Category: Economics & Finance

Reflections on economics, investment and the financial world

The new economics: 5 new issues should we be worrying about

Last week I identified five issues we don’t need to worry so much about in modern economics. Symmetry demands that I balance this with five issues that we should be worrying about more.

That’s much harder because there are a lot more than five things that are very important. So I need to thin down the list. First I have excluded things that people are already very preoccupied with, such as inequality and poverty. They may be important, but I want to show how thinking needs to change. Besides I suspect that the solutions to many such issues will be indirect rather than arising from pulling them apart directly. I thought hard about whether to include environmental sustainability, or greenhouse gas emissions in particular, as this would be a really good place to start modern economic policy. But that isn’t new, and many economists are already wrestling with it. What I can say is that moving away from a focus on increasing production and consumption is part of making this problem easier to solve.

And I have also exclude issues too nebulous to approach systematically. This includes the topic of human wellbeing. We absolutely need to be thinking about wellbeing, and break out of the thinking that we can use measures of income or expenditure as a proxy. But trying to construct alternative measures and focusing on them instead is the wrong way to deal with this.

Anyway here’s my five:

1. Private debt

This isn’t exactly a new issue, though economists have often struggled to know what to do with debt. I remember in pre-crash days (and even afterwards) people suggesting that macro-economists could ignore debt levels since all debt cancelled out – one person’s debt is another’s asset.  In fact debt was always at the heart of monetary policy, which has been at the heart of macroeconomic management since the 1980s.

This was when the idea of regulating aggregate demand (and the business cycle) through public fiscal policy and public debt, often referred to as “Keynesianism”, went out of fashion. Instead, the theory went, you could do something similar by manipulating interest rates. A lower interest rate would encourage people to bring forward investment plans and raise demand when the economy was running slack. Likewise, if inflation looked like an issue raising the rate could rein in demand. Although this clearly meant using private debt to regulate aggregate demand, economists were very shy about saying so. They kept on talking about the money supply instead, clinging to a picture of people using banknotes to settle all their transactions, whose supply was regulated by printing presses.

It was not until the crash of 2008-2009 that serious doubts were raised about this in the economic mainstream. In fact interest rates are a very imperfect way of managing aggregate demand, and high levels of private debt create financial instability. The crash itself was more complex than that – a lot of the problem was financial institutions lending to each other to generate fees and bonuses. Low interest rates were only part of toxic mix. But most mainstream economists still seem to think that private debt is a good way to regulate demand, provided banks are sufficiently regulated.

An alternative view of debt, put forward by heterodox economists such as David Graeber (if I can call an anthropologist that), is that it is the root of all evil – an instrument whose sole purpose is to dehumanise and enslave. This idea is not without merit, but a modern economy has come to rely on debt to carry out three things in particular which are more constructive. The first is to allow businesses to invest in capital projects which in turn make the economy more productive. A second, sometimes overlooked, is to provide working capital as a lubricant that keeps the wheels of a complex economy in motion; most business to business transactions are on credit. And thirdly it allows private individuals to buy assets by spreading payment over their useful life. Debt also helps private individuals deal with temporary cash flow problems, though this can lead to serious social problems with loan sharks, and I don’t think this role is an important part of a functioning economy.

But, in the developed world at least, debt is mostly used for other things than these three, and in particular it is used to support speculation, and to generate income for middle men (aka “financial engineering”). Lending to private individuals to support property purchases spills into this economically useless territory. Some suggest that easy money is creating more demand for residential property more than society really needs.

In short, private debt has a useful role to play in the economy, but at current levels it is a source of financial instability and tends to exacerbate inequality. Policymakers need to start distinguishing between useful and dangerous debt, and clamp down on the latter. Alas they show little interest in doing so.

2. Low pay

One of the features of  modern economies is the spread of low paid or insecure jobs. Economists have traditionally been pretty relaxed about this. They assume that it is a temporary problem that will rectify itself quickly, and it must be the fault of a poorly functioning labour market. But it seems to be a big problem is in the less regulated labour markets (such as the USA and Britain); the more regulated markets tend to have high unemployment instead. It is one of the driving forces behind the suspicion of immigration, and the feeling by working class people of being let down by the elite. Technological change seems to be making this worse.

But the traditional economists are right up to a point. Solving the problem is not about throwing away market economics, such as creating lots of high paid but useless jobs in the public sector, or arbitrarily high minimum wages. These would create more problems that they solve. Neither am I convinced by the fashionable idea of topping up low-paid workers income with a universal basic income. The point is to find ways of giving ordinary workers more power. Such power comes from one thing: a shortage of workers compared to the opportunities available.

The public sector surely has a role in this. An expanded public sector with meaningful and skilled jobs (teachers, nurses,social workers) may well be part of it, but the public sector does need a bit of rethinking before we can turn it into an instrument of economic engineering. I am intrigued by ideas of job guarantees to take surplus workers out of the market – though I can see many ways this could go wrong. Should lifelong liberals accept that managing immigration flows is a part of it? Maybe, but allowing workers opportunities to work in other countries may be part of the solution too. The truth is I’m pretty short of answers, but the point is that we need to be looking at ways of tilting the job market in favour of the disadvantaged, without creating either mass unemployment or pointless jobs.

3. Economic clustering

Economists have long noticed that successful businesses tend to cluster together geographically, creating a pattern of a small number of prosperous islands amid a general sea of poverty and disappointment. In Britain this is a very serious problem, and we are not alone. Various attempts have been made to address this, including regional subsidies, pushing public service institutions out to struggling regions, creating deregulated freeports, and so on. They almost always disappoint. The extra money pumped into the poor regions flows straight back to the rich ones. Meanwhile the poorer areas become hotbeds of disillusion and discontent.

Economists don’t seem to be very interested in solving this problem, to judge by the articles I read in The Economist. These largely take the line that clustering improves productivity and should be encouraged. We should concrete over the green spaces in prosperous areas areas, and build more homes there – while bulldozing the empty homes elsewhere.

But what I can’t help noticing is that the problem is worse in some places than in others. France and Britain, for example, but not nearly so much in Germany, extending into Austria and Switzerland, or in Scandinavia. The big difference between these healthier regions and neighbouring Britain and France is political structures, both now and historically. Greater Germany, if I may call it that, and Scandinavia, have much more decentralised political structures, going back through history. Centres of political power attract economic clusters. We need to understand that better. By reorganising our politics we may alleviate the problem. And maybe technology will one day start to undermine the current successful clusters.

4. Intellectual property

In the new economy intellectual property, such as copyrights, patents and so forth are becoming much more important. Unfortunately, the idea that such property rights over ideas is a something innate and sacred is being accepted lazily by politicians, quietly egged on by business vested interests who like to pretend they are fighting for impoverished artists and inventors. This needs some serious pushback, because intellectual property rights are being used by the rich and powerful to oppress the rest of us. It is also used by multinational businesses to manipulate profits into low tax jurisdictions.

Intellectual property rights do have a socially useful purpose – to help reward and stimulate creativity.  But they should only be as strong as necessary. I’m intrigued by the idea that intellectual property costs should not be tax-deductible (I think similarly for loan interest…). Doubtless this is too extreme to work, but there may be intermediate ideas better prospects. And what about making intellectual property non-transferable? That would stop patent trolls, an activity that no social merit at all.

4. Effective public services

This sounds obvious, but I am really struck by how few economists understand how different public services are from private ones, and how they must often be managed in a completely different way. It is no wonder that they are so badly managed. On the one hand public services have been managed without any incentives to be efficient, and becoming useless, conservative bureaucracies who have lost touch with their purpose. This is why so many of us with memories of the 1970s and 1980s are so suspicious of calls on the left to re-nationalise railways and energy services. On the other hand, if you run public services like private businesses they lose touch with their purpose in a different way. They try to avoid or pass on the difficult cases, or try to turn them into lucrative repeat business instead of solving problems; they hollow out key performance indicators so they become a meaningless game; they soon learn to manage their political masters rather than their customers.

But highly effective public service can be done (London’s primary schools for example, though the current government is trying its best to undermine and destroy their achievements). Ultimately we need to understand that public services are about solving complex problems using skilled professionals that engage with their users as human beings. Creating institutions that can do that, and identifying the more from the less effective ones, is something that should be engaging economists and policymakers much more.

Conclusion

I have gone on enough. But I hope I have shown why I think that fresh thinking is needed as our society moves through its next phase of economic development.

The new economics: five things to worry less about

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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.

 

Secular stagnation: the curse that still haunts developed economies

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The financial crash of ten years ago was something of a paradox for conventional economists. It took most of them by surprise, and dented their reputation. And yet economists became more important than ever to the running of our world. But now, to listen to most of them, the equivocation is over. We’re back to normal, as the global economy looks in much better shape. This looks complacent.

The crash was a double shock to economists. The first was how it happened at all, when most economies seemed to be purring on at a relatively steady rate of growth (often referred to as the trend rate), which seemed to relate to growing productivity, and which most economists, driving through the rear-view mirror, assumed to be a law of nature. The second shock was that developed world economies, especially the British one, were so slow to recover. Economists  simply assumed that with a bit of stimulus, economies would not just return to trend growth, but make up for lost ground too. I don’t think any advanced economy has done this – and in Britain we lag far behind. In the years after the crash an expression was coined, or rather resurrected, to describe this second problem: secular stagnation.

The person whose name is most attached to this is Lawrence Summers, who had been prominent in the Clinton administration. By it he meant that economies could only achieve growth by extraordinary and unsustainable efforts to stimulate it. And, as Mr Summers recently pointed out in the FT, you cannot say that it has disappeared. Growth has returned, but the measures required to produce it are unsustainable. What he is referring to is the extraordinarily low interest rates prevailing in the developed world.

This has been going on for so long that we have become accustomed to it. But what do negative real interest rates mean? They mean that in order to use up available savings we have to create investments that have little or no financial return. Now that is at the margin, not on average, but even so it does not suggest an economy that is at all healthy. If investments don’t produce a return, productivity will not advance, and growth will not be sustained. And in particular we will accumulate debt that cannot be paid off. Or not without inflation which destroys the accumulated wealth of the middle classes. And sure enough, many economists are warning us about mounting debt levels. In due course this will lead to a financial crisis.

Why are we in this situation? And what can we do? There are many speculations as to why, and most commentators, including me, tend to gravitate towards the one that suits their overarching narrative. Many blame a skewed distribution of income for creating a surplus of savings that cannot be used properly. Others say that modern businesses don’t need so much traditional capital (Google doesn’t need to issue debt or share capital to keep its investments going). Then there is the gradual ageing of the population reducing the size of the workforce. Others blame the wrong sort of stimulus – if only government spending hadn’t been cut back (“austerity”), we’d have bounced back in no time. My favourite is the Baumol effect which suggests that we are in a transition towards industries, like healthcare, that are less financially productive, though still improve human wellbeing. Whatever it is (and it could be all at once) it’s a problem because it is dragging down the potential growth rate.

And what can we do? People often talk of unconventional policies, but what are they? The most interesting idea is  to run up bigger government budget deficits. Piling up government debt is much safer than piling up private debt, as we are doing now. Why? Because governments can finance that debt by a process that is usually referred to as creating money, and the burden can be shared more equitably.

But piling up debt and creating money often ends in tears. The best current example of that is Argentina, with rampant inflation and impatient foreign creditors. The problem for Argentina is that its monetary system has been mismanaged for so long that much borrowing, public and private, has to be in foreign currency, which the central bank cannot create. But there is an opposite example. Japan has been piling up public debt for decades, and the central bank has been buying up debt, with few apparent ill-effects.

So how do you know whether you are Japan or Argentina (and no doubt Argentina looked like Japan once)? The first, obvious, difference is that Argentina has had a current account deficit for some time, while Japan has generally been in surplus. That means that Argentina is importing more than it exports and requires financing by foreigners – who are less likely to be happy to take payment in domestic currency. Current account deficits usually flow from budget deficits – though not always, as the recent crisis in Spain showed. That would be a bad sign for countries like Britain that also have a current account deficit. But Britain’s standing in international markets looks a lot more like Japan’s than Argentina’s. The government has no trouble in borrowing in sterling, and the same goes for most British businesses.

So why are we in Britain so worried about budget deficits and debt? One explanation is that we have been persuaded into this view by malign political forces who use the analogy of household financial management to make their case. But there are deeper worries. The first is how do you tell when you have gone far enough with budget deficits and need to stop? The traditional economists’ answer is when inflation starts to take hold. But it might be too late by then, and anyway it is not so clear that in a modern, globalised economy inflation works in quite the way economists think. You know it is too latewhen there is a rush of people trying to change domestic currency into foreign, creating a panic and to people, including the government, having to borrow in foreign currency. That can happen without inflation.

The problem behind that is the politics of it. Opening up the possibility of more government spending is a huge boost to the power of central government politicians, who do not have strong incentives to apply the brakes when they need to – any more than those bankers did before the crash of 2008. It is too easy to believe your own hubris. I think this happened to the Labour government in the mid 2000s when the government should have started to tighten spending but decided not to. This didn’t cause the financial crisis, but made it harder than it should have been to manage. Even now, though, it is impossible to get anybody on the political left to accept that. It’s the one thing that unites Jeremy Corbyn with Tony Blair.

Still, we should be able to find ways increasing government borrowing that helps stimulate demand more sustainably. Building public housing is one idea. Other infrastructure policies should help (but not all of them). There’s also a case for taking a longer view on some public spending, like education , community policing, mental health services and public health that heads off future trouble. But not building more navy frigates or, even, hospitals. We might need these, but they need to be securely funded by current taxes. The trick politically is to create a system of checks and balances that lets you invest productively and not let central government managers run away unchecked.

Behind this lies an important but rarely acknowledged idea. It is that, in the 2010s and onwards, public investment is often more productive than private investment. And that, I think, is one of the causes of secular stagnation. So in the developed world we need more public investment, and that we can afford to borrow much more to pay for it than most people think. And we need less private investment, much of which is wasted on asset recycling schemes that will end in tears. It may well take another financial crisis before we start to realise this.

 

Automation should not lead to a workless society. Bad economic management could.

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The current issue of Liberator, an anti-establishment house magazine for the Lib Dems, bemoans the lack of policy on the advance of automation and robotics:

If we are heading for a world in [which] relatively few people conventionally work – because machines can perform tasks better and cheaper – how will the non-working population be paid, and what will it be paid for?

Such thoughts are prevalent in chattering circles these days. On one occasion I expressed a little scepticism in a Facebook conversation, given that current employment rates have never been higher – and I was quickly shouted down for having my head in the sand. As it happens the Lib Dems are developing policy here, with a working group on the “21st Century Economy” in the advanced stages of deliberation, having already held a consultative session at Conference. But what should liberals be thinking?

The claims about automation and robotics are not all hype, though there is a fair bit of that too. Artificial Intelligence (AI), and its harnessing of “Big Data” is in the process of revolutionising many areas of work. This has proceeded faster than I personally expected, after AI had gone through decades of marginal progress combined with absurd hype. Many jobs  are now threatened, including vehicle drivers and many professional roles. Just how far this is going is very hard to say. Colossal resources are being ploughed in, and there have been some spectacular achievements, and yet few of the breathless boosters of the technology appear to have much idea of what intelligence actually is – they just project present progress into the future and assume that AI will catch up with humans. There is no magic in the human brain, after all, just cells, chemicals and electrical connections. My guess is that at some point AI will hit a point of diminishing returns, and progress will slow.

But not for a while yet. Meanwhile undoubtedly consume many jobs will be replaced there will be a lot of economic disruption. But are we heading to a near jobless society? Here I struggle. Quite a bit of progress has been made already, after all, and yet in many countries, Britain in particular, employment has never been higher. And not just that. We are constantly aware of jobs that need to be done that are being cut. This is a lot of what is behind the fuss about austerity. Not enough care workers, doctors, or police officers: the list goes on. And there are plenty of new fields of endeavour that are opening up: cancer treatments, mental health care, green energy and so on. So the jobless society looks like self-harm rather than an inevitability.

Indeed a conventional economist would say that there is nothing much to worry about. Similar things were being said in the 19th century, as new technology cut swathes through agriculture and textiles. That didn’t work out too badly in the end did it? As one industry becomes more efficient, it simply creates demand for others. I believe that a lot of this has been happening already. A lot of the new jobs are being created in low productivity sectors of the economy, meaning that overall economic growth is not advancing as much as many expected. That’s just the nature of the beast.

But that is too complacent. A closer examination of 19th Century economic development reveals a lot of human misery as workers were thrown out of modernising industries. It was not at all clear for many years that human wellbeing was being advanced. In any case economists tend to overlook the the specifics of how particular technologies affect the overall economy. The massive advances in working class and middle class welfare in many economies after 1945 until the 1970s is often attributed to good management of overall demand in the economy. And yet it had everything to do with the advance of light industry and office work, based on technological breakthroughs made in the war years, which were particularly good for the creation of medium-skilled jobs. We do have to look closely at the specific implications of technologies of the age, and adjust our economic management to ensure the best outcome for overall human wellbeing.

The post war boom was particularly happy on two fronts. It threw up a lot of new things that people wanted to buy, from cars to washing machines to cosmetics and new textiles. And producing them was intensive in mid-level jobs on the factory floor, distribution and administration. Further, other industries, like insurance, produced the same mix of things people wanted and lots of jobs. But modern technology is focusing on efficiency rather than labour intensive new products. A lot of it is about replacing labour with capital, without necessarily producing much more product or service.

But are what people are going to need more of? Overall we do not need to consume more things or eat more food, though in parts of our society that is clearly true. The technology sector itself will generate a lot of demand, in the development of new systems, and in teaching people how to make best use of them. A second obvious area is health and care. The health economy has huge potential to expand, especially here in Britain – it is much larger in the US, even when so much of the population is excluded from it by lack of insurance cover. And an ageing population will not only need more health services, but general care too. Automation and AI in health and care is also likely to generate more work, by opening up new treatments and by making diagnoses more available, faster than it destroys work by making things more efficient. That has been our consistent experience to date. And a third area of potential expansion is what is being called “experiences” – entertainment, travel, games and so on. This is mixed up a further wrinkle: a possible increase in leisure time. People may want to work fewer days and hours. This will both create work (depending on what they do in that leisure time) and reduce time available to work.

But there is an obvious problem with all this: money. And by money I do not mean limits to real resources, but the fact that if there is not an even distribution of spending power, too many people will not able to afford these things, while a minority will have more money than they can actually spend things that create work, rather than being part of a churning cycle of finance and property . That cycle of finance, incidentally will also create some jobs – but this looks more like part of the problem than the solution. The problem is that the jobs being created, in sectors with low productivity, are often too badly paid or insecure for people to buy enough services and things. This is the way things seem to be heading in too many developed societies.

Technological advance should be a good thing. It allows us to do more while consuming fewer of the world’s scarce resources. But s skewed distribution of income means that the changes to work patterns risk suffocating the economy rather than advancing wellbeing. That is one of the central challenges of our times.

 

The Budget shows that the Tories are in a political cul-de-sac

I will break my self-imposed silence because yesterday’s British Budget is one of those great set-piece occasions which can be used as a moment of reflection. Predictably, most in the news media squander this in a silly game of speculation about the short-term prospects of political leaders. But the Budget poses more profound questions.

The government faces two profound economic problems, which it must either learn to live with or expend political capital to solve. These are low productivity and housing. There are other big problems, of course: Brexit, austerity, regional disparities and income inequalities, for example. But Brexit is more about means than ends; austerity is symptom of the productivity problem; and the other problems are not so high on political agenda right now, though they are important to both housing and productivity. Broadly speaking, the government is being forced to embrace the productivity problem, and is doing its best to confront aspects of the housing problem, without being able to do enough.

Let’s look at productivity first. This is about production and income per hour worked. Since unemployment is now low, and immigration is looking less attractive, increasing productivity is the key to raising incomes, and, above that in my view, to raising taxes. Weak tax revenues lie behind austerity – the cutting of public spending to levels which are now unsustainably low. The government is forced each year to spend extra money to fix some crisis or other brought about by austerity. This time it was Universal Credit and the NHS. Next year it will be police and prisons, after that it will be schools and student loans. And so it goes on – this is no way to build for the future. The government could try to raise taxes, but this is so politically unpopular that not even the Labour Party is talking about it – they persist in thinking that there is easy money to be raised from big business, rich people and confronting tax evasion. So growth it must be, and productivity must rise. But productivity is stuck in a rut. The big news for this Budget is that at long last the Office for Budget Responsibility has given up hoping that there will be a bounce back, and so reduced its forecasts of income growth, which are used to set tax and borrowing assumptions. The Chancellor, Philip Hammond, talked about fixing this, as all politicians do, but in practice has done very little about it. Labour, for all their huffing and puffing, are no better. Both parties propose a number of sensible small things, like increasing public investment and education, but nothing that gets to the heart of the issue.

So the political class have chosen to embrace slow productivity, by their actions if not their words. They are right, though they need to think through the consequences. My take on the productivity puzzle is different from pretty much everybody else I have read. I think that the primary cause is what economists call the Baumol Effect. The problem is not the failure of British businesses to embrace improvements, but the limited demand for goods and services that are susceptible to advances in productivity, such as manufacturing. There are things that can be done to raise such demand, but these mainly have to do with increasing incomes for those on low incomes – people with high incomes consume less as a proportion of income, and spend more on low-productivity items that confer status. Also if demand for exports could be raised, and imports diminished, that would help – international trade is mainly about high productivity goods. But nobody really has much idea how to deal with these problems beyond tinkering at the edges with minimum wage adjustments and such.

So what of housing? What, exactly, is this about? It is about high costs to both buy housing and to rent it. This is a very complex problem with deep roots. Most analysis is superficial, but this article in the FT by Jonathan Eley is a good one. Among a number of interesting points he makes is that the low number of new housing units being built in recent decades compared to earlier ones is a bit misleading. In those earlier decades a lot of housing was being destroyed: slums and temporary housing for victims of bombing in the war. It is not necessarily true to suggest that the problem is that too few houses are being built. In fact there are deep structural problems with the housing market. One is that private borrowing has been made too easy; another is that changes to housing benefit has subsidised demand for private rental accommodation. The result of this and a number of other things has forced up the price of land relative to the housing  built on it, and made trading in land central to economics of private sector developers.

The upshot of this is that it is hard to see any solution to the housing problem without a substantial intervention by the state to directly commission house building, and social housing in particular. Another issue is building on greenbelt land outside cities, which is now forcing suburbs to turn business premises into housing, and turning suburbs into an unhealthy housing monoculture. Caution on greenbelt building is warranted, of course, as suburban sprawl, as demonstrated in so many countries in the world, is not desirable either. Mr Hammond did practically nothing on either of these critical issues. He did try to tackle the housing problem, but mainly through the private sector and private markets which are structurally incapable of making things better for the growing proportion of the population weighed down by excessive housing costs.

That is entirely unsurprising. Solving the crisis, especially in an environment of low economic growth, means that current levels of house prices and rents have to fall. That is a direct attack on the sense of wellbeing of the Conservatives’ core constituency: older and better off voters. And if that isn’t enough, property developers and others with a vested interest in the current system are showering the Conservatives with money. A politically weak government is no shape to take this on.

And that, I think, is the most important political fact in modern Britain. Housing costs are not an intractable problem that we must learn to live with, like productivity. One day it will solve itself in an immense period of pain as land prices, and much of the financial system, collapses. The sooner it is tackled the less the pain will be. Labour may be useless on productivity, but they are much stronger on housing. They have a much better prospect of doing something useful. That does not mean they will win the next election – the forces of darkness on the right should not be underestimated. But it does mean that Labour is looking to be the lesser of two evils.

For my party, the Lib Dems, this is important. It means its stance of equidistance between Labour and the Tories needs to be modified. The turning point, in hindsight, should have been that moment in coalition with the Tories when the then Chancellor George Osborne said that he could not support the building of more council houses because that meant more Labour voters. The coalition should have been ended then and there. Just as in the 1990s when the Lib Dems leaned towards Labour, the party needs to accomplish the same feat now. It is much harder because Labour has abandoned the centre ground. But that is where the country is at.

Household debt: the slowly developing crisis of capitalism

This week there is much debate on whether the Bank of England or the US Federal Reserve should raise interest rates from their current rock-bottom level. Behind this lies an important debate on the future of our economic system. A crisis, arising from high levels of household debt, is in the making.

Let’s set this in some sort of context. In the 1950s and 1960s levels of household borrowing (that is mortgages, car loans, consumer debt and such) were strictly managed, in a system designed to ensure financial stability as part of the global Bretton Woods system of managed exchange rates. This era is often viewed as something of a golden age by people on the left, as there was steady growth across all levels of income, and high levels of social mobility. There is a tendency to attribute this to the Keynesian consensus, of which the Bretton Woods system was a part. In fact it also had a lot to do with the explosion of  consumer goods industries which set in motion a virtuous circle of job creation and increased household consumption.

By the 1970s this system had broken down. The Bretton Woods system collapsed as the United States sought to finance the Vietnam war without raising taxes. We entered the world of floating exchange rates, which allowed much greater freedom for both public and private sectors to borrow money. Middle East tensions saw a spectacular rise in oil prices, which disrupted developed world industries. The consumer boom started to reach saturation, and growing productivity halted the job creation machine. Much heavy industry, such as coal-mining, and steel production, became obsolete, along with other job-rich industries like textiles. Keynesian economic management simply led to inflation while unemployment continued to rise.

Enter the neoliberal era, starting in the 1980s. Governments embraced the freer financial system. Consumer demand was now sustained by growing levels of household borrowing. Alongside this came an expansion of world trade. Developed countries bought growing amounts of goods from developing economies in Asia; the first wave were the “Asian Tigers”, especially South Korea and Taiwan; these were followed by the giants of China and India. This expanded trade reduced prices for consumer goods, and allowed a period of steady, if somewhat uneven, income growth in the developed economies. Slowly the developed economies reshaped themselves to a combination of highly productive high technology jobs, and a mass of low productivity service jobs, especially in healthcare. But the uneven nature of income growth, sustained by household borrowing was creating strains by the mid 2000s. In Britain household debt had increased from about 50% of national income in 1980 to 160% in 2007.

Then the great financial crisis struck in 2007, reaching its climax in 2009. This was only indirectly linked to high levels of household debt. The crisis mostly arose because the finance industry was allowed to grow in a very unstable way. This gave the illusion of growth, especially in Britain, in the years before 2007, only for the awful truth to be revealed when the government had to bail the system out. By and large, that source of instability has been fixed. But meanwhile globalisation as a source of growth for the developed world has run its course, while increasing productivity has become like running up a down escalator. Improvements in one area of the economy are most likely undermined by the creation of low productivity jobs in another, in a process economists call the Baumol effect. We are stuck in an era of low economic growth in the developed world.

Which is why some people are starting to worry about levels of household debt. Since the crisis household debt in Britain has been bumping along at about 140% of income, and it has been trending up in the last two years. But people’s capacity to repay debt is weakening. Back in the 1980s it was assumed that rising incomes would make debt more affordable. This is plainly not the case.

A further risk factor is that central bank interest rates are rock bottom. These interest rates are not the same as what is charged to real people and businesses (something we learned during the crisis, when the central bank cut interest rates, but most consumer interest rates went up). But it doesn’t look as if the interest rates people pay are going to get any lower, and so debt become more affordable. In the past central bankers could help alleviate crises by cutting interest rates, but now they have run out of road.

A third risk factor is asset prices: the price of property, shares and bonds. All three look high by objective measures, and so could fall. The process by which asset prices are set is complex and mysterious. But if assets are sold to unwind debt, then prices are liable to tumble.

Stagnant incomes; interest rates that can’t be cut; asset prices that look too high. This is a toxic brew. Some people hope that by raising interest rates gradually, we can slowly normalise the financial system, with overall levels of debt stabilising or even falling. Others fear that any rise in central bank rates will trigger a downward spiral.

But we need to understand that wider perspective. The neoliberal system has become unsustainable, and developed countries (especially the British and American ones that embraced it so wholeheartedly) need some fresh thinking.

One point should be clear, but still remains under-appreciated. Levels of private debt need to fall, and the safest route to doing so, without a disastrous collapse in demand, is for public debt to replace it. In other words we should not be so worried about budget deficits and national debt. However government spending needs to focused on things that will support the transition to something more stable, rather than just propping up structures that will be unsustainable in the long run. Ultimately national debt can be unsustainable too (though just when that point is reached is very much a matter of context; Japan has public debt of 200% of income without much sign of trouble). This is a national debate we badly need to have.

A second point also seems quite clear to me: asset prices must fall. This includes property, shares and bonds. This is required to correct some of the toxic inequalities of wealth. That will clearly create hardships and problems, but the government must stand ready to tackle these. Putting off the evil day will not help. That is why I think that central banks need to start the process of raising interest rates.

And a third point is that we need some serious policy ideas on how to tackle the issue of low pay for low-productivity jobs. It is no use hoping that productivity is going to resume the steady growth it saw in the later 20th Century. The forces that drove that – automation of manufacturing, and globalisation – are played out. In my view that means a much bigger role for the state in supporting society – but not by an unaccountable and out of touch central government.

These are radical changes. History teaches us that such radical change only comes from crises. There will be a new economic crisis. The only question is when, and whether our leaders will be intellectually prepared to manage its aftermath.

 

Economists are failing to understand the 21st century economy

When is a fact not a fact? When it is an economic statistic. Economists use  statistics like GDP, productivity or inflation, as if they were facts. And because economists set the terms of public policy debate, the rest of the world follows them. But they are abstract artefacts, designed to help us see the facts, but which conceal as much as they reveal. There may have been a time when this didn’t matter much. That is certainly not the case now. We are missing something very important.

Economists like to accuse others of the fallacy of composition. That is the assumption that the finances of a nation work on the same principles as that of the households that make it up. For example, the budget constraints in a household work in an entirely different way to those for state finances – which doesn’t stop politicians lecturing us about the absence “money trees”. But economists are the world’s worst at a very similar fallacy: assuming that national level statistics represent the truth for individual households and businesses.

This is very striking with discussions about productivity, such as on this morning’s Radio 4 Today. This is newsworthy here in Britain. Growth in productivity grew at about 2% a year in Britain until 2008, during the financial crisis. It then stopped growing – creating what is often called the “productivity puzzle”. This is happening, to a lesser extent, in other developed countries too. It is the news now because the Office for Budget Responsibility has admitted that its assumption that productivity growth would revert to historical norms has failed to materialise for yet another year. That matters because it affects forecast tax revenues, around which the Chancellor of the Exchequer must base his annual budget, due next month. It is also the explanation offered for the fact that rates of pay seem to have stagnated for many Britons.

What is productivity? It is output per worker per period worked (typically a day or an hour). If you work in a ball-bearing factory it is relatively easy to understand what this actually means. You count the number of ball-bearings produced in a month, say; you count the number of hours worked in that month; you divide one by the other. Because of this simplicity it is easy to imagine the national economy made up entirely of ball-bearing factories or close equivalents, so that if productivity rises, it means that more ball bearings are being produced for the same number of hours. And most of the discussion about productivity uses something like this mental picture. Economist speculate about businesses using cheap labour as a substitute for upgrading capital equipment, for example. This is like the butler in Kazuo Ishiguro’s The Remains of the Day who immerses himself in his familiar daily duties so as not to confront the realities of the changing world around him.

To understand this, consider two groups of problems. The first type of problem is how do you actually measure output? The more you consider this, the harder it gets. Start with some obvious problems: what is the output of a squadron of jet fighters? Then how do you compare organic carrots with carrots grown on a farm pumped with environment-degrading chemicals? Or an iPhone 6 with an iPhone 8? Or is a loss-making factory with few people and overpriced robots really more efficient that a profitable one with lots of labourers and primitive machinery? Economic statisticians wrestle with such questions, but largely hidden from view. Economics undergraduates are barely troubled with such issues, and are quickly ushered on to the certainties of supply and demand curves and medium term fiscal policy. The result is a series of estimates and fixes, but not enough discussion about what they all add up to. Occasionally a conservative politician will pop up to suggest that lower-paid workers should be much happier because improvements in technology aren’t properly reflected in inflation. But that’s about it.

The second group of problems is conceptually somewhat easier: it is variations in the composition of the economy. Overall productivity may be improving not because individual businesses, or even industries, are becoming more efficient, but because industries with a higher measured productivity are taking a larger share. In fact it turns out that this was largely the case in Britain before 2008, with the expansion of banking and professional services. Just how productive these industries were in reality was thrown sharply into question in the following year, when banking threw up eye-watering levels of losses, from which government finances have never recovered.

These difficulties have been known about for a long time, and professional economists are more aware of them than the public whom they lecture. But they are shrugged off, with the assumption that it all comes out in the wash. Policymakers should be doing something about productivity, they say. This needs some serious challenge. And the consequences of that challenge are profound.

My first challenge is known as the Baumol effect, or more usually known, revealingly, as “Baumol’s cost disease”, as if it was something to be eradicated rather than an ordinary physical constraint. Suppose a legal firm adopts a highly efficient artificial intelligence system and makes most of its workers redundant. And then those workers take up jobs such as being personal trainers or producing craft pottery. All the positive productivity effects of the firm’s investment in AI is neutralised by the displaced workers moving into low-productivity jobs. Perhaps we are at state where most productivity improvements are being statistically neutralised in this way? After all, the more efficient an industry becomes, the fewer jobs in that industry there are overall.

Now let’s get into territory that mediocre economists really want to avoid: human alienation. One way of looking at productivity is that it advances by two alternative means: cutting wastage and cutting human content. By and large nobody will argue with cutting wastage. Vacuum cleaners have liberated home-keepers; time spent in queues is good for nobody; and so on. But cutting human content, and human contact, is distinctly two-sided. This is the world of standardised products, specialisation and automatic interfaces that may reduce costs but leave workers and users alike cut off from their fellow human beings, and being forced to conform to somebody else’s idea of what they should be. That is alienation, an idea first made famous by none other than Karl Marx in the Communist Manifesto – a document of startling insight. Alienation can be to the good overall, but it often isn’t. And there are bad signs all around us, from the obesity epidemic, the poor mental health of teenagers (especially girls), to the breakdown of community activities in our cities. Now, to back to my example of the legal firm, what if one of those displaced admin assistants finds life much more fulfilling as a personal trainer, even if the pay is miserable? A conventional economist would fret that surely it is better for her clients to download a demo video from You-Tube so that the trainer can work in a soulless call-centre? Well it would for those aggregated statistics, but not necessarily for the state of the human condition. In fact many economists suffer from acute double-think. On the one hand they praise markets and the wisdom of freely made choices of individuals over bureaucratic planners. And yet when those freely made choices go to more leisure, low productivity work and locally-sourced vegetables, they moan like mad.

But there is one sense in which those economists are right. Those aggregate statistics have one useful purpose: in planning taxes. Taxes are based on the money economy, which is the foundation of those statistical measures. If the stagnation of productivity is a fact of life, and actually represents a struggle against human alienation, then tax revenues are going to stagnate unless the rates increase. And since demand for tax funded services is liable to keep rising, we are going to have to think very hard how we order people’s relationship to the state. We are surely heading for an era of higher taxes. But how to design these taxes?

Instead we just get useless calls for action to raise productivity. Time to move on.

Universal Basic Income is a problem dressed as a solution

Slowly but surely Universal Basic Income (UBI) is becoming a totem policy on the left. Longer standing readers of this blog will know that I am sceptic. But should I be reluctantly reconciling myself to the idea in some form?

Recent impetus for UBI has come from the US, where it is favoured by high tech businessmen worried about the implications of progressive automation. They worry that there is a great hollowing out going on, with mid-skilled jobs disappearing, and the workforce being divided between a very well paid elite of professionals and business owners, and a majority of low skilled proletariat in ill paid and insecure jobs. If the latter can have their income topped up by some form of UBI, then they will be able to afford a higher standard of living, and they will be less beholden to the elite. Many businessmen think that the latest advances in artificial intelligence are about to make the problem much worse – hence the need for such an intervention.

The left is worried by similar issues. The more thoughtful are concerned by a breakdown of consent for the welfare state, where state aid is doled out based on need. If everybody is entitled to the same level of state aid (with allowances for age and disability, perhaps), then there will be less resentment by the slightly better off members of the working class against those receiving aid. Since the left is generally bereft of ideas that are not simply reinventing the 1970s, this one is getting a lot of support. The Green Party in Britain has adopted it; many in Labour (and the Lib Dems) are sympathetic.

Various small-scale pilots are being set up in America and Europe. In fact something like it has been in operation in various places in the US for some time. Alaska pays all its citizens a dividend from its natural resources wealth (the Alaska Permanent Fund). The amount is modest and variable: since 2010 it has ranged from $878 to $2,072 a year – but it is popular. Meanwhile a number of Native American reserves pay a fixed income from gambling concessions. The social effects of this are not so benign, which is no doubt why so few UBI never mention them. The money does not make up for a lack of decent jobs and social infrastructure, and the money is spent on things that do not engender long-term well-being, though enriching unscrupulous salesmen.

One thing should be very clear from any but the most superficial analysis. If the level of UBI is to be set high enough to deal with basic human needs, so that it can replace the bulk of state benefits, then taxation will have to be unfeasibly high. So high that instead of fostering consent it is just as likely to breed resentment as the current system, and a massive drive by businesses and rich people to smuggle their profits abroad to evade payment. That is before recipients of UBI start complaining that the system is unfair because their circumstances (living in a high-cost area, educational needs, health problems, disabilities) create greater need. The idea that UBI can replace a whole series of benefits with a massively simplified system is for the birds. I also think such a system would lead to alienation which would exacerbate social ills. Alienation results unless people are engaged in genuine dialogue resulting in some form of contract; the idea behind UBI is to reduce the need for dialogue and contract.

If UBI-max – the replacement of most state benefits -is ruled out, what we are left with is  much more modest. It might replace the personal tax allowance and extend it to those who aren’t working, and re-badge the basic state pension, removing it from the contributory principle (something that the Coalition advanced in the UK in 2010 to 2015). This would effect a modest level of redistribution and ease life slightly for some groups of hard-pressed. No doubt it would mean higher taxes, though some benefits might be clipped to help pay for it. I’m not sure that this is worth it – and it is hardly very radical. The tax free allowance is only worth a couple of thousand pounds a year.

But there is another approach that is worth mentioning – suggested by the former Greek Finance Minister Yanis Varoufakis. This goes back to the Alaska Permanent Fund. The state acquires stakes in major businesses, and especially the big monopolistic businesses that are increasingly dominating our daily lives. A dividend would be distributed annually from the income generated by this fund. Over time this fund would grow and start to produce respectable sums.

Mr Varoufakis is a socialist; the idea of states taking over chunks of privately held capital will not bother him. Others might be nervous; the state has not proved to be an effective shareholder on the whole, the less so the more management is politicised. It might also create public acquiescence with monopoly profits, compared to more efficient models. But it is an intriguing idea. It does go to the heart of the problem – the excessive accumulation of capital in the hands of relatively few people, and its control by corporations that funnel disproportionate rewards to a few. It also starts to tackle another often-overlooked problem: how hard it is for people on modest incomes to accumulate savings without them being eaten up by transaction costs. This is why so many private sector pension plans are so ineffective, and why a state-funded basic pension is such a good idea.

How would the state fund its capital acquisitions? There are broadly three ways: appropriation, taxation or borrowing. Appropriation is simply tax by another name – maybe businesses could be forced to offer shares to the state instead of corporation tax; and by the same process a minimum distribution might also be forced. There a couple of problems with this, though. First of all it would confine the fund to domestic assets, when so much of the surplus capital is held by international businesses. Second, businesses come in all sorts of legal structures, some of which are more conducive to income distribution than others. Any attempt to appropriate shares could cause businesses to evade by changing legal structures.

But a sovereign wealth fund funded by taxation or borrowing gets around the need for direct appropriation. The problem is that it would take an awful lot of money before it reached a size that it could generate an income that the public would notice. Take the UK. One thousand pounds for 60 million people is £60 billion. At a 2% yield that is £3 trillion capital value – getting on for twice the level of the national debt. Even a New Monetarist might that feel state borrowing on this level carries risks. Of course the idea is that capital growth will help to fund this over time, and if built up slowly, it would be easier to accommodate – but cash distributions would also be tiny for a long time.

All this leaves me thinking that UBI is a symptom of the problem, and not the solution. The world is becoming too dominated by big institutions, such as companies like Google or governments and state agencies. These try to simplify processes in order to make them manageable – and this leads to excessive accumulation of power by elites, in government and business – and the alienation of the majority. UBI is just another simplified solution designed to fit this general pattern. It is advocated by people that support such one-size-fits-all approaches – be the monopolist businessmen or advocates of a mighty central state (such as socialists) .What we actually have to do is tackle those excessive concentrations of power. And that is much harder.

Neoliberalism’s three blind spots and how we move on

In my last proper post I examined the idea of neoliberalism, a set of ideas that is at the heart of modern economic policy. I concluded by saying that most people think it has failed. But how can we move on?

The first point to make is that the two central insights of neoliberalism seem as valid as ever. The first is that markets provide the best way of processing information on complex human needs and how to meet them – and they do this far better than bureaucracy. The second is that governments and regulators are beset by dysfunctional incentives – and tend to serve the interests of elites and client groups, rather than the people as a whole.

This is the starting point for those that continue to defend the philosophy, though rarely by that name. They suggest that the problems that have arisen since the 1990s have much more to do with the advance of technology and globalisation than anything else. This is a rather pessimistic view. It suggests that society in the 1990s was faced with the choice of embracing technological change, with the benefits to health and wellbeing that resulted, or a futile attempt to keep change at bay for the sake of social stability. It is hard to think of any society that has successfully followed the latter path. The collapse of blue-collar and white-collar middle-income jobs was pretty much inevitable. And countries that seem to be more successful in embracing this change, like Germany, have done so by adopting policies that have undermined their global neighbours’ attempts to do the same thing. Germany preserves swathes of middle-ranking jobs only by exporting large quantities of manufactured goods to other countries compared to what it imports. By this pessimistic view, the world is being swept forward by technological change and governing elites are powerless to stop it. We may be alarmed at the political backlash, but any new leadership that this sweeps into power will most likely make things worse than better.

There is doubtless some truth to this. It is very striking how the political backlash seems bereft of new economic thinking. The right wants to create higher national boundaries and limit free trade between countries. This thinking recalls policies that deepened and prolonged the Great Depression in the 1930s. The left wants to expand state control. The Labour manifesto in Britain in the recent general election recalls to me the failed development policies in places like India in the 1950s and 1960s before a turn to neoliberalism unleashed massive growth. That isn’t entirely fair, of course, as both left and right also indulge in some new thinking. But it is really quite worrying that the only new idea on the left that has any currency is universal basic income – an idea that has no chance of meeting the huge expectations being placed on it.

But there are clear problems with neoliberal thinking. I think the three key blindspots are capital markets, Baumol’s disease and human organisational capacity. Add these together and you get pointers to what a post-neoliberal economic philosophy might look like.

First: capital markets. Hayek’s insights on the efficiency of markets does not to apply to assets, as distinct from goods and services. The market value of assets does not reflect their future economic worth. Bubbles build and burst, creating ruin in their wake. The problem is as old as the capital markets themselves – but that does not stop these markets from causing society’s resources from being allocated inefficiently. Another problem is that asset price inflation reinforces a gap between the haves and have-nots, and, in Britain, between the young and the old. Neoliberals (like the Economist newspaper) often say that the sky-high prices of land in popular cities simply reflect the laws of supply and demand, and that we should build more homes where people want to live. Whatever the truth of this, it is surely clear that excessive levels of personal debt are a large part of the problem – as well as the issue of human organisational capacity that I will come to. This causes the prices at which supply and demand balance to be much higher than they would be otherwise.

To cut a long story short, modern developed economies (especially the Anglo-Saxon ones) place far too much reliance on private debt, and this leads to instability and inequality. The risks associated with state debt, by comparison, look easier to manage. One leg of the neoliberal system of economic management, monetary policy, is broken.

The second issue is what economists call Baumol’s disease. This idea has been in circulation for decades, and is taught to economics undergraduates. It is amazing how little its implications seem to be understood. Baumol pointed out that as productive sectors of the economy develop in efficiency, the less productive sectors bulk up in proportion. Agriculture used to account for the bulk of the British economy; but as it became more efficient it eventually sunk to a small fraction of it. The same is now happening to manufacturing. As we become more efficient the bulk of jobs will be in sectors where high productivity is impossible or undesirable. And in the current situation they will increasingly be in sectors where market solutions have been found wanting. These include healthcare, education and law enforcement. These sectors are dominated by government and the public sector. We must expect the public sector to grow, and we must learn how to manage this, rather than trying to push the boundaries of the state back.

My third issue is what I have rather clumsily called human organisational capacity. The human brain can only handle a limited number of connections efficiently. And humans are at the centre of human organisations. Artificial intelligence won’t change that; it will simple extend the reach of what individual humans can do. This human capacity sets limits to the size and scope of human organisations. Organisations that grow eventually face a stark choice. They either become staggeringly inefficient, or their operating systems have to be very lean, requiring few people to operate them. Commercial organisations are forced into the latter category by competition. Dealing with a large corporation now, like Google, Amazon or PayPal is extremely frustrating for ordinary human beings, unless you manage to stick to the automated procedures that they prescribe – which are unable to handle any degree of complexity. Modern technology is allowing these commercial organisations to extend their reach by cherry-picking things that are simple to deal with, and leaving behind the difficult ones. This is creating a hollowing-out effect that is one of the big drivers of inequality.

Governments, meanwhile, are left to pick up the pieces. But they are subject to similar limitations. They have to choose between monstrous inefficiency or simplification. As tight finances force them into the latter course, power accretes to an elite in geographically concentrated centres of power. Neoliberals tend to shrug at this, and simply say that this is price we pay for a more efficient society. But I think it points in a different direction: to towards the decentralisation of political power, and the development of local democracy. One country has taken this idea further than any other: Switzerland. But if you go there you do not find grinding poverty as people are forced to choose between local control and drawing the benefits of modern society. You find one of the most prosperous societies in the world, with economic activity geographically spread out. One key thing to note: the Swiss have not just found ways to devolve political power to relatively small units, but they have also found ways to involve their citizens in taking responsibility for the society that they live in.

All this raises many, many questions. But the overall direction of travel is clear. We need to expand the scope of the public sphere (I am being careful not to use the word “state”), but also to shrink it geographically and allow people to take more ownership of it. Markets are useful, but we need democracy too.