Economics & Finance – Page 16

Nowadays it seems to be the economists who are obsessed with the short term

The relationship between economists and politicians is often strained. It’s easy to think that economists are taking a detached view of public policy and its long term effects, while politicians simply jockey for advantage at the next election. But, strangely, that doesn’t seem to be the pattern right now. It’s the politicians who are urging short term pain for long term gain, while the economists say it can all be left for another day. It is the politicians who have a better grip on reality.

The nature of the relationship between political leaders and economists has changed as economics has evolved. I think it was President Truman in the late 1940s who said he wanted to find a one-handed economist, so fed up was he with his economic advisers saying: “One the one hand this, but on the other hand that”. He wouldn’t have that problem today: there is no species of public policy commentator that is more one-handed than an economist nowadays, so confident do they seem about what they are saying.

In the late 20th century supply-side economics took hold, after the economic traumas and stagflation of the 1970s. This held that the route to economic success was in making sure that markets worked efficiently and government expenditure kept on a tight reign. Economists bewailed the fact that their advice was so often ignored by politicians, who found their prescriptions unpalatable. Only the unelected President Pinochet seemed to take economists at their word, as he implemented a series of reforms in Chile. The expression “politically impossible” was frequently used in discussions of economics. In fact politicians, starting with Britain’s Margaret Thatcher, largely implemented the supply-side economists’ advice, but this was only really acknowledged by most economists after the event.

But things seem to have moved on again. Politicians in Europe, including Britain, are grappling with the size of government in the wider economy, and pushing ahead with supply side reforms. This is hard political work, with scant reward on offer at the ballot box. But do politicians get credit from professional economists? Not a bit of it. Instead austerity policies are blamed for anaemic growth and high unemployment. Scarcely a day goes by without some economist, like Paul Krugman, Martin Wolf or Samuel Brittan thundering away that all this is foolish and bound to end badly: looser fiscal and monetary policies are needed, and the problems of government deficits can be sorted out another day.

What accounts for this? It is tempting to conclude that there is simply a time lag in economic thinking between the academics and the politicians. In academic circles the supply-side mania has run its course. It was always incomplete, and too often, not least during the great economic crisis of 2007-09, it had very little of value to say. Neo-Keynesianism had taken hold, with an updated series of macroeconomic models designed to deal with the issues that arose in the 1970s. The politicians, perhaps, haven’t moved on.

But I think there is a different explanation. It is that the politicians are much more aware of what is really happening in our economies, and the changes that are needed, while the macroeconomists are blinded by their use of aggregate statistics. The politicians can see that there are some fundamental problems with the way their economies are functioning, especially here in Europe. The first problem is that the state has become too large and inefficient. A second is that the progressive aging of populations is progressively weakening economies. A third is that globalisation has changed the rules of economic management. I could add a fourth issue, which is that the world’s financial systems have become dysfunctional, except that I think this is confusing politicians and economists alike, and is not a driver of tension between the two.

Economists agree with this analysis of problems by and large, of course, except that I don’t think that most have woken up to the implications of globalisation, and its profound implications for the way prices and wages rates are set. What the politicians appreciate is that these problems are desperately hard to fix, and that putting off the evil day is not going to help. In particular the central problem is to shrink the state. Politically it is much easier to put through tough changes in hard times, and not when things seem to be ticking along nicely. And if you look at the political forces that seize on what the economists are saying, you will find that they are mainly those that do not see the need to shrink the state at all.

Alongside this disagreement about the best time to reform is an economic judgement. Politicians are sceptical that sustainable economic growth is at all easy to find. Many economists think back to the decade before 2007, when 2% annual growth was more or less taken for granted, and assume with a wave of the magic confidence wand, this growth will come back – and that we might even be able to make up some of the lost ground. Even now I have seen some economists who should know better projecting trend growth before the crisis, to estimate the true cost of the recession. So in the five years since the crisis, the economy should have grown by 10%, they say; in fact it has shrunk by 4% (I haven’t checked that number), so the crisis and bad economic management has cost the economy 14%! But what if that 2% tend growth wasn’t for real? What if it was simply pumped up by borrowing and trade deficits? And what if the progressive aging of the population makes sustainable growth of 2%, or even 1%, unreachable? Blinded by their aggregate statistics, not enough economists are asking these questions, and still less following through their implications. But it is all too obvious to most politicians, and businessmen, come to that.

The gap between politicians and economists isn’t helped by the fact that the former keep using government debt as the main driving force of their argument. This is politically convenient, but the economists rightly spot that it is insufficient of itself. If the economy could readily be kicked back into a 2% growth trend with a bit of fiscal pump-priming, then the debt argument would not hold water. In today’s FT Samuel Brittan accuses politicians of falling for the fallacy of composition: that whole economies work like family budgets. In fact there are deeper reasons for what politicians are doing.

There is further disagreement over investment spending. Many economists think that they have found the magic bullet. Government funded infrastructure investment can both act as a short-term fiscal stimulus while delivering longer term benefits to the economy. So why are the politicians so reluctant to spend more on capital projects, and even cut them back? And yet this is another blinded by aggregates issue. The economists’ argument only holds water if the investment projects actually deliver economic benefits. This is much more difficult in practice than it is in theory. Under the last government investing in hospitals must have looked a sure-fire winner, given the ever rising demand for healthcare services. But we are now finding, as hospitals are collapsing under unaffordable PFI debts, that it wasn’t so easy. Too often they built the wrong sort of facilities. This is situation normal. The usual result of a public sector infrastructure project is to end badly. Japan’s investment splurge in the 1990s, in similar economic circumstances, simply caused many “bridges to nowhere” to be built.

And so, in this debate, my sympathies are with our political leaders.

Japan: are there lessons for other developed economies?

A while ago I wrote that the radical economic policies of Japan’s new government under Shinzo Abe would be an interesting experiment for the world. They were much lauded by austerity sceptics, such as Paul Krugman, who drew attention to aggressive monetary policies and fiscal stimulus, which they were advocating for other developed economies. I was sceptical. But early results have exceeded expectations. There is a good analysis here from the Economist, which also discusses the new government’s nationalist tendencies. Is this evidence that the austerity policies being pursued by much of the rest of the developed world are mistaken?

My scepticism when I last posted was based on two things. First that the policies hinged on companies raising wages, when their profits were under pressure. Second was that, based on Mr Abe’s previous form, I did not think that structural reforms to Japan’s economy would be pursued with vigour. On both counts it looks as if I was too pessimistic. This means that Japan’s economy might well get a sustained period of growth, and that it will reduce the burden of government debt. But applying its policies to other developed economies is problematic. There are three reasons for this.

The first is that for longer term success it is still the element of structural reform that is critical. Mr Abe refers to his programme as “three arrows”, in reference to a Japanese folklore story that you can snap the shaft of a single arrow easily, but not three held together. These three are monetary easing, fiscal stimulus and structural reform. Austerity policies in Europe and America are firmly based on structural reform: especially in reducing the size of the state. Opponents of austerity tend to want to halt or slow down structural reform. Some say that it should wait until growth is resumed; others would rather avoid the reform process altogether. The three arrows approach would in fact promote reform, alongside the monetary and fiscal palliatives, and, indeed, the more considered critics of austerity do say this. But here there is a problem: Japan does not have an oversized state, so cutting back government expenditure is not a major reform priority, as opposed to opening the economy up to more competition and reforming corporate taxes. In Britain, France, Italy, Spain and so on the size state has run beyond what the economy can sustain, and so it has to be cut back, which in turn drains demand from the economy in the short term. There is good reason to doubt whether fiscal or monetary stimulus, beyond their current levels, are compatible with the need to shrink the state.

There is a second important difference in Japan. Its economy has a trade surplus and (which is linked) a savings surplus, albeit temporarily challenged as it has to import energy while its nuclear programme is in abeyance. That means that a fall in the exchange rate, as has happened to the Yen, will generate an immediate bonus to businesses, easily outweighing the extra costs imposed on the economy. This allows companies to put wages up. The savings surplus also means that the economy is not dependent on borrowing from overseas investors, who might be shaken by such currency depreciation. This is not the case with the austerity economies. Where their exchange rates have fallen, as in Britain, this has simply contributed to the squeeze on consumers without benefiting business to anything like the same degree.

Mentioning the exchange rate brings me to a third observation. It is that a lot of Japan’s success so far has less to do with with the country’s actual economic policies than with the effect of announcements on the zeitgeist. Implementation has hardly started, and yet the exchange rate has already plummeted and stock market risen, which is having the necessary warming effect, and set off a virtuous circle. The same can be said, in reverse, for austerity policies in the West, of course. But where reforms are necessarily painful, this is almost impossible to do. Economists have long been reluctant to admit the role of psychology in macroeconomic policy, and have let it in only gradually (through such ideas a inflation expectations). Governments and central banks have long known it – and Mr Abe’s government is acutely aware. The question for Europeans, in particular, is whether further aggressive monetary easing, linked to higher inflation expectations, combined with some fiscal stimulus would lift the zeitgeist and get the economies moving again. We have reason to be sceptical.

Almost all the developed economies in the world are experiencing difficulties. It is easy to fall in with the idea that this must be for similar reasons and that the solutions for each economy are similar. In fact each major economy is unique. And the differences between Japan and the others is amongst the largest. Abenomics may work for Japan, but that does not mean they will work anywhere else.

How is Labour’s economic stimulus meant to work?

ON Monday at lunchtime Labour’s leader Ed Miliband was subjected to a fierce interview by Martha Kearney on the BBC Radio 4’s World at One. The main subject of contention was Labour’s economic policy, and in particular whether the party’s plan for a temporary cut in Value Added Tax would increase government borrowing. Mr Miliband did not want to say this, only that, because it would stimulate growth, it would help bring down government debt in the medium term. This was not an assured performance by Mr Miliband, but beyond that it seemed to me, perhaps unfairly, that he only had a superficial grasp of the economics involved. If so, he shares this superficial understanding with many members of his party, who lap up quotes from economic commentators such as Paul Krugman, and marry it to half-digested economic theory. So how is it meant to work? How can a temporary tax cut reduce government debt?

Let’s start with the Keynesian multiplier, which is widely taught in basic economics, and which I suspect comes to mind to most people here. You really have to do a bit of maths to understand the implications. Suppose you have an economy with a national income of £100bn a year, and an average tax take of 40%. You decide on a 1% stimulus with a temporary tax cut of £1bn. As people receive the extra money, 40% of it goes in tax, and they spend, say 80% of the rest on domestic goods and services (it doesn’t work if people use it to pay off debt or spend it on a foreign made car…). This adds £480m to the economy with extra expenditure straightaway. And this process continues in a virtual but diminishing circle, as that £480m is taxed, spent and so on. If everything turns out to be mathematically consistent the stimulus adds over £900m to the economy. You have nearly 1% growth! This has cost the taxpayer (added to national debt) of £1bn in the first instance, but a lot of this has come back in extra taxes from the growth.

This is what people half remember when economic experts like Mr Krugman say that stimulus can reduce debt. But there are two problems. First of all, although on my fairly realistic assumptions most of the cost is clawed back, about a quarter of it isn’t. Keynesian stimulus cannot pay for itself at this simple, basic level unless people increase their spending by more than the stimulus itself. And secondly, it is a one-time event, so that you get 1% growth for one year, and then it stops, unless you repeat the giveaway. This tax cut is temporary. When you put taxes back up again, the whole process goes into reverse and the economy shrinks back to where it started. Something very like this happened to the last Labour government’s temporary cut in VAT: a small bounce that was undone when the cut had to be reversed, which, of course, they then blamed on the Coalition.

All this is well known to the Paul Krugmans of this world though, otherwise they wouldn’t be writing economics textbooks and winning Nobel laureates. When they advocate stimulus they are actually talking about something else: the effect of such a stimulus on the national zeitgeist. That 1% lift may make people and businesses happier. Businesses go out and invest more money; people save less, perhaps thinking that their share and property values will go up, and consume more. If this happens then all bets are off; the economy grows further, the government gets more taxes and the stimulus can pay for itself quite quickly and easily. Investment is particularly important; Maynard Keynes’s critical insight was that recessions happen when investments don’t match the amounts people save.

What to say about this? There are two potential snags and an irony. The first snag is that the zeitgeist is a hard thing to manage. The whole thing can be undone by another crisis from the Eurozone, for example, which might reduce prospects for exports and dent confidence generally; or there could be some other crisis. The second snag is that this model of short-term growth assumes that there is spare capacity in the economy. When people and businesses go out and spend, domestic companies can readily ramp up production, employ new people and so forth. This is usually the case in a recession. But not always. In the 1970s, after the price of oil skyrocketed, the economy had to be restructured in order to grow – which was particularly hard because of the trade unions. Attempts to stimulate the economy simply led to high inflation while doing nothing for unemployment. Today, more flexible and globalised markets seem to have reduced the inflation threat – but stimulus can still be dissipated on imports and asset prices. What of the British economy now? Many commentators think that the British economy should be “rebalanced”, reducing its dependence on financial services and North Sea oil, as well as excessive private consumption fuelled by debt and property prices.

These potential snags to stimulus are why many critics of the government, such as the FT’s Martin Wolf, and many Liberal Democrats, such as the Social Liberal Forum, say that any stimulus should take the form of added public expenditure on investment, in infrastructure and homes. Since these have an inherent value, and help expand the economy’s capacity, there should be much less risk. This is a sensible idea in theory that is a lot less easy in practice. The public sector has a tendency to invest in wasteful projects for political rather than economic reasons.

This is where Labour’s plans are quite distinctive. They talk about temporary tax cuts, and hint at increased current expenditure. This is founded on a belief that there was not much of a problem with the pre-crisis economy, or unsustainable about the growth rates achieved in the years leading up to it. The crisis was simply a problem with the global financial system, and the country’s poor performance since is down to incompetent economic management from the Coalition. This is pretty much what Tony Blair said in his recent piece for the New Statesman. If you believe this then capacity is not at issue, and the zietgeist should be readily easy to fix.

And the irony? Left wing economic commentators like to laugh at the “Voodoo economics” of Laffer curves and self-funding tax cuts advocated by far-right commentators. Paul Krugman talks about their belief in the “confidence fairy”. But the left’s economic beliefs are no less dependent on their own confidence fairy.

Monetary policy is a useless collective noun

At the time of the financial crisis of 2007 and 2008 it was commonplace to say that modern economics, especailly the macroeconomic variety, was in crisis, and needed a fundamental rethink. Alas, the vested interests of established economists have prevailed. Very little rethinking has occured, and this mainly tweaking rather than anything big. This is most striking in the area of monetary policy. The debates now going on in Japan and Britain remind me of the academic papers and discussions that I read about while an economics undergraduate at UCL in 2005-08. Circumstances have changed (in Britain anyway) but not the economics.

Economists of complain that amateurs are guilty of the fallacy of composition: to assume that was is true for a household, say, is also true of all households grouped together in a single economy. It may sensible for a single household to save more of its income to repay debt: but if a whole economy tries this at once, it could be disastrous. But economists are guilty of their own fallacy, though one for which I have not found a commonly used name. I will call it the fallacy of collective nouns. It is idea that by collecting together a group of disparate elements and giving them a name, that you have created a new entity that allows you to ignore its component parts. Most macroeconomic concepts are such collective concepts: GDP, inflation, and so on. Such collectives are useful only up to a point, and then you have you have to look at their component elements. And yet most macroeconomists, even very intelligent and distinguished ones, can’t bear to let go of their collective concepts and carry on using them long after their usefulness has ceased.

This is clearly the case with the idea called “monetary policy”. The conventional idea is that an economy has something called a “money supply”, which can be manipulated through policy instruments under the control of a central bank. In turn this money supply affects the behaviour of the people that form the economy with fairly predictable effects on things like consumer prices,wages, investment and output. All of this is very questionable in a modern economy. It is much more helpful to think of the particular components of “monetary policy”: central bank interest rates, state purchases of its own and other bonds, bank regulation, and so forth, and how these affect the various parts of the economy acting through the financial markets.

The conventional economic thinking runs something like this: the economy (Britain and Japan in particular) is stagnating with relatively low levels of inflation, but high or rapidly rising levels of government debt. In order to pay back this government debt you need to break out of the stagnation and grow, or (whisper it) let inflation make the debt more affordable. To do this you need to “loosen” monetary policy and increase the supply of money. With more money in their pockets, people go out and spend more, leading either to growth or inflation. To do this the central bank lowers interest rates, and where this does not work, use other measures like Quantitative Easing. Cue lots of debate about the relevance of inflation targeting and its alternatives (nominal GDP targets for example), all well within the comfort zones of economists.

There are very many problems associated with this line of reasoning. It is far from clear what money is. However it is clear that commercial bank accounts form the most important part of it, and this is a function of commercial bank policies, not those of a central bank, whose influence is increasingly marginal. It isn’t clear that large bank balances lead to increased spending, least of all on constructive economic things like consumption or proper investment (as opposed to chasing up the value of assets in fixed supply). Rising prices do not necessarily make debt more affordable: that requires rising income for the people holding the debt. And it goes on.

All the verbiage around “monetary policy” is clouding the issue. There are two problems being faced the British and Japanese economies: weak output and excessive debt. Weak output in turn has two components: using spare capacity (i.e. that created simply because of slow demand) and strucural problems. In Britain there is a big argument about how much of the problem is spare capacity and how much is structural. If it is largely spare capacity then simple macroeconomic solutions may have merit: you just need to boost confidence a bit to lift demand. But even here it is not self evident that any of the loose money policies will be much help. In Japan there seems to be even less spare capacity.

I can’t help thinking that what policy makers really mean by “loose monetary policy” is higher wages. Increasing consumer spending power through increasing wages will lift confidence, and even if it is not based on increased productivity, it will make debts easier to pay off, including public debt through higher tax revenues. This lurks behind a lot of the talk about greater tolerance for inflation. But in Britain we have the wrong sort of inflation: rising import costs through a lower pound, and increased government charges. This really isn’t helping. If policymakers want higher pay it would be better to throw away the weasel talk about loose money, and talk about pay. There is some evidence for that in Japan, but this only serves to show how difficult the policy is in practice.

The Japanese government also deserves some credit for the fact that it is not advocating looser monetary policy by itself, though you wouldn’t guess that from much of the coverage here. It is one of three prongs, the other two being fiscal stimulus and structural reform. There is plenty of scope for structural reform in Japan, and this gives their economic policy some hope for ultimate success if they follow it through. But it is the prospect of quick and easy solutions through fiscal and monetary policy that is exciting people.

In Britain a chronic trade deficit shows major structural problems, no doubt partly as a result of reduced North Sea oil. This requires the economy to be producing different things, not just more all round. Loose talk using economic collective nouns is making this harder to see and address.

David Graeber’s Debt the First 5,000 years – the emperor has no clothes

One of the books I received for Christmas was David Graeber’s Debt, the First 5,000 Years. Mr Graeber is an American anthropologist, now working at Goldsmiths in London, who has been active in the anti-capitalist Occupy movement, and describes himself as an anarchist. The book promises to give some intellectual heft to the anti-capitalist case, by examining the origins and history of debt and money, and how we need to rethink it. So far so good. But after the book promised so much at the beginning, I can hardly contain my disappointment with its limp ending.

The book starts well enough. He immediately focuses on modern economics’s weakest point: the theory of debt and money. He may labour the nonsense of the economist’s creation myth of a barter a economy a bit too much: economists aren’t really interested in history after all. But economists’ confusion over the role and meaning of money is evident; personally I wouldn’t use the barter myth to illustrate this, but the way economists still talk about printing preses and helicopter drops when trying to explain monetary policy. Mr Graeber runs his hand across the soft underbelly of economics, but then, instead going in for the kill, he throws away the knife. He rejects the whole, quantitative, mathematical language of economics. He thinks that the discipline’s attempt to preserve moral neutrality is in fact condoning immorality and violence. Like it or not, numbers and mathematics are central to our society’s workings, and rejecting these tools out of hand leaves Mr Graeber’s arguments with very little purchase.

The full, awful implications of this are not immediately clear, however. Mr Graeber puts the question of money and debt into an anthropological context, and this is a good read. I found his categorisation of human interactions into three types very illuminating. These types are exchange, what he calls “communism” and hierarchical. The exchange relationship is the typical arms length commercial one: one item is exchanged for another, typically money, and there are no further implications for the relationship between the parties; it ends with the transaction. A communistic (or perhaps communal would be a less provocative word) transaction is typical of close communities: transactions aren’t exchanges, those who are able give to those who are in need, all a part of a wider, long term relationship. Relationship is also key to hierarchical transactions, but it is one of authority. A lower individual pays tribute to a higher one, while the higher one may cast beneficence to those beneath. Mr Graeber is careful to say that none of these is inherently superior to the others, and any society needs to use all three. But he complains that the modern world puts exchange relationships on a pedestal at the cost of communistic ones, costing the quality of human relationships.

All this leads into a broad historical narrative – the 5,000 years – of the Eurasian continent. Originally money develops as a credit relationship, and is not seen as a thing in itself: its accounting function is the critical element, and it is woven into the fabric of society, based on trust. But then the idea of precious metals, gold and silver in particular, becoming money in its own right rapidly took hold across the entire continent. The effect, in his telling, was malign. Money existed independently of states and relationships. Soldiers could loot money from one place as they destroyed it and spend the proceeds elsewhere. It facilitated both the running of armies and trading of slaves. Sinister, cynical empires came to dominate the world in Europe, India and China in the centuries before and after Christ.

These empires then broke down (or changed nature in China) as precious metal (bullion) money was drained from the system. In Mr Graeber’s telling this has much to do with the new world religions (Christianity, Islam and Buddhism) in what he calls the Middle Ages. His account is admirably even handed in its geography, rather than the customary focus on Europe. In this age Europe is a barbaric offshoot from the civilised worlds of the Middle East and China. Credit becomes central to commerce, which operates independently of the state, and is based on trust. This is something of a golden age to Mr Graeber, though not the European end.

This unravels in the Renaissance, with the Europeans leading the way. Gold and silver is looted in America and then traded with the Chinese. An age of violence and destruction is born, as trust is no longer required in trade and commerce. Then, in the 17th and 18th centuries the malign instruments of modern finance, bonds and shares, are invented in order to fuel society’s appetite for war. Meanwhile, the slave trade takes off, destroying African society amongst other victims. An age often portrayed by western historians as one of progress, Mr Graeber portrays as one of a descent into destruction. This is deliberately provocative, but he has a point: this is an age of war, colonialism and slavery.

And it is here, as the industrial revolution begins, that Mr Graeber’s account runs out of steam. All the building blocks for capitalist society are in place, and its evil roots clear; he almost says “and the rest is history”. He swiftly moves on to his final chapter, where a new era begins with the collapse of the Bretton Woods system, and with the inevitable collapse of capitalism in its wake. I was expecting to read an account of the era of economic growth, but there’s practically nothing there. And the awful truth dawns. Up to this point I had been giving Mr Graeber the benefit of the doubt, for all his provocations. But the emperor has no clothes. When it comes to describing the modern world he is utterly out of his depth and as a result anything of consequence he has to say (and there are some) seems a matter of random chance. An example is his idea that the purchase of US Treasury securities, which will always be rolled over rather than repaid, is in fact paying tribute to the primary military power. the USA. He spots a problem with this account: the Chinese are amongst the largest buyers, and they are power rivals. He then has to concoct a story that this is part of a long term Chinese game. This is really very silly. The Chinese are buying US Treasury stock because they are running a big trade surplus and there is nowhere else for its surplus dollars to go; the power transfer implied is minimal; but the trade surplus is an important element of the Chinese development strategy, which involves building up production in advance of consumption, and in the great scheme of things the dollar surplus isn’t that important to them; it’s only money – if they lost the lot in a crash tomorrow, how much does it really matter? The Chinese seem to have grasped Mr Graeber’s message about money rather better than he has himself. Mr Graeber’s lack of economic literacy has him floundering to comprehend what is happening around him.

His thesis is that modern capitalism is a typical bullion economy based on power and violence, and the absence of trust, with exchange and hierarchical transactions driving all else out. Most people in developed economies are little better than slaves, tied to their employers and struggling to pay off debt. Debt is used to enslave people. But this system is fundamentally unstable and is in the process of collapsing.

But after the emperor-has-no-clothes moment there is no aspect of Mr Graeber’s thesis that doesn’t look questionable. Is is really true to say that capitalist transactions are based on the ultimate sanction of force, and not on trust? Is it not trust that distinguishes advanced capitalism in say, Denmark, from the less developed versions in Russia and China?

And he misses the whole issue of growth. This process, driven mainly by increased productivity, has improved the lives of countless millions – and is genuinely popular with most people in both the developed and developing world. It is by no means evident that today’s workers can be compared to Roman and African slaves. And debt has played a critcal role in lubricating this growth process, by allowing investment: payment now for a later gain. The whole culture of investment is omitted from Mr Graeber’s analysis: debt for him has but one purpose: to enslave the debtor by forcing him to make a promise he cannot keep.

Mr Graeber’s failure is underlined by the absence of any practical ideas about how the world should change to make it better. His only idea is a Jubilee: a systematic forgiveness of debt. But he hasn’t thought about the social chaos that would result as all savings were wiped out. The modern way of doing a Jubilee is called hyperinflation. It is hardly evident that the phenomenon that created Nazism is necessarily helpful to the development of society and the empowerment of the poor.

Is there anything to be retrieved from Mr Graeber’s spectacular collapse when confronted with the modern economy? He happens to be right about an awful lot of things. Money is best regarded as an abstract concept, a social invention without underlying reality. Debt also is a social convention that can outlive its usefulness, and should not be treated as sacred promise. The exchange method should not be idealised as model for all life, as Chicago School economists do. And economic growth in the developed world does seem to have hit natural limits, whose consequences we still don’t understand. Capitalism may indeed collapse if it continues in its current form.

But the answer is not to condemn capitalism as the work of Satan, and hope for something better to turn up. Mr Graeber’s work is pure antithesis. Progress is made by synthesis: by taking capitalism and making it better. And you can’t do that by rejecting the discipline of economics, for all its manifest faults.

Does Britain need the City?

The British governing class has reacted furiously to the European Parliament’s attempt to limit bankers’ bonuses. Once again their central argument is that it is a threat the wholesale financial services businesses that are based in the City of London, which they say is critical to the British economy as a whole. This is an argument that is regularly wheeled out by not just the establishment, but even by normally sensible commentators such as The Economist. The British public at large seems largely unmoved, however. This is a topic that could do with closer examination.

The City is an astonishingly successful business cluster, where I worked for 18 years up to 2005. The main controversy surrounds an very well-paid elite of traders, fund managers and investment bankers. These people, or the businesses they are part of, contribute disproportionately to national income – though exactly how much I am less clear about. Financial services consist of nearly 10% of the country’s GDP, but this includes a lot of businesses that are clearly not part of the City (retail bankers, estate agents, financial advisers, and so on), in spite of attempts by many commentators to conflate the two. But their high income reminds me of the joke about Bill Gates wandering into your local bar and the average income there soaring (this joke needs updating – Bill Gates’s income will have dropped alot in the last few years). If the City bankers leave, the country’s GDP may suffer, but that doesn’t been that everybody else is necessarily poorer.

But, the argument goes, these well-paid people spend their money here and create jobs. This argument is much weaker than it first appears. Rich people don’t spend all that much of their incomes on the sorts of things that create local jobs. A lot of their income is saved, with little of this saving going into productive investment in the UK economy. A more immediate problem is that a lot of their money is going into property, and other things where supply is limited (plumbers, school teachers at private schools, etc). All this does is bid up the price and put them out of reach of ordinary people. Still, if these businesses really are global, and having them on British soil contributes to the British trade balance, then some sort of net economic benefit is plausible.

A sounder argument can be made through taxes. City businesses and their employees pay a lot of tax under Britain’s progressive tax system (mostly income tax and national insurance on those bonuses – global businesses are very slippery on the matter of corporate taxes). How much? I don’t know: but it could amount to 1-2% of GDP (that’s guesswork working from the 10% of GDP for financial services income as a whole). There is an irony here. Very often we hear that our high taxes are damaging the City – but if they didn’t pay tax there would be little point in having it.

But behind this there is a deeper question. Are the services the City provides socially useful? In principle they should be. Our complex economy depends on finance to link those with surplus money with those who have productive investment projects to get off the ground. It’s what pays most people’s pensions. In principle fund managers, even those in hedge funds and private equity, should be helping this along. But a great deal of scepticism is in order. Too much energy is wasted in various intermediate devices – such as derivatives – whose value is difficult to see. Too much money is lost between one end of the process and the other. High profits, an economist will tell you, are a sign of economic inefficiency. It is the industry operators that are getting rich, not their clients. The aim of public policy should be to bear down on the industry to make it much less profitable, while maintaining its socially useful purpose.

But if it a global industry, can’t the British economy rake in the benefits of this inefficiency at the expense of the rest of the world? There are problems. First is that as global governments get to grips with the dysfunctional wholesale finance industry, it will gradually become less profitable, and the benefit reduces. The EU tussle on bonuses is but one part of this process, even if it is badly directed. The second problem is that the British taxpayer can become more embroiled in the industry than it should be. The bailout of British banks in 2009 surely wiped out many years of tax revenues derived from them. In any case income from financial services tends to be volatile, and so less useful – it disappears when you need it most. A further problem is that high City pay diverts the brightest local people away from more socially useful work.

So overall I find the case for special treatment for the City to be unpersuasive. What we actually want is for London to be a global hub for a smaller, less profitable and more functional financial services industry. The government is doing some quite sensible things: raising capital requirements, and separating investment from retail banking. This should limit the government’s exposure to bailouts, and reduce the level of finance (“leverage” in the jargon) available for trading operations, which believe is the critical issue. Other actions are more ambiguous: tougher regulation sounds fine, but it is in danger of harming decent retail banking businesses and reducing the level of competition as a by-product.

And as for the EU bonus regulations: I don’t think they will help much. They do not tackle the central issue, which is why banks are making so much money in the first place, and able to pay such large bonuses. But neither do I think they will do any real harm. Lower variable pay, and hence higher fixed pay, for banks may sound as if it increases risk, but it will force managers to ask more searching questions about what they are doing. And if more whiz-kids go to Singapore, so be it.

The public’s foul politcal mood: symptom or disease?

Is depression an illness? It can be. Many people suffer depression that is so severe that it overwhelms them. They need help and we categorise it as mental illness: a condition with a life of its own, where medical intervention is recommended.

But for most of us, most of the time depression is just part of the ordinary fabric of living. It is a necessary step in the way the mind adapts to new realities in the world around it, especially changes that are unexpected or unwelcome. We don’t understand why the human mind has evolved in this way, but it clearly is not a malfunction. We must accept it and work through it. This common wisdom is summarised in popular models such as the Kübler Ross model of the five stages of grief (denial, anger, bargaining, depression, acceptance).

We can compare this personal mental phenomenon to current public attitudes to politics, especially here in Britain, but elsewhere too. This is partly a simple metaphor; but also some of the same psychological forces are at work. The public mood with politics is foul. Is this a disease, or merely a symptom of an inevitable change that is taking place in our society, that we simply have to come to terms with? And how should politicians respond?

The latest evidence for the public’s mood comes from the recent Eastleigh by-election. The main established parties locally, the Liberal Democrats and the Conservatives, both lost votes, and much of their support was grudging, based on keeping somebody else out. The grumpy anti-establishment protest party Ukip jumped from nowhere into second place. The official opposition, Labour, made no headway. And, in more classic depressive behaviour, turnout fell significantly from the General Election in spite of an extremely intense campaign, where voters were getting daily leaflet drops and their phones did not stop ringing.

If this is an inevitable response a changed reality, we don’t have to look very far for a culprit. In the 15 years from 1992 to 2007 Britain has enjoyed steady economic growth. If the benefits of this growth have gone disproportionately to the rich, they have neverthless been spread widely. Pay-rises regularly beat inflation. The benign effects were reinforced by easy money which supported both consumption and rising property values. This didn’t seem like a golden age at the time (though there was a brief note of euphoria at the turn of the Millennium), but it served to set some fairly stable and benign expectations. Politicians squabbled of the extra things they could do with “the proceeds of growth”.

But this collapsed in 2007, when the financial crisis started, with a sharp economic contraction in 2008-09. Worse, in 2013 there seems no sign of things getting any better. While politicians on the left and right argue that growth can be restored, the public remains entirely unconvinced. You have to be a real optimist to think that Keynesian stimulus would offer more than temporary alleviation; and it could make things worse in the long run by taking the national debt sky high. The right wing’s supply side revolution would make things worse for most people in the short term, and probably only better for the already wealthy after that. Monetary loosening seems to involve sucking life out of the Pound, and so making things like energy, cars and foreign holidays yet more expensive – probably with only share and bond prices showing any benefit.

What on earth has happened? The public suspects that something has changed about the economy and society which means that the benign years before 2007 will not return. This builds on the natural human tendency to project current circumstances into the future. It so happens that I feel that this public instinct is well grounded. Slow growth is here to stay. Much of the growth before 2007 was a mirage.

This need not be a bad thing in itself. There is plenty enough resources to ensure a decent standard of living for everybody. But the political priorities in a low growth world are very different from what they used to be. Distribution of wealth becomes a top political issue. Government must learn to be frugal. We must focus on improving wellbeing rather than monetary wealth. But these changed priorities require a big psychological adjustment, so it is no wonder that there is anger, frustration and depression amongst the public.

If that is all, then the bad mood is simply a symptom of the changing times, and politicians should see through it to focus on the changed priorities. Politicians need to show empathy with the public, but not be panicked into populist policies. Aided and abetted by an unhelpful press, much public anger is directed at such things as immigration, the European Union, health and safety legislation, and human rights. But politicians should not be fooled by this anger; the public is in fact deeply ambiguous about all of these things. Deep down they sense they are necessary to the way we want to live our lives, the odd silly excess notwithstanding. Instead politicians should focus on reform to the tax and benefits system, improving public services, developing a housing strategy, securing energy supplies and fixing the still-broken financial system.

But many thoughtful observers, Paddy Ashdown for example, are convinced that the bad public mood is much deeper than this. Its beginnings predate the financial crisis of 2007 after all. There is a deeper feeling of disenfranchisement that will not go away. This needs more direct intervention. While I am not apocalyptic as Lord Ashdown, I think he has a point. British politics is not corrupt, but it is conducted by an elite class that does all it can to avoid being held to account. Reforming this will be hard work though. Devolving more power to local level is surely part of it – though fraught with danger. Whether the current government’s localism reforms have achieved anything useful is open to doubt – though the growing number of City Deals are more promising. Taxation powers are the critical issue, and nobody shows signs of grasping this particular nettle. The opportunities to re-enfranchise voters are surely mainly at the local level – but that means the delegation real power, and responsibility for real trade-offs – rather than the one-sided lobbying of the centre that currently dominates local politics.

The public mood is both a symptom of change that is running through our economic system, and also a deeper problem in its own right. Both call for honest liberal reforms, and not the sour populism that it immediately encourages. Let us hope that the public, through its anger and frustration, recognises this. They often do, if any politician has the courage put the case to them.

Britain’s economy: is the right right?

Britain’s economic performance since the Coalition government took over in 2010 has been as dismal as today’s cold, damp and grey London weather. Negligible economic growth; government finances that stubbornly refuse to improve, even as services and benefits are cut; and although unemployment is trending down, this is at the cost of pay and hours being squeezed. In political and media circles most of the debate about this state of affairs is around managing total economic demand: the “Keynesian” critique (quotation marks since using a dead economist as a source of authority does not do justice to the critique). Much less prominent is a right-wing critique. Yesterday Allistair Heath, Editor of City AM produced a 10-point plan in The Telegraph online, which neatly summarises this perspective. It is worth thinking about this a bit.

Mr Heath’s 10 points, in his “Supply-Side Manifesto” are as follows:

1. Cut corporation tax to 11pc; abolish capital gains tax

2. Cut current government spending by 2pc this year

3. Wage war on zombie firms

4. Reform the labour market

5. Allow private sector to finance big transport projects

6. Build 300,000 homes a year

7. Scrap renewable energy targets

8. Create mini-jobs for welfare recipients

9. Allow for-profit firms to run schools

10. Make it easier for consumers to switch suppliers

The basic premise of this is that it is what Britain needs is a supply-side revolution to get going. In other words it must be made easier for businesses to grow, and there must be greater incentives for private sector investment. There is something to this. Britain’s economy before the crisis struck in 2007 was unsustainable, and much of the growth in the preceding half-dozen years was a mirage. The most convincing evidence of this is the country’s current account deficit – consistently 2-3% of the economy (and the trade deficit much worse). This seemed to be the result of an inflated exchange rate. As the crisis struck, the pound duly depreciated. And yet, as the Economist pointed out a couple of weeks ago, the current account deficit has not recovered (unlike after 1992, when the pound fell out of the ERM). This bespeaks a deep malaise in the economy. This is much more that a dip in the business cycle that can be cured with fiscal stimulus and/or loose monetary policy. Indeed both such policies could make things worse by pushing out needed investment.

It is common wisdom that the British economy needs to be “rebalanced”: but this seems to be happening only very slowly. Reduced dependence on financial services and public expenditure are clearly both part of any such rebalancing, and we do seem to be making some headway here. But what is to take their place? Thinking about the “supply-side”, or how the economy actually delivers the goods and services it needs, is a welcome relief from banging on about aggregate demand, and its assumption that all this can be left until later. But it is here that I mostly part company commentators such as Mr Heath. Let’s have a quick look at the ten points.

Cut capital taxes to encourage investment. This idea has a respectable intellectual history, but there is a problem. It tends to encourage wealth creation by the rich without much impact on the rest of society. And as the rich tend to save rather than spend their incomes, this doesn’t do much to fix the wider malaise. I’m not so sure that attracting footloose international capital will help much in an economy of our size anyway, (unlike Ireland).
More cuts to government spending: no ring-fences. I do agree that government has to be smaller and more efficient – but the country is very dependent on government sponsored services, such as education and health. We are up against what economists call “Baumol’s Disease”, as well as demographics; there is a limit to amount we can expect from efficiency savings. There is plenty to discuss about how these services are to be funded and structured, but crude cuts are a blind alley.
Allow more companies to go bust. I have more sympathy with this one, though I am not convinced that this is really what is blocking investment.
Labour market reform: reduce job protection. I am more ambiguous on this than most liberals, perhaps hardened by my experience as a middle manager. Improvements can be made, but the evidence that this is what is holding us back is weak.
Big transport projects financed by private sectors (tolls, etc). Easier said than done. The cost of big capital projects is escalating, and returns less certain. I think the current government is pushing ahead with this as fast as politics will allow.
Housebuilding. Here the right wants to unleash the private sector by overcoming planning constraints. Mr Heath is being a bit disingenuous here: he means plastering the green-belts with cheap and shoddy new housing estates. But there is a housing shortage; and we do need to compromise on the green belt. But we need good quality homes and more social housing, with development gains being used to finance social infrastructure, such as schools.
Junk renewables for coal and gas. I’m not sure that an economy built on cheap, carbon intensive energy is the right way to go. I expect that Mr Heath does not believe in climate-change. Moving away from cheap energy dependence is one of the pieces of rebalancing that has to be achieved. Green energy should be part of any growth strategy.
9., & 10. These are throwaway ideas given a sentence each. I don’t necessarily disagree, even with for-profit state schools, but I don’t think they will help the supply side by much.

So there’s me being very negative about a whole series of practical ideas. So what do I think? First point is that we need to accept that, for a whole variety of reasons, growth in most developed countries will be very slow for the foreseeable future. We need to adapt our expectations to this, and think more clearly on how to deliver improved human wellbeing without it. Second, we need to think hard about under-used human resources: that means mainly people living outside the English South-East and a few other hot-spots. Simply building more houses across London’s greenbelt and moving people there does not feel right. There are no big ideas here, but lots of little ones. Dumping big government agencies in these places is not one of them, though. Third we have to rethink public services. The reforms need to focus on improved commissioning and getting results. But we also need to think about such politically toxic issues as co-payment – since taxes will not be enough to fund the nation’s needs. Plenty of ideas for future blogs, but that’s enough for now.

So the left bangs on about Keynesian demand management, in the hope that longer-term problems can be solved later; the right chases a fantasy of growing businesses unleashed by smaller government. The public seems sceptical of both. Rightly so.

Abenomics: why it doesn’t look good for Japan’s economic experiment

A few years ago, as the Greek crisis unfolded, an Economist blogger suggested that its austerity programme would be an interesting experiment. Did the then fashionable idea of austerity growth have any validity? The answer to that experiment seems to be a clear no, though now doubt there are get out clauses. Now a very different economic experiment is taking place in Japan, after the election of Shinzo Abe and the Liberal Democrat Party last December. It is popularly referred to as “Abenomics”.

Abenomics, described by the Economist here, has three elements: increased infrastructure expenditure, looser monetary policy (through focus on a higher inflation target), and “supply-side” structural reform. This coordinated nature of the policy is one of its most important aspects. Here in Europe we are used to fiscal policy pulling one way, while monetary policy and structural reform pulls in the other. All this has “Keynesian” economists like Paul Krugman in raptures (I used the inverted commas because no self-respecting economist accepts that label, it’s just common sense after all, though their political supporters love it). Japan has been stuck in the economic doldrums for two decades, and these economists feel that at long last the country might be digging its way out. Better still, success in Japan will show that these policies can be applied in other developed economies. But this analysis is deeply flawed – a case of macroeconomic blindness, a sort of failure to see the trees for the wood.

Look again at Japan. Its unemployment rate is currently a shade over 4%, having fallen from a peak of 5.5% in 2009. Compare that to the UK’s rate, which has hovered around the 8% mark since 2009, compared to about 5% before the crisis. This does not suggest a huge amount of slack in Japan, even allowing for distortions in the way it measures its unemployment. Growth will have to come about either through productivity growth or new people entering the workforce (e.g. through immigration). There is plenty of scope for both. Japan may have some of the world’s most efficient companies, but these dominate its export economy only; there is a lot of inefficiency in domestic markets. Japan has long eschewed immigration as placing an unacceptable strain on its social infrastructure. All this depends on the third prong of Abenomics, structural reform. And yet the government already seems to be going slow on this, afraid that the public will disapprove, with bad consequences for upper house elections due later this year.

In fact what Abenomics really seems to be about is to make government debt more affordable through setting off inflation (specifically of incomes, and hence tax revenues). Japan’s inflation has been very low, and negative for much of the stagnant period. Even this may not work – economists understand little about how inflation actually comes about, assuming that it is some kind of endogenous variable in that depends on such things as aggregate demand and money supply. Instead the policy may simply lead to state bankruptcy – though that is no doubt a long way off.

What are the implications for the rest of us? The justification for “Keynesian” policies in most developed economies, including th UK, remains intact because our high unemployment shows that there is quite a bit of slack, though we don’t actually know how much (the 1970s stagflation crisis arose because economists too readily assumed that unemployment meant economic slack). But they are not the answer to raising long term growth rates. And Japan’s agonies with inflation and government debt may well foreshadow future dilemmas our own governments will face.

What arrogant economic commentators, like Professor Krugman, need to accept is that economies are the sum of freely made choices of individual citizens, excercised through both markets and the ballot box, as they try to shape the world they live in. They are not the creation of governments and policy makers playing with their economic toolkits to win prize for the biggest ~~d**k~~ growth rate. Japan’s stagnation is the result of choices that Japanese people are making about the sort of place they want to live in, one which consideres wider factors than monetary income. Get over it.

Growth: the deeper questions

Today first estimates of the UK’s final quarter GDP show that the economy shrank by 0.3%. There will be a lot of posturing around this but it doesn’t mean that much. GDP is not a direct measure of wellbeing (unlike unemployment, for example), and it isn’t that clear how one quarter’s statistics have a bearing on people’s day to day lives. Besides these early estimates are not very reliable. Still these GDP figures do prompt some wider questions.

The first is about short-term economic strategy. A large number of government critics, loosely referred to as “Keynesians” though no professional economist would accept that label, say that a series of poor GDP returns reflect a failure of economic management. Firstly that cutting government expenditure reduces demand, which has a multiplier effect to shrink the economy as a whole. Second that the government should in fact be doing the opposite: using fiscal policy to use the same multiplier effect to boost the economy at large. I don’t intend to discuss this much further today, except to make this point. These arguments have weight because the UK economy is in recession, with high unemployment. This means, or should mean, that there is slack. Slack is usually inefficient, especially when unemployment is involved, and evidence that the slack is being taken up would come from better GDP growth figures. But what people are talking about is a short-term effect: once the slack is taken up the economy bumps into more substantive constraints and “Keynesian” stimulus would have undesirable effects, such as inflation or an unsustainable trade deficit. But what are the prospects for growth in the longer term, and does it matter?

There is now quite widespread pessimism about the long term prospects for growth in the UK and other developed economies. Mostly this is ephemeral. People assume that current trends simply continue; a few quarters of stronger growth and the mood will lift, even if this says nothing about longer term prospects. But more serious questions are being posed. Mostly these are based on demographics – the aging of the baby boom generation – and an allegedly slowing pace of innovation. The Economist had an interesting article on the latter a couple of weeks ago. This explained the reasons why people are becoming pessimistic – but then pointed to reasons for counterbalancing optimism. I think The Economist is right as far it goes: innovation picks up in some areas just as it slows in others. But they miss an important wider question about the role of economics itself. They too easily assume that innovation will lead to increased productivity and this to growth, in accordance with conventional economics. I think this may be breaking down.

Try to think about this in terms of three ways in which economic wellbeing advances. First is the conventional consumption which dominates economists’ thought. People consume more goods and services, and the economy is able to deliver these because productivity rises. Second is the consumption of what I would describe as personal goods and services. This superficially resembles the first sort of consumption, but the very nature of these goods and services is that productivity cannot grow. Think about personal therapy – shorter sessions or sharing sessions with more people undermines the product we want to buy. Another example is status goods – often the whole point is to show status by buying goods or services that are produced at low productivity. And finally people may opt out of the conventional economy altogether: take time off, pursue hobbies and so on.

So what if people direct their energies (and use innovation) to consuming personal goods and/or opting out, rather than consuming conventional goods? Economic wellbeing advances but GDP growth does not; in the case of opting out, GDP actually shrinks. Economists tend to be very dismissive of this, and try to assume their way out the problem: in particular that than economy advances on all three fronts at once, so that conventional consumption is representative of the whole. This has worked well enough for the “opt out” option: I am assured that there is good evidence that leisure increases alongside consumption, not in opposition to it. But there is a logical problem with the advance of personal goods, and economists have a name for it: Baumol’s disease, after the economist who pointed it out. The more productivity advances on conventional goods, the higher share of the economy is taken up with personal goods – and you have to work that much harder to improve productivity on conventional goods to achieve the same level of growth. Economists may have named it, but they still usually ignore it and its implications. They usually just have a quick moan that we should spend more energy trying to improve the productivity of services (the problem is usually defined in terms of agriculture, manufacturing and services – with what I am calling personal goods being part of services).

But I think the whole balance is shifting. There are limits to the extent that people will want to improve wellbeing by simply consuming more mass-produced goods and services. An increasing proportion of the population has reached that limit (I certainly have), instead increasing leisure or buying “quality” (lower productivity) goods. And look at innovation. I consider my smartphone to be a fantastic technical advance that has improved my life a lot. But has it helped the conventional economy by helping me to produce more services for other people to consume? It hasn’t. Quite apart from the demographic issue, which is real enough (and you could say this is actually the same thing, with people choosing more leisure by retiring for longer and consuming more personal services through hospital and other care), the rate of conventional economic growth is slowing in the developed world.

Does it matter? After all economic wellbeing may still progress. Unfortunately there are two reasons that it may: debt and taxes. These two lie at the very heart and purpose of the conventional economy. Debt and credit tend to get washed away in a high growth economy – but it will get increasingly difficult for people, businesses and governments to service past debts in a low growth environment. And a lot of the personal services that take up a higher and higher proportion of our economy (like health) are funded through taxes, as well as support for leisure (pensions) – and yet if the conventional economy does not grow this will bulk larger.

Debt and taxes. These issues are destined to dominate developed world politics in the century to come.