Adair Turner – thinking liberal

The new economics: five things to worry less about

Reading Adair Turner’s lecture on the implications of robotics on the economy has been an inspiration. Following my blog last week, I want to develop the thinking to try and get a better focus for liberal policymakers.

The first point to make is that although the current kerfuffle is around the advance of machine learning and artificial intelligence, this only builds on trends that became important in the 1970s. This was when the previous spurt of growth, based on a huge expansion of consumer goods and services, was coming to an end, in the developed world at least. This I have called the the Age of Light Industry. It featured a virtuous circle of increasing consumption and the creation of middle-ranking blue and white collar jobs. Economists lazily assumed that this was the natural flow of technological progress. It broke down partly because consumption started to reach saturation (few people need two fridges), and partly because technological development became more about making businesses efficient than developing new products for consumers.

And we should not assume that advancing technology automatically makes things better for the majority. Lord Turner drew on the example of the first industrial revolution (the Age of Textiles in my schema), when technological improvements drove up productivity in agriculture and the textiles industry, destroying a lot of artisanal jobs. These jobs were replaced by lower paid and less skilled jobs, such as low-skill factory hands, or domestic servants for the newly enriched farmers and factory owners. The result was widespread destitution. Lord Turner shows sympathy for the Luddites, who are these days usually vilified, who tried to fight this trend. This was in the later 18th to earlier 19th century, and it wasn’t until the later part of the 19th century that things started to get better for the working classes. This was in part because demand for factory jobs rose with the development of heavy industries (railways, mines, steel, ships, armaments, and so on). But it also arose because of political reforms, and an adjustment by political leaders about how economics had changed: for example the realisation that social security for the masses was affordable.

We need these things now: political reform, and a waking up to the new realities of economics. One way to make this point is to consider the things, central to mainstream economic policy making, that we don’t need to worry so much about. Here are 5.

1. Average productivity

I don’t need to say much more on this after my post on Lord Turner’s lecture. Improving productivity matters for individual businesses and public agencies. But we can’t expect statistics on the economy as a whole to tell us anything very useful, because new jobs are beiong created in low productivity services (think personal care) or in arms races that don’t add anything overall (cyber crime; designer goods; ever bigger yachts; hi-tech weaponry). Unfortunately this means that growth rates in the money economy are liable to be slow, which poses questions for how to fund public services and social safety nets.

2. The national debt

Two features of the new economy should change the way we think about public debt. First is that businesses generally need less capital, as more value comes from intellectual property than capital equipment. You can see this by looking at the modern giant firms: Google, Apple, Facebook and so on – and compare them with the old ones – GE, IBM, General Motors, etc. That reduces the need for business capital. Also the new economy is concentrating surplus wealth amongst a minority, who will inevitably want to save and invest much of their earnings. So the savings go up and investment opportunities go down. As Maynard Keynes would have told you, this is a recipe for recession. But government debt can fill the gap. Instead of putting their money into businesses, or fuelling property bubbles, the rich can buy government bonds instead. And while the need for business investment falls, the same can’t be said for public investment – there is still plenty of call for that (schools, railways, and so on). Developed world governments are finding it comparatively easy to sustain a much higher level of debt than they previously did. Japan has led the way, as with so many aspects of the new economy. National debt there is now over 200% of GDP, when the conventional wisdom quite recently was that 90% was a practical limit. And the budget deficit is 4.7%, compared to a growth rate of 1.1%, so it’s still going the wrong way, with barely a murmur from anybody.

Of course this leads to an important question, to which there remains no clear answer. When is there too much national debt? And how big a budget deficit is sustainable? Roughly speaking, when a country has to borrow in a currency other than its own, it is likely to hit trouble. Japan still doesn’t; it helps that it does not need much foreign currency because it runs a current account surplus. Britain does not have that luxury, but the government still has no need to borrow in foreign currency.

This is important because governments can expand their own currency supply (unless they are in the Eurozone, another story), which gives them a useful lever in managing their debt. Clearly there are limits to how much it is wise to use this power – but those limits are not as severe as people thought..

And it makes little sense to drive down levels of government debt, which some conservative politicians like to do, or did before the era of Trump. There is much kerfuffle about it being irresponsible to let future generations pay for our current profligacy – but future generations will have access to highly productive technologies.

3. The dependency ratio (aka the demographic time bomb)

There is much worry that a higher proportion of older workers and retirees will drag down a future economy. Some suggest steps to increase the birth rate to counter this; it is also offered as a reason to allow high levels of immigration. But, as Lord Turner points out, if the new technology is destroying good jobs and creating poor ones, there is something to be said for fewer workers and a higher dependency ratio. Besides, it is not hard for people to retire later if that’s what the economy needs.

4. Global trade

Even before Donald Trump decided to inflict his ideas about international trade on the world, the volume of world trade was in decline. People fret about this because expanding global trade was an important source of economic growth in the 1990s and early 2000s. But things have changed. As China’s economy matures, it has less need to produce cheap exports. This is not particularly good news for developed economies, who are having to replace those cheap imports with something a bit more costly, but that is a temporary problem.

Longer term, increased automation will reduce the relative value and volume of traded goods. Traded goods are among the first things to be subject to automation. And as production gets more efficient, their value as a proportion of the total economy declines (this is the Baumol effect, a favourite of mine). So trade will be less important.

Technology develop will also reduce the need to trade in the first place. It will become easier to produce things closer to home, since cheap labour will be much less of a factor, and intellectual property is more mobile than a skilled workforce. I also have a hunch that much new technology will reduce economies of scale, making one-offs cheaper (think about 3-D printing), which undermines a nother reason for trade.

Mr Trump’s trade wars are still an act of self-harm. But, a bit like his reckless approach to the US national debt, he has the forces of history on his side – a big difference between now and the 1920s.

5.Inflation

Since the 1970s economists have been obsessed with inflation. The idea was that if demand across an economy outstripped sustainable supply, inflation would result – so it was a critical indicator that things were in balance. This developed into the idea of an ideal Goldilocks rate, not too high and no too low, as a central ingredient of sound economic management. It became the key, sometimes only, target for central banks’ monetary policy.

In fact the forces that determine prices and inflation are more complex than this, and new developments are taking it further from this idea. There are other ways for excess demand to play out, such as property bubbles and other forms of financial instability. One explanation for the financial crash of 2007/2008 was that excess demand, especially in both the US and the UK, had been allowed to develop, taking the world financial system to breaking point. With theirs eyes fixed on a stable inflation rate, most economists failed to see the crisis developing.

This is important, because if I am right about point 1 on national debt, there will be a temptation for governments to stoke up aggregate demand. They might think that this is perfectly sustainable if inflation remains low – but something else is likely to go wrong instead. Meanwhile an obsession with central bank inflation targets is wasted energy. Interestingly enough, the best example of this is again Japan. There the issue is that inflation is below target. But no matter what policymakers do, the effect on the rate of inflation is minimal.

Conclusion

So productivity, national debt (and budget deficits), the dependency ratio, global trade volumes and inflation don’t matter as they used to. That’s quite a change. What what should we be worrying about instead? I will return to that.

Adair Turner: the advance of robotics changes economics

Expounding my views on economics can be a lonely business. Though they are based on nothing more than conventional economic theory, few commentators even acknowledge the line of thought. Not long ago the FT columnist Martin Wolf wrote an article on a favourite topic of mine, the productivity “puzzle”, which went through a series of potential explanations without mentioning the Baumol effect at all. I pointed this out in the comments, but this was doubtless futile. Then the cavalry came. Adair Turner gave a lecture in Washington DC last April, which only recently seems to have been published, and which picked up many of the themes that I have been banging on about, not least about productivity and Baumol. This time Mr Wolf had to take notice, and he published a column on it without venturing to disagree. Perhaps the view will start to break out into the mainstream.

The lecture was entitled Capitalism in the age of robots: work, income and wealth in the 21st Century. It goes much further than I have, explains the logic more rigorously, and follows through more thoroughly on important implications. Though I have long known that Mr Turner has being saying similar things, I feel vindicated.

He starts with the possibility that robotics could replace pretty much all of what we now consider to be work, and asks what the implications of this are. This is a clever angle, since the rapid advance of robotics and artificial intelligence, following the development of machine learning, is giving a lot of people pause. In reality the phenomena he describes first become important more than 40 years ago, when such ideas on robotics were just science fiction (notably Arthur C Clarke’s 2001: a Space Odyssey). This was when what I have called the Age of Light Industry started to run out of steam, even as it has continued to dominate the way people thought about economics. It’s worth describing the five sections of the lecture.

When, not if

In this Mr Turner makes the case that the complete automation of work is really just a matter of time. This is a popular view amongst techie types, though I am sceptical. The advance of intelligent machines runs in spurts of incredible speed, between periods of very little progress. In 2001 Clarke expected what is sometimes called “general AI” to be developed by, well, 2001. It remains a distant dream. The trouble is that developers persist in thinking that the human brain is analogous to a computer, programmed by an intelligent mind. That’s a bit ironic, since they are mostly ardent atheists, but they haven’t grasped the difference between evolution and design. The advance of machine learning only came when that understanding was modified; but machine learning has limits. It may take a long time before technologists make the next breakthrough.

But any disagreement I have with Mr Turner is of little importance because I with him agree about three things. Firstly that robotics will transform the world of work in the next generation and more. Secondly that it will affect some areas of work more, or more quickly, than others. And thirdly even if robots are able to do things, we may not want them to.

Explaining the Solow paradox

The Solow paradox arises from the great economist Robert Solow’s comment that “you can see the computer age everywhere but the productivity statistics”. That was in 1987, but it’s even truer now – it is the productivity puzzle. Why is it that, with the pace technology development as fast as ever, increases in average productivity are slowing down? Mr Turner points to three things.

The first is my old friend the Baumol effect, from a paper by William Baumol in 1967. Workers released from areas of high productivity tend to move into jobs with lower productivity, or a lower rate of productivity improvement, which will neutralise the effect of the original productivity advance on average statistics. So if a farmer doubles productivity, he might sack half his farm workers and employ domestic servants instead. This is a well-trodden trail for readers of this blog, but Mr Turner explains it in more detail than I have ever attempted. It is clearly true in the area of robotics which of itself it creates few jobs.

The second thing is something that I have only hinted at, and which I find interesting. As we get wealthier, we spend more on “zero-sum” activities – activities that may advance individual interests, but not society overall. Cyber crime and the security industry that counters it is an example. The search for status goods, such as high fashion is another. These activities drive arms races between rival players, including the literal arms race of deadly weapons. Not mentioned by Mr Turner you could add extracting and burning fossil fuels to the list.

The expansion of zero-sum activities creates a couple of problems. First is how do you measure measure productivity of something where the output is often negative? The answer, for statisticians, comes from the monetary income generated – which is circular: you can’t tell the difference between inflation and productivity. A second problem is that it means measured economic income, such as GDP, becomes increasingly detached from human wellbeing. What is the point of getting a higher monetary income if it simply disappears in higher property costs (land is a classic zero-sum game), security and badges of status? This is not far from the point I have made that the most dynamic bits of the British economy before the financial crash were in finance and professional services, which are (mainly) classic zero-sum activities. Discounting this and you find that “real” growth was lacklustre long before austerity kicked in.

The third reason for the Solow paradox is that a lot of the benefit to new technology is non-monetary, and doesn’t reach the economic statistics. We are living longer, for example. This is an argument often used by people on the right to suggest that things are much better than they look, and that we should not worry about stagnant or reducing incomes among the majority. This is not a debate that I have ever got into. Mr Turner acknowledges its validity, but not the conclusion that those on the right draw from it.

Meaningless measures in the hi-tech hi-touch economy

This is an attack on standard economic measures, notably GDP and productivity. Economists have always acknowledged the weaknesses of GDP as a general measure of whether an economy is delivering what people need – but those weaknesses are growing to the point of absurdity. Well, not quite. GDP (and especially the nominal measure which doesn’t try to adjust for inflation) is a useful measure for the management of money in the economy. But we cannot assume that if GDP per head is growing that so are people’s wellbeing. Likewise wellbeing may advance while GDP is stagnant.

This is an old idea. Mr Turner develops it by following through the thought experiment of what happens when most work is automated. Measured economic activity then most arises from what economists call “rents” – returns on asset such as land and intellectual property.

Developed economies: average is over

Where this is leading is to an increased gap between a lucky minority of people who are well off, and a growing body of people stuck on very low incomes. The middle ground is disappearing. Notwithstanding some on the right who shrug this off, this is a major problem. And mostly we are looking for solutions in the wrong places.

The problem will not be solved by educating everybody to a high standard so that they all have the skills to programme robots, though improving education is surely a good idea anyway. Inequality does not have its root in a skills gap, but in the nature of work. Education will simply turn into another arms race for the small number of well-paid jobs. Neither is a focus on improving productivity going to help. This simply replaces middle income jobs with lower paid ones. Meanwhile we worry about things, like the increasing proportion of elderly people, that probably won’t be such a problem after all.

But in developed countries, and many middle income ones, like China, the problem should be soluble. The economy will have the capacity to produce a good standard of living for everybody. Mr Turner suggests a number of policy responses:

Income support such as universal basic income. He sees the logic but is sceptical.
Offsetting the concentration of income, wealth and rents. Assets and higher incomes need to be taxed more. Intellectual property rights need to moderated, rather than strengthened, as now.
High quality urban development. To enhance areas that would otherwise be left behind.
Adequate wages and status for caring services. This will require some form of political intervention.
Celebrating craft skills.
Increased leisure.
Education for life and citizenship – breaking free from the idea of education for productivity.

Developing economies – the old ladder destroyed

The prospect for low-income countries, especially in sub-Saharan Africa, does not look good, though. The development ladder used by Asian economies from Japan to China to join the ranks of the better off, is being knocked away. There will be no demand for cheap manufactured exports, as richer countries will do more for themselves. This is a serious global problem which will require a change in development thinking. It will be important to slow population growth.

Implications for economic theory

Mr Turner concludes by pointing out that all this makes much conventional economic theory obsolete. It is too focused on maximising income to improve wellbeing. It is based on a series of idealised assumptions, such as the non-existence of zero-sum activities, whose usefulness is vanishing. Higher levels of income do not necessarily mean that wellbeing is improving.

This is easily said, but few have taken on the implications. In Britain Conservatives still talk of the virtues of an open market economy to produce a better standard of living for all. Meanwhile Labour focuses on capital investment and productivity. This is yesterday’s economics.

But more people are calling for a rethink. What Adair Turner does so well is to use conventional economic logic to show why conventional economics doesn’t work any more, and that we need fresh approaches. That’s what this blogger is trying to do in his own, much smaller way.

What went wrong with economics?

It is commonplace to suggest that economics, as taught in our schools and universities, badly failed prior to the great financial crisis of 2007/08. But beyond this, things get a lot less clear. People tend to pipe up and attack aspects of the discipline that they have never liked; in the circles I move this tends to be the “neoliberal” ideas of well-functioning markets. This does not seem to be based on any real analysis, though. And universities plough on teaching the same old stuff as if nothing had happened, no doubt because nothing particularly coherent has replaced the old models. It is worth looking at the substance behind the remarkable failure of this discipline, which attracts so much intellectual heft in our era.

The failure of economics, and the imperious discipline of macroeconomics in particular, has been described brilliantly by Adair Turner in a recent lecture. I have already referred to this in an earlier post, but now I have been able to lay my hands on a copy of the text. It’s a challenge to read the 38 pages if you don’t have an academic economics training; but it’s well worth a try if you are not too daunted by this.

My personal perspective comes from the fact that I was a mature student on the BSc undergraduate course in Economics at UCL in the years 2005-08, just as the boom years were coming to an end, and the crisis started to develop, though before the seminal bankruptcy of Lehman Brothers, and the full blown crisis that followed in its wake. We were taught the standard macroeconomic model, referred to as the neo-Keynesian model, which nearly comprised a consensus at the time, although our lecturers were not beyond a little healthy scepticism.

Three related failures stand out. The first was an indifference to the potential macroeconomic impact of finance, and debt in particular. The fact that debt levels were exploding did not affect the models at all. You may think that economists are obsessed with money, but they treat it as a veil, and they try to see through it to a “real” economy of people and things. Finance is just tactics; a means to and which should not bother the imperial-level grand strategists too much. Besides, debt is two sided; for every debtor there is a creditor, and it all cancels out. If Matthew lends Mark £100, who in turn lends it to Luke, who in his turn lends it to John, who actual invests it in something, what has happened? £100 of debt has turned into £300 but there is still only £100 of investment. The bottom line is that Matthew lent £100 and John spent it; Mark and Luke are where they were beforehand. Do the machinations of intermediaries really matter?

This was much too complacent. Suppose Matthew, Mark, Luke and John are financially stretched, and a £100 loss will push them over the edge. If John’s investment fails, and he goes bust; he can’t pay Luke, who can’t pay back Mark, who can’t pay back Matthew. All four go bust, whereas just two would have done if Matthew had lent directly to John. The more overall levels of debt ramp up, the more likely it is that such contagion effects occur. I remember British policymakers expressing disbelief that a little trouble in the U.S. subprime property market could possibly have such a big global impact. And it isn’t just bankruptcy that is the issue; financial difficulties could simply cause a reduction in consumption – which would cause excessive saving in the economy at large, with bad macroeconomic effects, which can be very widespread from a rather small proximate cause.

The second problem was the fact that so little of the borrowing was invested in new investment projects, as theory supposed, with the majority being directed towards buying existing assets, and some to support additional consumption based on increased asset values. Hyman Minsky long ago pointed out that this type of investment simply led to asset price bubbles. And even if it had been directed towards “proper” investment, a similar bubble effect can occur. The latter was a point made by Friedrich Hayek. In spite of these warnings, the possibility of asset price bubbles, and what to do about them, was widely ignored.

The third problem centred on monetary policy. Economists used a theory of money that had scarcely moved on from the use of notes and coins. They assumed that bank money works in an equivalent way; that banks only lend money that has already been deposited, and that the whole money creation process is controlled by the central bank. Over a century ago the Swedish economist, Knut Wicksell pointed out the absurdity of this. Commercial banks effectively have the power to create money out of nowhere. And in any case, it really isn’t possible to distinguish the “transaction money” on which the theory depends, from other sorts of money, for example that being held just for safekeeping. I have frequently blogged about this blindness of conventional economists, shown by their frequent references to non-existent printing presses, and talk of throwing bundles of banknotes out of helicopters. This is almost as nonsensical as a metaphor as it is literally, and shows an utter failure of imagination.

The outcome of these failures was that most economists thought that high levels of debt, and the possibility of asset price bubbles, were just details that should not detain the grand strategist, and that the main thing was for central banks to watch consumer price inflation, while finance ministers should simply keep budget deficits small.

So, as the world’s finance sector boomed, finding ever cleverer ways to hide slimmer margins by increasing leverage, and debt levels exploded in many developed economies, the world’s policymakers looked on without too much concern. Inflation and budget deficits looked fine; everything else would sort itself out in due course. Indeed, since the world economy was delivering steady growth, many thought they had found the answer to life, the world and everything. If it ain’t broke, don’t fix it. And many economists made a fortune from the finance boom. Most of the students on my course chose it as a path to get rich via investment banking or management consultancy.

It is, incidentally, easier to say that economists were wrong, than it is to say that the disaster was their fault. If more economists had piped up to sound warnings, the political pressures to ignore them would have been overwhelming. If they had been heeded, then maybe banking would have been a bit less out of control. But there were other factors driving the instability, including the huge export surpluses of China and oil exporters – which pumped money into the developed world financial system, creating near-on insoluble problems. The situation would have been a bit like global warming – strong awareness from the academic community quite unable to stop overwhelming global political forces and the power of sheer human greed.

Still, the discipline of economics has been left in a sorry state. As Lord Turner points out, in the 1950s they had all the knowledge and insights needed to take it in a less blinkered direction. Wicksell, Hayek and Minsky were all highly respected economists; Maynard Keynes highlighted all the issues lucidly in his General Theory. But instead economists went up a forty year blind alley, becoming more sophisticated with the detail even as the fundamentals became more and more unrealistic. East coast liberals were as badly off track as Chicago supply-siders. It’s no wonder that so many are still in denial and still teaching the discredited models, as if only a few details here and there need to fixed. How can you discard such a huge volume of thinking in one go?

But the economic disaster is too big to be glossed over. Whether or not economic theory has caught up, policymakers understand that the banking system is a major problem, and that you can have too much debt. The last time such a disaster hit economics was in the stagflation era of the 1970s; let’s hope economists’ response to this crisis is more robust than that one!

Are the Muslims right about debt?

The Biblical invocation against usury, making loans for interest, has been discarded by the two older Abrahamic religions, the Jews and the Christians, though it persists in Islam. I used to think the prohibition was another obsolete idea, based on a misunderstanding of the usefulness of finance. But as time goes by, the more I come to see that the biblical fathers, or God if you prefer, were on to something. The dysfunctional nature of financial markets is one of the modern world’s most pressing problems.

This reflection comes on the fifth anniversary of the collapse of Lehman Brothers, which was the point at which the current financial crisis broke out into the open. This has lead to a flurry of newspaper comment. I was most drawn to an article by Gillian Tett in the FT, covering a talk given by Adair Turner, the former head of Britain’s financial regulator, the FSA. Unfortunately this behind the FT paywall, and I cannot find coverage anywhere else. Lord Turner produced a blog, but this only covers part of the subject matter, and not the most interesting bit reported by Ms Tett. Lord Turner says that we have not really come to grips with the failure of financial markets that became evident with the Lehman episode.

The most eye-catching thing about financial markets, which is the main point made in the blog, is the explosion of private sector debt. In 1960, according to Lord Turner, household debt in the UK was just 15% of total income; by 2008 it has risen to 200%. If you start to add up loans made by financial institutions to each other, then even that figure looks pretty tame (837% according to this rather good Economist School’s Brief on the subject – though this suggests a little confusion in Lord Turner’s numbers on household debt). But the statistic that hit me most forcibly was the claim that only 15% of the money that flows into financial products actually gets invested in proper wealth-creating projects.

Macroeconomists have long been dismissive of the significance of debt and financial markets in their imperious declarations about the state of national and global economies. These are just means to an end, and they all cancel out – one person’s debt is another’s asset; what matters is the real world of what is produced and consumed. Economists are reluctantly having to rethink this, though most would still rather divert the discussion into conventional subjects about austerity and money supply. Lord Turner’s 15% statistic, however, should translate the issue into one which even an old-fashioned macroeconomist can understand. There is a massive gap between what people set aside to save, and what is actually invested. Financial markets are meant to be the channel by which savings are turned into investments – but instead they are simply a smokescreen hiding a black hole, as it were.

Let’s pause for breath, and look at the problem from another angle. One of the critical points of economics, too often forgotten, is that money and financial assets have no intrinsic value. They are simply useful tools by which we can coordinate the process of producing work and consuming its output. You can think of it as being a bit like electricity. You cannot store it. If people want work now, and consume later at leisure, the simple act of putting aside money won’t do the trick. You have to persuade other people to be around to do the work for you when you want to do your consumption. The wider purpose behind financial products is to help us to do this, to balance our over-production now (i.e. saving) with over-consumption later, or vice versa. Theses activities depend on coordination with people who want to do the opposite, and that is what financial markets are meant to do. How? Through investment. Investment is work that is done now to produce things that can be consumed later. This allows production without consumption in money terms to be balanced by a real world equivalent. Maynard Keynes’s great breakthrough was understanding that the failure of the money and real worlds to match was the main cause of recessions.

So if 85% of savings are not actually invested, there is a problem. Where does the money go? There seem to be two main places. Firstly a lot of it consumed by intermediaries – those fat-cat salaries included – to no real purpose. Secondly a lot of it goes into inflating the prices of assets, real estate or financial assets, that exist already. In other words it is a colossal waste of time which simply serves to make a lucky few rich. And meanwhile huge volumes of debt are being created, much of which can never be repaid. Or, to put it another way, we have manufactured vast banks of financial assets which are not worth anything like what we think.

This spells trouble ahead, as this situation will only resolve itself through, one way or another, debt being forgiven and assets written down. The owners of those assets show no sign that they understand this; or if they do, they simply assume that it is somebody else that will pay. Meanwhile the best we can do is not to make things worse. Amongst other things that means continuing to make life miserable for the banks and the financial sector, and hope that, as they shrink, they concentrate on the more socially useful aspects of it work.

What those old Jewish and Christian fathers understood, and Islamic scholars still understand, is that debt creates moral problems by dehumanising the relationship between debtor and creditor. Financial assets are in fact human relationships between real people, which we are attempting to abdicate responsibility for. Alas though, it is unthinkable that our current economic system, with its manifold benefits, can be created or sustained without them. But we would all be better off if we understood the moral and personal implications, and consequent limitations, of financial assets and the markets through which we acquire them.