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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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The Happy Band of the Self Employed 

How many workers does the typical American firm employ?   Actually, it is a trick question. The answer is ‘zero’.  More than 50 per cent of all companies in the United States are one person operations – the owner, and no-one else.

This fragmentation of size is increasingly reflected in the UK.  Here, the main growth is in self-employment rather than through one-person companies, but the principle is the same.  According to the Office for National Statistics, in 2014, 4.6 million people were self-employed in their main job, accounting for 15 per cent of those in work, the highest percentage since data were first collected 40 years ago.  Total employment in the second quarter of 2014 was 1.1 million higher than in the first quarter of 2008, just before the economic downturn. Of this increase, 732,000 were self-employed. So the rise in total employment since 2008 has been predominantly among the self-employed.

Good news, of course, which reflects the flexibility of the British labour market, though it seems to come at a cost.  The ONS estimates that the average income of the self employed has fallen by no less than 22 per cent since 2008.   Ed Miliband and the conventional Left denounce these developments.  Proper jobs have not been created, and people have been forced against their will to take large cuts in pay.

Earlier this year, a major study by the Royal Society of Arts exploded this as a myth.  Only 1 in 4 who started up in the recession said that escaping unemployment was a key motivating factor. A much more common answer was to achieve greater freedom. The self-employed are also happier than typical employees. Eighty-four per cent agreed that they were more satisfied in their working lives than they would have been in a conventional job (66 per cent completely or strongly so). The RSA argued that forgoing material benefits for more meaningful returns is a sign of a new ‘creative compromise’ at work.

In fact, basic economic theory suggests that well-being increases when people are offered more flexibility in the trade off between work and leisure.  To caricature the old days, you were offered a 40 hour week, take it or leave it.  But being self-employed allows you to choose your own point on the supply curve.

The RSA’s ideas are being taken forward in an exciting way in a new book by Adam Lent, director of their Action and Research Centre.  The book, Small is Powerful, is, naturally, crowd funded.  Lent argues that not only is the era of big government, big business and big culture over, but that this is unequivocally a Good Thing.  Intriguingly, in the wake of the recent by-elections, Lent writes about Zombie Politics, and why big politics continues despite nearly everyone having lost the faith.  He does not really deal with the issue of how, in the internet economy, the small can suddenly become terrifyingly big, witness Google and Facebook.  But his book opens a window on how our world is changing.

As published in City AM on Tuesday 14th October


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More ideas like HS3 are needed to solve our regional problems

In London and much of the South East, the recovery has been well under way for a considerable time.  House prices boom and restaurants are packed.  The economic data for the UK as a whole looks just as encouraging, with employment being at its highest ever level.

Yet there are persistent complaints that the recovery is not spread evenly.  Many areas are alleged to still be in the doldrums.  The bogeyman of austerity is invoked to explain the geographically uneven nature of the recovery.  Restraint on public spending has undoubtedly worked for the economy as a whole, contrary to the beliefs of liberal commentators.  There is perhaps a kernel of truth in the allegation at a regional level.  Like all governments, the coalition has rewarded its own supporters in terms of the allocation of central funds to local authorities.  As a result, many councils in the North are facing a punishing squeeze on their spending levels.  And it is precisely in these areas where state spending plays a large role in the local economy.

But the uneven spread of prosperity as the recovery gathers pace is nothing new.   There is a huge amount of inertia in the labour market experiences of different local areas.  So once a town experiences a high rate of unemployment, it becomes very difficult to alter its relative position.  The rate of unemployment still varies with the overall state of the economy, though the rate in such an area remains relatively high.  The town continues to feel poor compared to more dynamic locations.

There are around 400 local authorities across the UK as a whole.  If we take the rates of unemployment in these areas in 1990 and compare them with the rates in 2010, the correlation is very high, at 0.81.  An area with relatively high unemployment in 1990 had a very good chance of experiencing the same thing no less than twenty years later.  In a recent article in Applied Economics Letters, I show that the same result holds for relative unemployment rates within the individual regions of the UK.  Incredibly, the correlation within regions over a 20 year period is even higher than across the UK as a whole, at 0.88.

This very strong persistent of relative prosperity, or rather the lack of it in some areas over a long period of time, does call for a thorough reappraisal of policy.  Even within an individual region, poor local areas essentially remain relatively poor compared with their immediate neighbours.  Conventional regional policies, on which many billions have been spent, have not worked.  At least the coalition abolished the futile Regional Development Agencies.  But, equally clearly, the market mechanism is not providing the answer.  Twenty years is a long period of time over which incentives ought to work.

George Osborne’s proposal for high speed rail links to connect the North within itself more effectively has attracted a lot of criticism.  But it is exactly such imaginative, potentially risky, concepts which are needed.  Conventional thinking has failed completely.

As published in City AM on Tuesday 24th June


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Psychology, not hard line maths, tells us why Osborne’s strategy is working

So, International Monetary Fund, wrong again! At the end of last week, the IMF abandoned its criticism of the UK government’s economic strategy. Christine Lagarde, the IMF chief, said her organisation had ‘underestimated’ the strength of the recovery in Britain. The IMF now believes that the UK will be the fastest growing of any major economy in 2014.

In complete contrast, Olivier Blanchard, chief economist at the IMF issued dire warnings in early 2013. George Osborne, he pronounced, was ‘playing with fire’. Unless austerity policies were abandoned, the UK economy risked a triple dip recession.

Both Blanchard and the IMF have got form on these matters. In early 2013, Blanchard and his colleague Daniel Leigh published an IMF Working Paper on the size of the fiscal multiplier. The multiplier, a theoretical concept invented by Keynes in the 1930s, is the most fundamental concept in the whole of macroeconomics. It measures the eventual impact on the economy as a whole, GDP, of a sustained increase, or decrease, in public spending. An increase in such expenditure brings more people into work, they in turn will have more to spend, the companies whose products they buy will have more revenue, and will employ even more people. The initial impact is multiplied through the economy. Sounds simple. But there are many potentially offsetting factors to take into account. Some of the extra spending will be on imports, for example, which does not boost domestic output at all. The bigger public deficit which the extra spending creates may lead to higher interest rates.

Economists have struggled for decades to arrive at a consensus on how big the multiplier really is. Whilst still being far from agreement, there is a general view that it is low. Indeed, a fiscal expansion, once all the other feedbacks are taken into account, may even lead to GDP rising by less than the size of the stimulus. Blanchard and Leigh argued, in contrast, that in the current circumstances, it is large and positive. So a fiscal contraction, the basis of the Chancellor’s policies, will lead to the opposite, to a sharp reduction in GDP. Events have shown this to be wrong.

The IMF duo cited approvingly other estimates, derived from the exotically named dynamic stochastic general equilibrium models (DSGE), that the multiplier is large. These models have been all the rage in both top academic circles and central banks. Blanchard eulogised them in an MIT discussion paper published three weeks before the collapse of Lehman Brothers in September 2008. Great progress had been made with DSGE models in understanding how the economy really worked. The state of macroeconomics, he declared, was ‘good’.

An inescapable problem for these highly mathematical models is that they do not take into account sentiment, the narrative which emerges around policy changes. Osborne’s fiscal contraction has gradually created a positive narrative across companies, so they are willing to create jobs and invest. Psychology rather than hard line maths is needed to tell us what the multiplier really is in any particular situation.

As published in City AM on Wednesday 11th June 2014

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Two cheers for the global recovery, but doubts remain in the Euro zone

Worries are growing about some of the countries in the Euro zone slipping back into double dip recession. By convention, a recession is when national output (GDP) has fallen for two successive quarters. But this is far from being news. In a substantial number of economies, output is lower than it was not just two quarters ago, but three whole years ago, at the start of 2011.

The quarterly numbers have wobbled around up and down over this period, but they are now unequivocally below the 2011 figure in Greece, Ireland, Italy, Portugal and Spain. No surprises there. But the list goes on to include Finland, the Netherlands and the Czech Republic.

An article in the latest American Economic Review by Reinhart and Rogoff puts the events into a longer historical perspective. These are our old friends, one of them a former Chief Economist at the IMF, who declared that when the ratio of public debt to GDP above the 90-100 per cent range, the likelihood of a financial crisis rose sharply. There turned out to be a mistake in their calculations. But this time round, their numbers seem sound. They take 100 examples of financial crises, across time and countries, and look at the subsequent recovery path of GDP. In no fewer than 45 per cent of cases, there was a double dip recession. So the current situation is somewhat better than this across the developed world.

From a historical perspective, there is more good news. Reinhart and Rogoff calculate that on average, following a financial crisis, it takes no less than eight years for GDP to regain its previous peak levels. The median, the figure where half the examples are below it and half above, is six and a half years. The difference between the average and the median is accounted for by a small number of very long recessions, which push up the average.

The latest estimates of GDP in the developed countries now suggest that in most countries the peak level of output was reached in the first half of 2008. By the time of the collapse of Lehman Brothers in September of that year, the West was already in recession. The falls in GDP were pretty sharp, but by the autumn of 2009, growth had resumed almost everywhere. In early 2014, some six years on from the GDP peaks of early 2008, output is now higher in the majority of OECD countries.

The recent financial crisis and the Great Recession of the 1930s are the only examples of truly global crises in well over 100 years. Yet, tentative though it has been, the pattern of recovery seems better than the historical average, despite the dramatic nature of the crash. A key reason is that policymakers did learn from the 1930s, and outside the Euro zone carried out expansionary monetary policies. Without a change of heart by the Euro’s monetary authorities, experience suggests the recession will simply continue, especially in the Mediterranean countries where GDP remains far below the 2008 peak.

As Published in City AM on Wednesday 21st May 2014

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Supply-side growth, not inflation, is the cure to the debt overhang problem

In the year to March 2014, consumer prices in Sweden fell by 0.4 per cent. This has prompted the central bank, the Riksbank, to abandon the normally cautious language used by such institutions. Over the same period, inflation was negative in a further seven European countries, such as Greece, Portugal and Spain. In eight other countries, inflation was still positive but very low, running at an annual rate of less than 0.5 per cent.

The Riksbank argues that these very low, often negative, rates of inflation are caused by a ‘very dramatic tightening’ of monetary policy. There is a definite risk of a slide into a prolonged depression similar to that of the 1930s.

Surely low inflation is a good thing? Well, up to a point, Lord Copper. The current batch of policy makers, scarred by the double digit inflation rates of their formative years in the 1970s and early 1980s, have been obsessed with controlling inflation for at least the past twenty years. They seem to have succeeded. The highest rate of inflation in Europe is currently that of the UK, at a mere 1.6 per cent a year. Thirty years ago, it was well in excess of 20 per cent a year.

The problem with low inflation is that debts, both public and private, retain their real value. A classic way in the past to cure a large debt overhang was to allow inflation to erode its value. Immediately after the Second World War, for example, the British government appeared virtually bankrupt. Public sector debt was 250 per cent of GDP, compared to its current level of around 80 per cent, a figure which still gives cause for concern. But the debt was fixed in nominal terms. Anyone who bought a government bond for £100 and held it to maturity would get £100 back. Inflation ensured that £100 was not worth what it used to be.

Under the long period of Conservative rule from 1951-64, inflation was low, with an annual average of 3.3 per cent. Even this was sufficient for prices to rise nearly 60 per cent. £100 in 1951 was only worth £64 in 1964. Inflation plus strong real economic growth, which expanded GDP considerably, wiped out the problem of public debt.

The real question is whether policy makers can do anything to increase inflation. The fact is that they did not collectively, across the developed world, suddenly become geniuses over the past two decades and learn the secret of inflation control. Inflation fell everywhere, despite, until the crash at least, steadily falling unemployment. The single most important reason for this was the integration of India and China into the world economy, and the huge increase in competitive pressure which this brought. This has not gone away.

We seem to be stuck with very low inflation for a considerable period. Instead of trying to put prices up, policy makers should encourage growth. Not by irresponsible increases in public spending, but by tax cuts and encouraging the entrepreneurial culture.

As published in City AM on Wednesday 23rd April

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