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Science does not always make sense

Science does not always make sense

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

Image: Pour by jenny downing licensed under CC BY 2.0

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How do you deal with someone who thinks the Earth is flat?

How do you deal with someone who thinks the Earth is flat?

Imagine you are relaxing at a bar enjoying a drink after a hard day’s work.  The person next to you strikes up a conversation.  Initially he seems reasonable.  But soon he begins to go on at length about how the Earth is flat and how a misguided cabal of scientists hides this truth from us.  You could try and persuade him of the error of his ways.  But the most sensible course of action is to make your excuses and leave.

Economists face the same dilemma in commenting on the policies of John McDonnell, Jeremy Corbyn’s new Shadow Chancellor.  They are bonkers.  For example, McDonnell believes that the problem of the public sector deficit can be solved by extracting an additional £93 billion a year from companies.  He claimed in the Guardian this is the total amount of subsidies which the corporate sector receives from the taxpayer.  The source of the calculation is apparently a report published by the University of Sheffield, with the same newspaper bemoaning the fact that no-one bothers to read it.  Could there be a reason?

Suppose, purely for the sake of argument, that the £93 billion figure is correct.  What might be expected to happen if companies are suddenly deprived of this vast amount of money?  They might slash dividends, an action with which McDonnell would almost certainly approve.  This would of course harm pensions, but perhaps this is the price to be paid.  But firms might equally well make major savings by getting rid of workers, by reducing wages, or by drastic cuts in investment and research and development expenditure.  Ultimately, only individuals and not companies can bear the cost of taxation, a profound insight of economics which many, especially on the Left, find hard to grasp.

By comparison, the economic wish list set out by Corbyn himself during his leadership campaign gives the impression he retains some residual connection with reality.  But is a Flat Earther more or less balanced than someone who, say, believes that the dimensions of the Great Pyramid reveal the hidden secrets of the universe, a quite popular internet delusion?

Corbyn argues that there is no need to place limits on the amount of welfare benefits which an individual or family can receive.  Economic growth will revive the economy to such an extent that employment will boom, and many people will be removed from welfare as a result.  In turn, growth will be generated by the activities of a new National Investment Bank.  But this is pie in the sky.  The failure of planned economies such as the Soviet Union, the failure of the National Plan of the 1964 Labour government, the failure of the Regional Development Agencies, none of this evidence shakes Corbyn’s faith in the inherent superiority of economic planning and dirigisme.

No doubt these policies will have some popularity in the regions which are already heavily subsidised.  But it is hard to see them striking a chord in the wealth generating parts of London and the South East.

As published in City AM on Wednesday 23rd September

Image: An Epic View of Earth by NASA’s Earth Observatory licensed under CC BY 2.0

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The national accounts are the new JK Rowling

The national accounts are the new JK Rowling

A potential candidate for the world’s most boring book is the Office for National Statistics’ National Accounts: Sources and Methods.  This book, all 502 pages of it, is currently available in hardback on Amazon for just 1p.  It does exactly what it says in the title.  It gives a detailed description of how the data in the national accounts – variables such as GDP, inflation, earnings – are estimated.

These data series are the building blocks on which economic policy is based.  The Bank of England has a mandate to keep inflation around 2 per cent.  The Chancellor frets if the latest GDP growth figures are weak.  All these indicators depend upon the detailed processes described in the book of gathering information, sifting it, and deciding what it means.

To an economist at least, the tedium of the book is interrupted by occasional pearls of wisdom.  There is huge uncertainty around any particular number which is produced.  Sources and Methods suggest that the potential margin of error around an estimate of GDP is plus or minus 1 per cent.  To put this in context, average annual GDP growth in the UK over the past 30 years is just 2.3 per cent.  For some of the more obscure statistics, the error margin was believed to be as large as plus or minus 15 per cent.

But national accounts have suddenly become sexy.  Sir Charles Bean, former Deputy Governor of the Bank of England, has been tasked by George Osborne to carry out an independent review of the quality and delivery of UK economic statistics.  There is a particular focus on the challenges of measuring the modern economy, with a rapidly rising proportion of all economic activity taking place via the Internet.  Measuring value in cyber society, with its completely innovative range of products and services, is a major intellectual problem.

The latest issue of one of the American Economic Association’s flagship journals, the Journal of Economic Perspectives, carries an article on communicating uncertainty in official economic statistics.  The initial estimates for any statistic are invariably revised over time.  These revisions are often large, so that the early estimates offer a misleading view of the economy to policymakers.  In the first quarter of 2014, for example, there was an unexpected fall in American GDP on the previous quarter.  Initially believed to be just 1 per cent at an annual rate, the number was revised to a much larger drop of 2.9 per cent.

The problem goes much wider. For example, national accounts statisticians rely quite a lot on surveys.  But ‘non-response’ can be serious.  In poverty statistics for the US, for example, over the 2002-12 period between 7 and 9 per cent of households in the sample yielded no data at all by not responding.  A massive 41 to 47 per cent gave incomplete data by not filling in all of the survey.

Statistics in general is suddenly fashionable. High starting salaries go to graduates who can analyse Big Data.  And the boring old national accounts find exciting new challenges.

As published in City AM on Wednesday 15th September

Image: Harry Potter by Halle Stoutzenberger licensed under CC BY 2.0

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Why economics can prevent Europe’s refugee crisis from becoming even worse

Why economics can prevent Europe’s refugee crisis from becoming even worse

Emotions are running high over the refugee crisis, with heart-breaking images arousing waves of compassion across Europe. As ever, however, economics lurks in the background. The tragic stories of refugees coming to Europe rightly elicit a call to help those in need, but we must understand the underlying realities to truly do something about this crisis.

We can contrast the general composition of the refugees fleeing Syria and those already encamped at Calais, for example. The Syrians are mainly family groups, whereas in Calais young men predominate. Incentives help explain their choices of destination. As they trail across Eastern Europe, the Syrians chant “Germany!” At Calais, however, everyone wants to get into the UK. The political situation is highly fluid, but Germany has had a policy of open borders for such refugees. Other European countries are less easy to get into.

Many of those in Calais speak fluent English and have high skill levels. They would make a much more positive contribution to this country than, say, relatives imported from the poorest parts of Pakistan and Bangladesh. Their families have invested large amounts of money in their journeys, made with the specific purpose of getting into the UK. The lighter regulatory burden imposed on the British labour market than in much of the rest of the EU is in many ways a great strength. But it does mean that it is much easier to work illegally here. In theory, employers can be prosecuted for employing illegal immigrants, but in practice this doesn’t always happen. Skilled young people can thrive, which is why they want to come – not to sponge off our benefits, but to work.

Incentives feature strongly in the highly emotive issue of the boat crossings too. Since the EU took the decision to rescue the boats, the numbers crossing have soared. The demand has increased after an important component of the price of the voyage, that of the chances of being turned back, has fallen sharply. But the consequences of this misguided liberalism have been to place more lives at risk. Indeed, there is increasing evidence that the so-called boat captains are now not even bothering to get on board themselves. They simply take their large fees and let the refugees steer as best they can. After all, why put your own time and effort into a task when the EU will, or least purport to, do it for you? So the crossings have become even more dangerous.

The role of incentives is misunderstood and so, too, is the most fundamental feature of economics – the allocation of scarce resources. “Saint” Bob Geldof may be able to accommodate refugees in his large underutilised homes, but for local authorities there is a real trade-off. Every refugee housed is a person already on the waiting list who has to stay on it. Not just that, but they tend to be allocated to the poorer parts of the country where property is cheap. Simon Danczuk, the leading Labour moderate, points out that his Rochdale constituency has already been made to accept more asylum seekers than the whole of the South East of England.

Economics may often seem harsh, but keeping its principles in mind can avoid outcomes being even worse.

As published in City AM on Wednesday 8th September 2015

Image: Un jove de Kobane (Síria) refugiat a la frontera turca. by Jordi Bernabeu Farrús is licensed under CC BY 2.0. 

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Scandinavia provides the evidence for Osborne’s war on welfare

Scandinavia provides the evidence for Osborne’s war on welfare

George Osborne’s budget has been met with predictable outrage from the poverty lobby.  The cuts to the welfare budget will allegedly create shocking levels of deprivation.  Young people in particular, it is stated, have been singled out for punitive measures.  On the face of it, the arguments do seem plausible.  Many people on benefits will get less money.  But slashing these payments is a policy which is very popular with the electorate as a whole.  The welfare state, created with the best of intentions, is increasingly seen not as a provider of services to the population as w hole, but as a means of transferring money to those on benefits.

A fascinating new monograph by Nima Sanandaji looks in detail at the welfare systems of the Scandinavian countries over the past century.  Its main title, ‘Scandinavian unexceptionalism’, could mean anything.  But the sub-title rams the message home: ‘Culture, markets and the failure of third-way socialism’.  Greece shows the failure of socialism when other countries are expected to pick up the bill.  Sanandaji writes about the failure of socialism when the tab for a large welfare state is handed to people inside the country itself.  Although they seem harsh, Osborne’s policies will eventually prove to be in everyone’s interests, including those of the poor.

The economic success of the Scandinavian economies long predates their large welfare states.  Between 1870 and the Second World War, for example, Sweden was the fastest growing developed country in the world.  Their success was not a miracle, but was based on standard ingredients such as an open economy, competition in domestic markets, the rule of law, and reasonable levels of taxation.

Even in 1955, the share of taxation in GDP was lower in Sweden, Denmark, Finland and Norway that it was in the UK.  In the case of the former two, the tax take was low by the standards of the rich nations at the time, being in the low 20 per cent range, very similar to the United States.  The Scandinavian experiment of high taxation and a generous welfare state only began in the 1970s.  By 1985, whilst the tax take in the US had remained at 25 per cent, almost the same as in 1955, it was 46 per cent in Sweden and 48 per cent in Denmark.

From the 1970s, the previously dynamic Swedish economy virtually stalled.  Between 1970 and 2000, net job creation in the private sector was zero.  Sweden fell from 4th position in the OECD table on living standards to 11th.  Taking into account sick leave, which grew enormously, and early retirement, the Nobel Prize winner Thomas Sargent calculates that the true rate of unemployment in Sweden since the mid-1990s has varied between 14 and 18 per cent.

The Scandinavian countries, with the partial exception of oil-rich Norway, began to scale back both taxation and welfare provisions in the 21st century and their economic performance have improved.  Correlation does not prove causation, but the Scandinavian experiences suggest that apparently generous welfare states eventually damage everyone’s prosperity.

As published in City AM on Wednesday 15th July 2015

Image: Stockholm by Michael Caven licensed under CC BY 2.0

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Supply side success is a cure for the drug of deficit finance

Supply side success is a cure for the drug of deficit finance

George Osborne’s plan to run financial surpluses and use them to pay off government debt has been met with the usual set of whinges and whines, mainly from academic economists funded by the taxpayer. Of course, their arguments are based purely on what they believe to be the intellectual merits of their case.  One of the more prominent names is David Blanchflower, once a Gordon Brown favourite on the Monetary Policy Committee, who at least is based in a private university in America. Blanchflower predicted that coalition policy after the 2010 election would lead to 4 million, and possibly even 5 million, unemployed. The actual figure now is 1.8 million. Still, economic forecasting is a notoriously difficult exercise.

It is clearly very difficult for a certain kind of economist to grasp the fact that an economy can prosper whilst at the same time the government balances the books. The two decades after the Second World War were probably the most successful in the entire history of the UK as an industrial economy, stretching back to the late 18th century. From the late 1940s to 1964, real GDP grew at an annual average rate of 3.5 per cent. Today, relatively few economists believe that we can sustain an annual growth of more than 2.5 per cent. And each additional one percentage point extra on GDP represents the best part of £2 billion worth of extra output.

Over this period, successive governments added virtually nothing to the size of government debt. In some years the government ran a surplus, and in others a deficit. But cumulatively, these more or less cancelled out. At the same time, low but persistent inflation eroded the value of the outstanding stock of debt, so that as a percentage of GDP, government debt declined sharply over these 20 years. Of course, fiscal prudence did not by itself cause the strong economic performance. Indeed, rapid growth leads to a growing flow of receipts from taxation, which makes it easier for a government to behave responsibly.

The key point is that the 1950s and early 1960s were very favourable to sustained growth driven by the supply side of the economy, by companies incentivised by the prospect of profit. The controls and restrictions imposed of necessity during the war had largely been lifted by the time the post-war socialist government under Attlee lost office in 1951.  Living standards has been ruthlessly squeezed during the war in order to divert resources into the armed forces. So there was a massive pent up demand for new consumer goods. Companies had been unable to invest during the war, so they wanted to build up their stocks of capital equipment rapidly. The net result was a prolonged boom, driven by the supply side, and enhanced by the renewed opening up of world trade.

Economic theory suggests strongly that longer term growth is driven by the supply side, by investment and innovation. If Osborne can create a climate in which these flourish, he will simply not need the drug of deficit finance.

As published in City AM on Wednesday 17th June 2015

Image: Piccadilly Circus c1960 by David Howard under license CC BY 2.0

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