Time to wake up to the de-industrialisation of advanced economies

Trying to understand the global economic crisis?  This article from Joe Stiglitz is required reading.

I have flagged it already on Facebook and Twitter, but without much in the way of reflection. In fact it has produced an epiphany moment for me.  I have maligned Professor Stiglitz in a past blog as producing only superficial commentary on the crisis, alongside his fellow Nobel laureate Paul Krugman.  This was based on one or two shorter articles in the FT and some snatches on the radio; I wasn’t reading or listening carefully enough.  Professor Stiglitz is one of the foremost economists on the current scene.  He used to be part of the Clinton administration, and worked at the World Bank in the 1990s, but his views proved politically unacceptable.  He also wrote the standard text book on public economics, which I used in my not so recent degree course.

The article is wonderful on many levels, but the epiphany moment for me came with his observation that, underlying the current crisis, is a long-term decline of manufacturing employment in the US, and by implication, other advanced economies too.  He draws an interesting parallel with the Great Depression, which was caused, he claims, by a comparable shift from agricultural employment – again in the US; I think that such a shift was less marked in Britain, but the depression was also less severe.  This decline in employment brought about a doom-loop of declining demand across the economy as a whole – which was only reversed by World War 2.  The war effort caused a boom in manufacturing industry which was readily redeployed into the postwar economy.  This view of the Great Depression rises above the fierce controversies over fiscal and monetary policy, and places them in a proper context.

We have been witnessing the decline in manufacturing employment for some years, and grappling with its social consequences.  The important point is that it is mainly irreversible. It has been brought about by technological change, which has improved productivity.  There is a limit to the number of manufacturing products that we can consume – just as there is a limit to the food we can consume, and we are at that limit.  So the number of jobs declines.

Of course the picture is complicated by the rise of manufacturing in the developing world, and especially China, and their exports to the developed world.  In the US I am sure, and certainly in the UK, more manufacturing output is now imported than exported, causing a further loss of jobs.  This is reversible, though, and in due course will reverse, as the developing world advances and loses its temporary competitive edge.  But this won’t be enough to reverse the overall trend of rising productivity.

But advancing productivity should be good news in the long run.  It releases the workforce to do other things, or, if people prefer, to increase leisure time.  So what replaces the manufacturing jobs, in the way that manufacturing took over from agriculture?  Services, of course.  What is, or should be, the product of these services?  Improved wellbeing.

Services have rather a poor reputation in our society.  Traditionalists see them as ephemeral, compared to the real business of making things – a bit like Soviet planners were obsessed with producing steel rather than consumer goods.  More thoughtful people associate them with poor quality jobs in fast food restaurants or call centres.  But it doesn’t have to be this way.

We need to develop clearer ideas of what tomorrow’s service-based economy will look like. That’s important because the way out of the current crisis is through investments that will take us closer to this goal, just as war led to investment in manufacturing in the 1940s (and earlier in Europe).

And the key to this is thinking about wellbeing.  This is important because one of the answers could be an increase in leisure, hobbies and voluntary activities – which is not normally regarded as economic activity at all.  Reflecting on this, I think are two areas whose significance will grow and where investment should be made, both of which raise awkward political problems – health and housing.

It is easy to understand that health and social care will take up a higher proportion of a future economy than they do now, and not just because of demographic changes.  These services are vital to wellbeing.  But we are repeatedly told that we can’t afford to expand them.  And that is because we are reaching the limits of what state-supplied, taxpayer funded services can deliver in the UK. (In the US it’s another story for another day).  The health economy of tomorrow will have a larger private sector component, whether integrated with the NHS or parallel to it.  But what should our priorities now be, while this private sector is on the back foot?  It seems sensible to make the NHS more efficient and effective, but foolish to cut jobs.  We should be building the skill base alongside the reform programme.  The chief critics of the government’s NHS plans (including the Labour front bench) are that NHS reforms should be stopped so that they can focus on the critical business of raising efficiency.  But maybe it should be the other way round – we should be pushing ahead with reform, but relaxing the efficiency targets and letting the costs rise a bit until the economy starts showing greater signs of life. then, as any cuts are made the private health sector can take up the slack.

Perhaps housing is pushing at the boundaries of what “services” are.  We traditionally view this as a capital investment.  But what I mean is providing more and better places for people to live in, whether they own them or not.  Most of the country is quite well off here, but poor housing is probably what divides rich from poor more than anything else – and more investment in the right places (decently sized social housing) could rebalance things nicely and dramatically improve wellbeing.

But beyond this we badly need to get out of a manufacturing mindset, both in the private and public sectors.  We should not view division of labour and specialisation as the ideal form of organisation (massive call centres, and so on), and we should value listening skills much more – I nearly wrote “communication skills” but most people understand this about getting over what you want to say, not understanding what your customer or service user actually needs.  This is happening only very slowly.

So I would add a third priority: education.  We need to greatly expand the teaching of life skills at school and elsewhere.  This would not only help build the skills that tomorrow’s economy needs.  It would help people make better choices in a changing world.

 

Capitalism, crony capitalism and neoliberalism. What’s in a word?

Are the Occupy protesters on to something?  Or is theirs just a hopeless battle against abstract nouns?

I have been rather exercised about some abstract nouns recently.  First was the word “Neoliberalism” selected by Simon Titley of the Liberator as one of three Bad Ideas to have infected British politics over the last 30 years, sweeping along the Liberal Democrat leadership with the rest of the mainstream.  The other ideas were the “Westminster Bubble” (the idea promoted by a lazy media that only ideas that have taken hold in Westminster matter), and that the Westminster elite have a monopoly of political wisdom (expressed by contempt both for grassroots activists).  Neoliberalism had a starring role in the previous month’s Liberator when Mr Titley and David Boyle roped it into their narrative of what went wrong with British politics in their article “Really Facing the Future”.  Mr Titley felt he had written enough already on the subject to explain what he meant by neoliberalism – unfortunately before I have been subscribing to Liberator.

Another tiresome abstract noun has been even more prominent: “Capitalism”.  This has been the main target of Occupy.  It was recently brought into further focus by Tory MP Jesse Norman in an FT article based on his pamphlet “The Case for Real Capitalism“.  This pamphlet is not a particularly coherent or convincing piece of work, though to be fair he does say that a longer, and presumably better argued, version is in preparation.  But by harnessing a couple of qualifiers (“crony” and “good”) he tries to make sense of capitalism, and brings neoliberalism into the picture too.  It’s good place to start a probe into whether these words have any useful purpose.

In Mr Norman’s picture the world has been suffering from “crony capitalism”.  He identifies various strands (e.g. “narco-capitalism”, taking it well beyond what I would call “crony” capitalism, which should really involve cronyism – business leaders being too close to political leaders.  Still he does offer a workable definition of bad capitalism:

Crony capitalism is what happens when the constraints of law and markets and culture cease to be effective.  Entrepreneurship and value creation are replaced by rent-seeking, and certain groups become enormously wealthy without taking risk. These factors in turn lead to long-term economic underperformance, and sometimes to social unrest.

Apart from the use of “crony” and the economics jargon of “economic rent” (which means profits accruing to a business over and above the opportunity costs of inputs) this is quite useful.  Something that is recognisably capitalism – an economy based mainly on private enterprise – can look like this, and when it does, it is bad.  But capitalism doesn’t have to be this way – hence Mr Norman’s employment of “good capitalism”.  This version emphasises the need for free competition and the consistent application of the rule of law.  But that by itself is not enough.

Mr Norman contrasts “good capitalism” with our friend “neoliberalism”, which does not have a moral dimension.  Like Mr Titley, he does not bother to define neoliberalism.  But from context I can identify it with what the FT writer and economist John Kay called “the American Business Model” in his 2002 book The Truth about Markets which was part of my Christmas reading.  This elevates the simplifying assumptions of classical economics (rational behaviour, consistent and stable preferences, perfect competition, and so on) into a moral value system.  In particular it idealises a ruthless focus on maximising personal gain in the framework of impartially enforced rules (property rights in particular).  This way of thinking remains very popular in America, with the Chicago School giving it considerable intellectual heft.  But it has never taken off in Europe, and Britain is very much part of Europe on this issue, as in so much else.  The emphasis on personal gain – greed – and antipathy to social solidarity are too much for all but a lunatic fringe to accept.  And that includes Conservatives like Mr Norman.  Good capitalism has a moral dimension – and one that celebrates the virtues of hard work and social responsibility.

Meanwhile the use of “neoliberalism” on the British left (including Mr Titley) clearly does not conform to the definition that Mr Norman uses.  Within its scope are swept Margaret Thatcher, Tony Blair, Gordon Brown and the “Orange Book” Liberal Democrats such as Nick Clegg.  But none of these are or were Chicago School types.  Apart from Mrs Thatcher, maybe, all see a huge role for government in our society and would expand its remit.  But they have criticised the way producer interests have captured public services, profoundly undermining its quality.

Another issue needs to be mentioned here: and that is financial explosion in the UK and US that occurred in the period 1997-2007, and which ended so badly in the current crisis.  This is closely associated with greed in the public’s minds, of bankers mainly, but also chief executives and (whisper it) all those ordinary members of the public that racked up credit card and mortgage debt.  This is swept into the general idea of “capitalism” and “neoliberalism”.  And indeed neoliberal ideas were used to justify the behaviour of many of the more egregious participants.  But true believers in neoliberalism have little difficulty in shrugging such criticism off.  To them what caused the crisis was excessive government intervention (e.g. by encouraging subprime lending in the US)  and the failure to uphold proper open markets (through the implicit government guarantee of banking activities, for example).

All of which renders the words “capitalism” and “neoliberalism” as useless abstract nouns.  There is little consistency in their use between the different political factions; their use by one faction is misunderstood by the other in an endless cycle of talking at cross purposes.  The Occupy movement seems particularly bad at this.

To make headway in the political debate we need to move on from the abstract to the practical.  What is the best way of providing health and education services?  What should the scope be of social insurance?  How can we get private businesses to invest more in the future and distribute their profits (or economic rents if you prefer) more equitably?

 

Religion, morals and the flight from rigorous thought

Last Friday David Cameron, the Prime Minister, gave a speech on the 400th anniversary of the King James Bible, which got a sprinkling of coverage in the weekend press.  In it he sought the help of Christianity and church leaders in helping to restore the country’s lost moral values, as evidenced by the summer riots, and Banking and MP’s expenses scandals.

My point isn’t to criticise this speech – I just don’t know where to begin – but to ask what such a speech says about modern politics.  In terms of intellectual rigour it wasn’t even trying.  But many people, and especially those of conservative instinct, will agree with its sentiments.  A nostalgia for higher moral values in the past; linking the country’s identity to the Christian faith; the feeling that s stronger standing of religious faith amongst other people will improve the country’s way of life.  The speech was no attempt to lead public opinion; it was following it.  Some commentators pointed out the political conventional wisdom against “doing God” – but this was not doing God, it was doing a warm fuzzy glow around the idea of religious faith and moral values.  As such it has not damaged Mr Cameron’s  standing.

Such lack of acuity in a senior political leader is something relatively new in Britain, I think.  It brings to mind Roy Jenkins’s remark about Tony Blair, in many way Mr Cameron’s role model, that he was “not a First Class intellect”.  Very clever, but I bit fuzzy.  It is impossible to imagine William Gladstone producing a speech like this one, or Margaret Thatcher, come to that.

This is a matter for regret.  Surely our political leadership should aspire to, well, leadership? – and try seriously to argue their cause and persuade the country about their vision for the way forward.  Even people who do not agree might see the force of the logic.  Instead we get a few half-baked ideas designed appeal to supporters’ prejudices.

And as for improving the standards of behaviour on our estates and boardrooms alike, this is just hot air.  Bad behaviour in these places, or their ancient equivalents, is absolutely nothing new, and does not correlate to a lack of religious standards – it has been known to permeate religious establishments.  And high moral standards have been the excuse for the infliction of much cruelty and injustice (think of the treatment that used to be meted out to unmarried mothers) in a way that, ironically, contradicts what Jesus Christ himself taught.  Religions don’t offer clear moral guidance, they offer a menu from which adherents pick and choose, and then claim the authority of heaven (think of the 9/11 bombers, West Bank settlers, Apartheid Boars, and so on).

Behaviour is a real enough problem.  But our Prime Minister just leads a national whinge.  He should aspire to more.

Is this the Eurosceptics’ Moscow moment?

Nearly 200 years ago, in September 1812, Napoleon reached the maximum limit of his nominal power when he entered Moscow with his army drawn from right across Europe.  His empire covered France, Germany, Poland, Italy, much of Spain (his lieutenants were in the process of driving back an advance by Anglo-Spanish forces that had temporarily liberated Madrid) and now much of Russia, including its Asiatic capital.  But he could not hold it; by the year’s end he had been forced to abandon Russia altogether, his army destroyed, and he was completely crushed within a year and a half.  For the Russians 1812 had proved a time of incessant retreat, as they avoided battle until just before Moscow (at Borodino), where they lost and were forced to abandon Moscow without a fight, but ultimately a year of triumph.

Is this a fair metaphor for the British Eurosceptics in their moment of victory at the British veto at last week’s EU summit?  Certainly their triumphalism is unbearable.  Bill Cash was described by one of our outraged local Lib Dem members as “the cat that got the cream.”  This follows one long process of retreat by British Europhiles as they conceded the political initiative to the sceptics, practically without a fight, time and again.

But the initial reaction of leading Lib Dems was strangely sanguine.  Nick Clegg was initially quite supportive of David Cameron.  On Friday night the deputy parliamentary leader, Simon Hughes, painted a positive picture to party members at a social event which I was attending.  Mr Clegg has changed his tune today, of course.  Whether that is because of the sceptics’ reaction, or because further details of what actually happened at the summit have emerged (for a flavour of this read the Economist’s Bagehot blog) I cannot say.

But the initial relief at the summit result shown by Mr Hughes has some logic behind it.  A treaty would have required ratification by the UK parliament, and demand for a referendum.  This sort of battle plays to the sceptics’ strengths – strong support by the press and a widespread wariness of extra EU power.  A referendum on a treaty change is the battle the europhiles least want to fight.  The sceptics can deploy a “have your cake and eat it” argument for a no vote – a vote not against the Union as such, but to protest against “Brussels”.  There will be no such battles now.  If there is a referendum it will be about whether we stay in the EU at all.

Instead the sceptics’ position might start to come under the sort of scrutiny that it has hitherto lacked, and be shown to be no more tenable than Napoleon’s hold on Moscow.  The summit has started that exposure process.  The sceptics’ armchair negotiators have said that we can use the British veto to negotiate major concessions, the “repatriation of powers”; but Mr Cameron proved unable to do this.  It has also been said that we were not isolated in the EU, and we could lead a gang of pro-market non-Euro members.  This against has been shown to be a hollow idea, as Germany has greater influence over these potential allies than we do.  Indeed a horrible spectre emerges, that the British blocking tactics make many of the EU’s institutions irrelevant while the other countries set up alternatives over which the British have no say.  The sceptics often complain about Britain shackling its fortunes to a corpse – but the corpse could be the official EU structures, rather than the European project itself…and that would be an outcome entirely of our own making.

And further eurosceptic fantasies will soon be exposed.  Their aim is to set up some sort of free-rider relationship to the Union, where British products enjoy free access without to European markets without our businesses having to comply with those pesky social regulations.  Some think the country can do this within the EU, using opt-outs, others that it can be done outside it, in the European Economic area (like Norway, Iceland and Switzerland).  But this requires the other 26 countries to agree with it.  All of them.  Why should they?

Just as the Eurozone optimists are having their ideas tested to destruction in a gruelling series of financial crises, so the eurosceptics might find themselves on the wrong side of the argument.  In both cases it is clear that the only tolerable escape route involves further European integration, not less.  Perhaps, like Napoleon’s collapse in 1812, it will happen quicker than we think.

The difficult truth about payday loans

The top story on the BBC Today programme this morning was about the expansion of so called “payday loans”, drawing attention to the shockingly high interest rates such loans entail (1,700% APR is typical).  This was hooked onto some research by insolvency group R3, which thereby got massive free publicity (Christmas came early for some PR person); the BBC web story is here.  Even the sober Financial Times runs the headline “‘Legal loan sharks’ target urban poor“.  This coverage makes me very uncomfortable.  Time and again middle-class do-gooders and commentators fail to understand the grim economics of being poor – and their interventions usually make things worse.

What are payday loans?  They are short-term loans (less than a month) for smallish amounts (typically £100s).  The timing and amount is related to typical paydays, hence the name.  Looking at moneysupermarket.com the typical charge is £25 for a one month loan of £100.  They are provided by in a reasonably transparent way by public companies, rather than in the informal economy.

How to think about this?  When providing financial products (similar logic applies to savings savings) it is easiest to think about three components.  The cost of the money; the risk of default; and the labour input.  The first two are well understood by everybody, and are directly proportional to the amount and length of time borrowed or saved, and can be understood as a rate of interest.  The third is usually ignored, because if your are well-off it doesn’t amount to very much in the scheme of things.  Labour input is the cost of actually providing the product (including distribution, admin, computers, and the rest); it is not proportionate to the value of the product, but to its structure, the number of transactions, and so on.  If you are dealing in millions of pounds it is negligible; but if you are borrowing (or saving) the odd £100 it is not.  £25 is a massive rate of interest for a £100 borrowing, but a run of the mill cost of labour input for a single transaction.  If you don’t have much money labour input is highly significant; it destroys your savings and ratchets up the cost of borrowing.

If the loan is genuinely short-term then it doesn’t look unreasonable, in fact.  What are the alternatives?  An unauthorised overdraft at your bank will cost way more than this, since British Banks have lighted on this as a way of cross-subsidising “free” banking.  And forget trying to get an authorised overdraft, which might well come with an arrangement fee, etc.  And it is a much better deal than the real loan sharks in the informal economy.  Credit cards (if you can get one) may be a better deal if you are careful.  In fact you could look at payday loans as welcome competition in the lending market.

Much of the criticism of this type of product centres on people who use this type of finance for longer term needs, rolling over each month.  This is a very bad idea and leads to even worse hardship, but is really right to ban this sort of product on the basis that it can be misused?  Cars kill hundreds (even thousands) of people each year, but this doesn’t mean we stop the public from driving them.  Much of the criticism is unbearably patronising.

There are two things we must learn from this.  First is that finance for the poor is more about transaction costs than interest rates and rates of return.  Longer term borrowing can be extortionately expensive; savings, including most pension plans, deliver much lower returns than those for better off people.  It’s part of the poverty trap that is not widely recognised.  And it’s one of the reasons why the welfare state is so important in developed societies.

And the second thing is that it is vital for everybody, and especially those on lower incomes, to understand finance much better.  School teaching on “financial capability” is essential.  Everybody needs to be numerate.

But well-meaning regulation, such as that which has pursued payday lenders in the United States, is a likely to make matters worse.  You can’t legislate away the laws of physics.

George Osborne, Ed Balls and the confidence fairy

Paul Krugman, the economics Nobel laureate and New York Times columnist, likes to talk of the “confidence fairy”.  It is a critique of right-wing “supply side” economists, who advocate cutting back on taxes and public expenditure and reducing government regulation.  These counter the criticism that such policies suck demand out of the economy and cause unemployment with the idea that confidence in the soundness of the government’s policies would boost business investment and consumption, and so create jobs.  But such beliefs have no more substance that a belief in fairies.

Mr Krugman believes in solid government management of aggregate demand of a type that is often called “Keynesianism”.  He was bitterly critical of the Obama government for not trying to enact a much bigger stimulus programme in 2008, at a time when the usual criticism was that he was spending to much.  These same arguments are emerging in the UK between the Chancellor of the Exchequer George Osborne and his Labour Shadow Ed Balls.

To be fair, Mr Osborne and his supporters, especially the Lib Dem ones, never made much use of the confidence fairy in the sense that Professor Krugman uses it.  The confidence they that they had in mind in supporting austerity was that of investors in government bonds, and the scary consequences of losing it.  But ultimately Mr Osborne does believe that business and consumer confidence will provide the economic growth and employment he seeks.  But what fewer people understand is that the policies advocated by Mr Balls and Professor Krugman require the confidence fairy too.

Let us consider the logic of the “Keynesian” stimulus.  Cut VAT as Mr Balls suggests and put this money in consumers’ pockets, who go out and spend it, creating jobs, which create further demand.  The Keynesian multiplier (no need for quotation marks here) does its stuff and £10bn of government stimulus might increase total demand in the economy by perhaps £20bn in a year.  But then what?  The extra demand has helped offset the cost (so the £10bn direct cost has been reduced to perhaps £6bn), but the national debt has still gone up.  But growth drops back to zero (or worse) unless there is yet another stimulus package of yet more tax cuts or government spending programmes.  To the extent that these measures are temporary (such as the temporary tax cuts advocated by Mr Balls, or the job programmes and extensions to unemployment benefit favoured by Professor Krugman) then the whole process goes into reverse, multiplier and all.  And if the programmes aren’t temporary, the government structural deficit has just got a lot bigger.  Unless the confidence fairy waves her magic wand.

And it is this boost in confidence that lies behind the case for government stimulus.  It is reinforced by the metaphors used to describe it, such as “kick-start”, “getting the economy moving” or the word “stimulus” itself.  A catalyst that improves confidence and hence gets businesses to invest and consumers spending more and saving less.  And the results would indeed be magical.  By spending and borrowing more you would reduce borrowings in the medium term by more than a strategy based on austerity.  But without the fairy it works no more than the supply-side policies do.  The problem is deferred and made worse, not solved.

So can such a stimulus boost confidence?  In the right circumstances it certainly could, such as those induced by a temporary external shock, perhaps literally as in an earthquake (one of the reasons why earthquakes seem to do such little damage to an advanced economy).  And here there is a genuine divergence of view.  Mr Balls, who perfectly literate economically, does not believe that the British economy pre crisis was fundamentally unsustainable, and so thinks that it should be relatively easy to recover the lost ground.  In economist-speak the British economy has plenty of spare capacity.  A number of professional economists, including the FT’s Samuel Brittan, one of my heroes, seem to agree.  But government economists and many others, apparently including the independent Office for Budget Responsibility, disagree.  The previous economy was over dependent on debt spending by consumers and government and cheap imports, sustained by an overvalued exchange rate and financial support from abroad that can no longer be counted on.  Mr Brittan thinks that the lower capacity of the economy is a self-fulfilling prophesy (i.e the longer the economy is depressed, the more difficult the recovery), but personally I think that the 2007 economy was in a very bad place, and was always going to take a long time to sort out.

But even if you don’t accept this, there is another problem.  The extra confidence induced by a stimulus package can be overwhelmed by outside events, such as the Euro crisis.  The UK economy, much more than the US one, is dependent on the world economy and is open to such shocks.  Right now looks the wrong time to bet on a calm world economy.

The Euro end game

It’s been a tough year for Europhiles, especially those, like me, who have always supported the single currency and thought Britain should have been part of it.  Most of them have been very quiet, and no wonder.  Whatever one says quickly has the feel of being out of touch and in denial.  And now this week the Economist asks in a leading article  Is this really the end? that has been tweeted over 1,200 times and picked up over 500 comments.  In today’s FT Wolfgang Munchau article is headlined: The Eurozone really has only days to avoid collapse (paywall).  Is now the moment to finally let go, and admit that the whole ill-fated enterprise is doomed?

There is no doubting the seriousness of the current crisis.  While most of the headlines have been about sovereign debt (especially Italy’s) what is actually threatening collapse is the banking system.  It seems to be imploding in a manner reminiscent of those awful days of 2007 and 2008.  The Germans’ strategy of managing the crisis on the basis of “just enough, just in time” seems to be heading for its inevitable denouement.  Unless some of their Noes turn to Yeses soon there could be a terrible unravelling.

The most urgent issue is to allow the European Central Bank (ECB) to open the floodgates to support both banks and governments suffering a liquidity crisis.  “Printing money” as this process is often referred to, seems the least bad way to buy time.  Two other critical elements, both mentioned by Mr Munchau, are the development of “Eurobonds” – government borrowing subject to joint guarantee by the member states – and fiscal integration – a proper Euro level Finance Ministry with real powers to shape governments’ fiscal policy in the zone.  Most commentators seem to be convinced that some sort of steps in both these directions will be necessary to save the Euro.

I have a lingering scepticism about these last two.  I thought that the original idea of allowing governments to default, and so allowing the bond markets to act as discipline, had merit.  The problem was that the ECB and other leaders never really tried it before the crisis, allowing investors to think that all Euro government debt was secure.

Still the short term crisis is plainly soluble, and most people will bet that the Germans will give the ECB enough room to avert collapse.  But that leaves the zone with a big medium term problem, and two long term ones.  The medium term one is what to do about the southern members whose economies are struggling: Spain, Portugal and Greece especially, with Italy lurching in that direction.  The stock answer, which is to enact is reforms such that their economies become more competitive, seems to involve such a degree of dislocation that we must ask if it is sustainable.  This treatment is not dissimilar to that meted out by Mrs Thatcher to Britain in the 1980s (an uncompetitive currency was part of the policy mix here, deliberately or not), for which she is still widely loathed.  And she was elected (though “democratically” is a stretch given Britain’s electoral system).  How will people react to unelected outsiders imposing such treatment?  Better than Britons would, no doubt, since there is so little confidence in home grown politicians , but it’s still asking a lot.

And that leads to one of the two long-term problems: the democratic deficit.   A lot of sovereignty is about to be shifted to central institutions, and it won’t be possible to give electors much say.  The second long term issue is dealing with the root cause of the crisis in the first place, which is how to deal with imbalances of trade that develop within the Euro economy.  Germany simply cannot have a constant trade surplus with the rest of the zone without this kind of mess occurring at regular intervals.  But there is no sense that German politicians, still less their public, have the faintest grasp of this.  For them the crisis is the fault of weak and profligate governments elsewhere.

So if the Euro survives the current crisis, there is every prospect of another one down the road, either political (one or more countries wanting to leave the Euro and/or the Union) or financial (say an outbreak of inflation).

My hope earlier in the crisis was that it was part of a learning curve for the Euro governments.  As they experienced the crisis institutions would be changed and expectations made more realistic, such that zone could get back to something like its original vision.  I am afraid that there is a lot more learning to do.

The equality problem

A nasty problem stalks those who think about public policy, especially here in Britain, and in the US.  It goes under the general name of “inequality” and is mainly about the growing disparity between the very rich and everybody else.  There is a lot of anger (think of the Occupy protests) and shaking of heads, little convincing analysis and and even less in the way of convincing policy ideas.  It’s worth everybody taking a few steps back and asking themselves what is going on.

Of course the debate about the justice of inequality is as old as political philosophy. But two new factors have changed the whole nature of the debate.  The first is that the people in the middle of the wealth distribution are getting left behind.  Depending on the stats and country the median family’s wealth is hardly growing at all, or stagnating, even as the economy as a whole grows (well, until 2007 anyway).  So long as the median family is doing nicely the political heat can be contained – people can ask whether the problem really matters.  But these stats make it appear that the country is being run for the benefit of a tiny elite – which makes it politically much more awkward.

The second new fact is that mobility between different levels of wealth appears to be declining.  If you start life wealthy, you are increasingly likely to stay that way, and if not, you are less likely to break the barrier into a wealthier world.  The traditional divide between those who are concerned about equality of opportunity and those who worry about equality of outcome is becoming a lot less significant.  Both lots are angry.

There remains much to debate about how bad for us all this growing inequality really is.  But you don’t have to be an equality extremist (like, or so I’m told, the authors of the popular book, the Spirit Level, which I’m afraid I haven’t read) to be worried about all this.  The political consent upon which our democratic society is founded is being undermined – and indeed the extreme polarisation of US politics is perhaps one aspect of this.

Why is this happening?  For all the quantities of research poured in to economics and the social sciences, there is rather little that is known.  Economists don’t like thinking about the distribution of wealth as opposed to those comfortable aggregates that conceal so much.  Mathematically it is an entirely different type of problem to the ones they are used to dealing with.  I have seen one valiant attempt to grapple with the maths, under concept of “wealth condensation“, which did a good job of modelling the sort of power distributions so characteristic of wealth patterns, but this was not by an economist.  Professional economists preserve their elite status through the gratuitous use of advanced mathematics; no doubt they feel very uncomfortable in dealing with problems that require sorts of maths they aren’t good at, or even no maths at all (e.g. through the use mass agent computer modelling).  What we get is some rather airy stuff about the impact of technological change and immigration, with the former usually being fingered as the more important baneful influence.

One fact is quite well understood, though, which is the winner takes all effect of mass communications.  Thus entertainment stars tend to win big or not at all – and similar can be said of sports stars.  The mass market seems to concentrate its attention on a small world elite, ignoring anybody that hasn’t quite made it.  This, of course, will increase inequality.  But it is a retail phenomenon which ill explains why bankers and big corporate execs do so well.

Because we so ill understand it, it is unsurprising that our solutions seem so inadequate.  In Monday’s FT the prominent American economist and policy person Larry Summers (paywall), after moaning about the problem, was pretty lame about what to do next.  He suggested looking at three things: challenging the privileged status of the well off (especially the effects of the massive lobbying power of big corporations), a bit of tax reform (which is as much about not making things worse by rolling back estate taxes, etc) and state intervention to even things up, especially through education funding.  All worthy, but it is difficult to think that it would have anything more than a marginal effect.  The anti-capitalists aren’t any more convincing, of course.  It’s the baby and bathwater problem.

Politically there seem to be two distinct poles of argument.  The right wing idea is that it is the excesses of the state that is holding back the middle, and if we taxed and regulated more lightly an entrepreneurial boom would help the middle catch up with the top.  I have to admit I haven’t seen this line of argument clearly articulated anywhere, but some such logic must lie behind the popularity of the American Tea Party, whose appeal goes well beyond the elite.  On the left people seem to think the answer is in a bigger state, which intervenes to help the less well off, cracks down on excessive wealth, and drags pay up by creating masses of comfortable public sector jobs.  A bit like Sweden before its economy collapsed in the 1980s.  Neither course looks very encouraging to a liberal.

So what to think?  I am not really any further forward than Mr Summers.  But it would help if we better understood why so many in our society are being left behind.  I shall return to the topic

Does the Euro need a Big Bazooka?

It is a commonplace amongst Anglo-Saxon policy makers that the Eurozone leaders need to use a “big bazooka” to solve the currency crisis that is engulfing the continent.  David Cameron has been particularly conspicuous in using this expression.  Is it all it is cracked up to be?

So what is a bazooka?  Originally it was a tubular musical instrument made famous by the comedian Bob Burns in the 1930s (Mr Burns and instrument in second picture).  It then became the colloquial name for an American tubular hand-held antitank weapon introduced in the Second World War (the illustration above is in fact of a more modern and shorter weapon).  This was a revolutionary innovation, using recoilless technology and the so-called HEAT armour-penetration system – which allowed infantry to threaten tanks in a way not previously possible.  The Germans quickly copied it with the bigger and better panzerschrek (“tank terror”).  They also developed countermeasures, including thin armoured outer skirts to their tanks, which set off the HEAT system before it could inflict serious damage.  In the 1960s the weapon became obsolete, replaced by more powerful technologies.

A “big bazooka” in the current context is used to mean the deployment by the state (central banks and/or governments) of overwhelming financial resources to bail out troubled banks and others in a financial crisis.  The idea is to break a vicious cycle of declining confidence in banks and others, whereby lack of confidence becomes a self-fulfilling prophecy as creditors seek to move their money into safer places.   The mere proposition of such resources can be enough to break the cycle, if credible, and prevent the resources ever having to be deployed.  The Americans can proudly point out to the use of the technique to solve a series of financial crises, from the Savings & Loan crisis of the 1980s, to the LTCM collapse of the 1990s and the Lehman crisis of 2008. Such tactics are conspicuous by their absence in the Euro crisis, fiercely resisted by the German political class in striking unanimity.

There is an irony that the original bazooka was quite a small weapon – but I suppose it was big for one held by a single infantryman, and the German version conveys all the imagery the metaphor needs.  A more telling parallel is that the bazooka, revolutionary when introduced, steadily became obsolete as the world got used to it.  No doubt the Germans will point out that the American use of “big bazooka” tactics on repeated occasions shows that there is a flaw.  The American financial system suffers a systemic crisis every 10 years or so.  This is the first such crisis the Germans have endured since their currency was refounded after the war – and that is because the Germans aren’t running the show.

The have a point.  The financial markets are amazingly short-sighted – for example that idea that the US and UK are safe havens because their central banks can overcome any crisis by “printing money”, or monetising debt, in the manner of Zimbabwe.  But the long term logic always wins in the end.  There seems to be a slowly dawning realisation amongst Anglo-Saxon commentators (for example last week’s Martin Wolf column, as well as the Economist) that the German position in all this amounts to a strategy, “just enough, just in time”, and not the absence of one – even if Mr Wolf grumpily calls it “too little, too late”.  The short-term costs of the German strategy are doubtless higher than the American way – but the longer term position is much less clear.

 

Markets aren’t people – BBC’s Peston is taking anthropomorphism too far

Yesterday there were some rather worrying developments in the market for Euro area bonds, affecting even French and Dutch government stock.  This caught the journalists on BBC Radio 4 off guard, including the famed Robert Peston.  They quickly fell into the lazy habit of describing the markets as if they were thinking and breathing people, albeit in a plural form, like “Bond markets looked on the Italian government’s plans sceptically and yields rose over 7%”.  This formula is usually used to link the movements in market prices to some new information or news event, regardless of whether any such link is actually significant.  The idea of this mythical person or people breathing down the the necks of governments is clearly an attractive way to communicate a point.  The trouble this morning was that there was no such easy link to make…which led at least one commentator to go a bit apocalyptic, that “the markets” had lost faith in the Euro completely and were expecting it to break up.  This was more or less where Mr Peston ended up.

I have always hated this anthropomorphism of markets, which is by no means confined to journalists – market participants clearly enjoy the false sense of power it gives them.  But markets are not people, they are mechanism by which buy and sell orders (in this case for securities) are resolved by striking a mutually acceptable price, often by computers these days.  When nobody is buying or selling much, and market makers have to quote prices, then indeed human sentiment plays a major part in price movements.  The market makers are usually part of a small and social group where collective sentiment can develop and they don’t mind telling outsiders.  Journalists can find out what these sentiments are by talking to a couple of people.  In this case the anthropomorphism does bear some resemblance to reality.

But as soon as the real money enters the market, then all this sentiment is mere chatter. And it often takes a bit of time for the real reasons for market price movements to emerge.  People have to guess, and journalists usually go no further than to tap into the chatter.  What moves the money?  There are whole variety of things, many which economists would not recognise as rational – like a fund manager simply dumping shares to avoid an awkward situation with a client.  Or, sometimes it can be plain errors.  Then, of course, with so much automated trading it can simply be the unforeseen interaction of computer algorithms- as happened in the notorious “flash crash” in May 2010.

So what happened yesterday?  I don’t know, of course.   But the best explanation came to me via the Economist’s Buttonwood column, itself quoting one Michael Derks at a company called fxpro.  In essence the Euro zone recapitalision of banks is having some malign effects.  The idea was that banks should reserve more capital against their assets, so that they are better able to withstand losses.  Reasonable enough (and vital to bring incentives at banks back into the real world, in my view), but banks can comply by dumping assets instead of increasing capital.  That is what many banks are doing, and they are choosing relatively liquid government bonds to dump – including those of the French and Netherlands governments, as well as the usual suspects of Italy and Spain.  It is a battle to prevent bank ownership being diluted, not a considered opinion on the future of the Euro.

Mr Peston should have known better, and helped his listeners try to understand what was going on, instead simply plugging this lazy and narcissistic drivel  Shame on him!