasonable. Blanket condemnations on the lines of Ed Miliband’s ‘zero-zero’ speech are wholly at odds with reality.

That said, there are undoubtedly serious problems with corporate tax regimes across the developed world. The increasing complexity of the legislation offers many opportunities for ingenious but perfectly legitimate avoidance schemes, such as Google’s “double Irish Dutch sandwich” described by Zucman. We can go down the route of trying to get greater international consensus on the treatment of tax, and steps have certainly been made in this direction. But it is a long and arduous process with no guarantee of success.

The simplest solution is to abolish corporate taxes on profits and to tax consumption instead. Ultimately, the tax burden can only fall on individuals. Taxing profits creates the illusion amongst the electorate that there is a free lunch. But someone, somewhere, pays. Higher corporate taxes might lead, for example, to lower dividends or lower wage increases. Companies might squeeze suppliers harder or cut back on investment. Tax needs to be transparent, so people can really decide what value they get out of it.

 

As published in City AM on Tuesday 18th November
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Wall Street no smarter than Mr and Mrs Average

Lurid stories about the excesses in the UK housing market continue to proliferate.  True, there is some evidence of a cooling, as the price rises tempt more sellers into the market and temporarily increase supply relative to demand.  But at the same time we learn in the Sunday Times that the good burghers of Cobham enjoyed on average – on average! – an increase in the value of their homes of no less than £647,000 over the past twenty years.  Other areas in the Home Counties saw similar huge capital gains.

The Bank of England is known to be concerned about the possibility of a new house price bubble, of prices being driven further and further away from levels which can be justified in terms of fundamental economic circumstances.  Such bubbles end in tears, and some readers may recall the dramatic collapse in prices which took place at the end of the so-called Lawson boom at the end of the 1980s.  In many places, house prices did not regain theses peak levels until the early 2000s.

The real worry is that any such bubble would have damaging effects on the rest of the economy.  The new buzz phrase in policy circles is ‘macro prudential’.  Central banks are now much more aware of the damage that shocks in just one sector can cause, as their effects cascade across the economy as a whole.  And it was in the housing sector that the financial crisis began in the United States.

Much of the public outrage about the crisis rests on the belief that the incentive structures in financial institutions encouraged people to take huge risks, with no personal downside.  Wall Street, it is alleged, knew about the risks of a financial collapse, but simply carried on securitising mortgages of ever decreasing quality.

A new paper in the American Economic Review undermines this widespread perception.  Ing-Haw Cheng, of the Ivy League Dartmouth College, and colleagues from Michigan and Princeton analyse the personal home transaction data of managers in securitized finance in the period immediately before the housing crash.   In other words, when they were buying and selling on their own accounts, using their own money, did they behave as if they were aware of the housing bubble and the looming crisis?

The conclusion is stark.  In general, these managers neither timed the market correctly, nor were they in any way cautious in their own transactions in the housing market.  They seemed unaware of the overall problems in this market.  Indeed, a sizeable proportion of securitisation agents were particularly aggressive in increasing their personal exposure to housing in the run up to the crash.

The problem, Cheng and colleagues conclude, was not the incentive structure.  It was a problem of psychology.  Company ethos fostered both over-optimism and groupthink.  Different beliefs about the housing market were not encouraged.  A massive divergence arose between the dominant narrative on Wall Street about the housing market, and what was actually happening to prices.   Monitoring beliefs seems crucial to avoiding the next crisis.

As published in City AM on Tuesday 22nd September

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