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Banks, cancer and Stephen Hawking

Banks, cancer and Stephen Hawking

Massive fines for banks, gross misbehaviour, huge bonuses for failure, bailouts at vast expense to the taxpayer: it’s little wonder that politicians and pundits can almost invariably win cheap applause by describing the financial system as being a cancer on society.

But in a deep way, cancer and the financial system do have much in common. They both exhibit qualities which in the scientific jargon are known as “robust yet fragile”. It is a key concept in the new but rapidly expanding field of complexity science, described by Stephen Hawking as the science of the twenty-first century. Complexity provides the tools which connect many apparently unrelated phenomena. Bright young people in particular need to listen to Hawking’s opinion to equip themselves with the skills which will make them really marketable.

The concept of “robust yet fragile” is relevant to almost any system which evolves over time. Successful systems develop features which enhance their ability to survive. In particular, they need to be able to withstand the continuous shocks and surprises which happen all the time in real life. The subject of last week’s column, Fifa, has just experienced a major shock which may prove terminal for the organisation. But for the most part, unanticipated events are on a smaller scale. Robust systems develop the capacity to absorb these kinds of shocks. It’s pretty obvious, one might think.

The important insight is that it is exactly the ways in which systems evolve to become robust which also makes them fragile. The global financial system during the decades prior to the crisis became increasingly interconnected. A massively complicated network of assets and liabilities developed.

At one level, this was good news. If a particular connection went under and a bank was left with a bad debt, the fact that it now had so many other connections, other contracts, meant it was more able to take the hit. But when confidence started to collapse in 2008, the very fact that financial institutions had become so closely entwined with each other meant that the adverse consequences spread like wildfire. The system was robust to most shocks, but had become fragile. The effects of a single piece of bad news could be transmitted across the dense network very efficiently.

Last week a major breakthrough in the treatment for many cancers was announced, and it illustrates the robust yet fragile nature of cancer. Cancer evolves continuously, thereby defending itself against standard attacks such as targeted therapies. It stays one step ahead and makes itself robust to the shocks designed to kill it. But its evolution has made it vulnerable to a new approach, which harnesses the body’s immune system to attack cancerous cells. The ways in which cancer has changed has made it easier for the immune system to recognise the difference between normal and cancer cells. True, it has required some very smart science to take advantage of this. But the robustness which cancer developed to cope with previous shocks has made it fragile to the latest one.

As Published in City AM on Wednesday 10th June 2015

Image: Ice Sculpture by William Warby under license CC BY 2.0

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Economists are not impressed by Piketty’s views on inequality

The financial crisis has undoubtedly created a demand in popular culture for works which portray capitalism in a bad light, such as the recent best seller by Thomas Piketty.  Piketty’s writing has gathered increasing attention from economists, and his arguments do not really bear scrutiny.

The focus of Piketty’s work is the long-run evolution of the ratio of capital to income.  He claims that this is now very high by historical standards, and will rise even further as the 21st century unfolds.  Wealth will become more concentrated and inequality will rise inexorably even more.

The message that capitalism inevitably leads to greater inequality is one that many people want to hear.  Unfortunately for them, it is wrong.  Piketty assembles an impressively large amount of empirical evidence. This shows clearly that from around 1910 to 1970, inequality actually declined sharply across the West.

Piketty argues that there were special factors involved in this period, which will not be repeated in the future.  But modern capitalism was essentially formed in the decades either side of 1900.  A truly massive merger and acquisition movement took place, and for the first time ever, companies existed which operated on a global scale.  So we have had a globalised capitalist economy for approximately 120 years.  For half this period, inequality fell, and in the other half it rose.  The belief that capitalism always creates inequality is scientific nonsense.

A devastating theoretical and empirical critique of Piketty is made in a recent paper by Bob Rowthorn, former head of the economics department at Cambridge.  Rowthorn became in his younger days an expert in Marxist economics, and so is ideally placed to appraise Piketty’s work.

Piketty shows that there has indeed been a sharp rise in the ratio of wealth to income in the early 21st century, to around 5 or 6 compared to just 2 to 3 in the 1950s and 1960s.  Rowthorn points out, using Piketty’s own data, that the whole of this increase is due to capital gains in both housing and the equity markets.  In real terms, the ratio has been constant in Europe and has actually fallen in America.  This is highly relevant.   A crucial part of Piketty’s argument about the future is that he believes that the rate of economic growth will be low.  But if growth is low over many decades, it is very hard to believe that there will not be a reversal of the increases in real estate and share prices, and Piketty’s measure of the ratio of wealth to income will fall.

From a theoretical perspective, mainstream economics has a great deal to say about the evolution of the ratio of capital to income, and the implications for wages and profits.  Piketty uses this theory.  But, as Rowthorn points out, the theory is set out in real terms, not in the current price terms which Piketty uses for his empirical evidence.

Economics can be very useful, not least in exposing the fundamental flaws in popular opinions.

As published in City AM on Tuesday 8th July

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The ‘Gentleman in Whitehall’ does not know best

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


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Lancashire and London have dominated the Premier League. Can it last?

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.

Paul Ormerod

As Published in City AM on Wednesday 2nd April

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Farewell Facebook?

So farewell, then, Facebook! That is the conclusion of a highly technical paper by two Princeton researchers, John Cannarella and Joshua Spechler, which received a lot of publicity in the press last week. The authors conclude that “Facebook will undergo a rapid decline in the coming years, losing 80 per cent of its peak user base between 2015 and 2017”.

The natural reaction of an economist to such a prediction is to ask whether the scientists have taken positions in options on Facebook’s future share price. If they prove to be correct, they stand to make a fortune. It is easy to be cynical about this kind of prediction, but a couple of important points can be drawn from the theme of the paper and the approach which is used.

Facebook currently has over 1 billion users worldwide, and a market capitalisation of around $130 billion. It might seem implausible to many that this giant company might collapse so rapidly. But this is exactly what happened to MySpace, the most visited website in the world from 2005 to early 2008. By 2011, it had all but disappeared. Even giant firms fail. This is the lesson of economic history, ever since companies operating on a truly global scale began to appear in the late 19th century. Of the world’s top 100 non-financial companies a century ago, in 1914, all with market capitalisations of many billions in today’s prices, most have either gone bankrupt or are mere shadows of their former selves. Some of them disappeared very quickly. Even the largest company can collapse.

The second point is about why people choose one thing rather than another. Economists try and explain this by referring to the observable attributes of the alternatives, such as price and quality. If a service like Facebook is fantastically popular, it must be because the product not only provides features which many people want, but because it does so much more effectively than its rivals. A dominant market leader can only be displaced, on this view of the world, if either a superior rival emerges, or if there is some unforeseen and sudden shift in consumer tastes.

This is not at all the approach taken by Cannarella and Spechler. Their model takes no account at all of the features of Facebook or its online social network competitors.  Instead, the decision whether to start using Facebook, to carry on using it, or to abandon it, is made solely by taking into account what your friends are doing. The approach provides a startlingly good account of the rise and fall of MySpace.

This is just one example of the mathematical models which are now being used to explain, very successfully, many aspects of consumer behaviour on the internet. Factors such as price and quality can be added to them. But the main driver of an individual’s choice is, quite simply, what other people are choosing. Marketing departments and ad agencies increasingly need top quants just as much as they need creative.
As Published in City Am on Wednesday 29th January 2013

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Britain’s New Industrial Policy: Can We Learn from the Mistakes of the Past?

The phrase ‘industrial policy’ seems to take us decades back in time. In 1964, a powerful catchphrase of the new Labour Prime Minister, Harold Wilson, was the need for Britain to embrace the ‘white heat of the technological revolution’. Sadly, by the 1970s this vision had deteriorated into a list of institutions, stuffed with dull businessmen and trade unionists, meeting to decide how to prop up yet another failed sector of the UK economy.

But the concept is now back in vogue. Perhaps surprisingly, given the historical experience, the coalition chose to preserve Labour’s Technology Strategy Board (TSB) quango. The TSB has a budget of £400 million to “accelerate UK economic growth by stimulating and supporting business-led innovation”. A key way in which it plans to do this is through the purchasing decisions of the public sector.

In October, Sir Andrew Whitty, CEO of GlaxoSmithKlein, produced a report commissioned by the Department for Business, Innovation and Skills on how universities can better support economic growth and drive exports. Whitty calls for the creation of “Arrow Projects”, supporting cutting edge technologies and inventions where the UK leads the world, with, in an excruciating pun, “universities at the tip”. Universities and Science minister David Willets eulogised the report. In language redolent of Soviet Five Year Plans, he stated that “we are making strides to help commercialise the work of universities under the Eight Great Technologies”.

It is easy to mock both the symbolism and the content of speeches and reports such as this. But the intention deserves to be taken very seriously. Thinking back again to the decades of the 60s and 70s, far-left radicals used to denounce the ‘military-industrial complex’ of the United States. Yet it has been precisely the interplay between the defence and security sectors and high-tech commercial companies that has led to America continuing to lead the world in technological innovations.

A fascinating new book by Bill Janeway, Doing Capitalism in the Innovation Economy, gives many such examples. The creation of the internet is well known, others include automatic speech recognition and digital computing. Janeway has made a personal fortune, not by financial speculation or by trading complex derivatives, but by developing and leading the Warburg Pincus Investment team which provided financial backing to a whole series of companies which built the internet economy.

A fundamental point which he makes is that both scientific research and invention, and its subsequent exploitation through practical innovations, necessarily involves a great deal of waste. This is something which British bureaucrats have, in the past, been unable to grasp. Ideas which are genuinely path-breaking cannot be conceived in advance. And, equally, the value of their practical applications is something which cannot be imagined before it happens. This means that many such ventures will fail. They cannot be conceived in advance. And, equally, the value of their practical applications is something which cannot provide the box-ticking security of projects which add tiny amounts of knowledge, or which make trivial improvements to an existing technology. So, Arrow and the TSB are to be welcomed, provided that they, and the Public Accounts Committee, recognise that most things fail.

As published in City Am on Wednesday 4th December 2013

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