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Economics After the Crash

After the director of research at the London School of Economics explained to Queen Elizabeth the origins of the 2007/08 credit crunch she asked “..why did nobody notice?” A simple question, but one which challenges not just failures of individuals but systemic failures of the science of economics. There have long been jokes about the uncertainty of economics but the failure of the profession to provide any indication of the scale of the problem that hit the US and then the rest of the world in 2007/08 challenged the very foundations of the subject.

Since then there has been a lot of rethinking and indeed some identification of trends which preceded the crisis that suggest a new “normal economics” which may render standard fiscal and monetary responses to recessions inadequate. Close to the heart of the crisis was Lawrence Summers,  as Director of the Economic Council for President Obama he shaped much of the policy response to the Great Recession. In late 2013 he reintroduced the concept of “secular stagnation”  originally coined in 1939 by Alvin Hansen in his address to the American Economics Association. Hansen’s argument was that certain factors (the lack of technological innovation and population growth) had created a context where low rates of growth would be the norm going forward.

Whilst a war and the reconstruction of Europe proved Hansen wrong there is real concern similar issues are now in play and set to create a new low growth norm. The issues around secular stagnation have been explored in a series of essays brought together in “Secular Stagnation: Facts Causes and Cures”. Whilst there is a variety of positions taken this collection of essays does contain some consistent themes.

Aggregate demand is seen as weak and with interest rates at the zero lower bound there is not much scope for monetary policy to stimulate investment. Demography with population growth slowing and life expectancy increasing the dependency ratio is set to increase across the world. In other words the number of those being kept by those who are working is set to increase.  High levels of public debt support austerian policy positions limiting the scope for debt funded public investment. Limited potential for technological innovations that are truly generically transformative like the steam engine and electricity.

Clearly each of these is subject to debate and argument. An additional one is the issue of inequality. This is seen as having been on a dual path. Internationally, levels of inequality have been declining as developing nations, notably China and India have integrated into the global economy. Intra-nationally, however, inequality has been increasing across the world. Wealth and income has become ever more concentrated in the hands of the 1% indeed even more so in the hands of the 0.1%.

It is not moral concerns of fairness that are the principle issues under discussion. Consumer capitalism needs consumers. If wealth is too concentrated then effective demand in the economy may be undermined. Added to this economic concern is one about the extent to which a modern democratic society can operate effectively if wealth starts to dominate the body politic. Stresses may start to build which the political process does not seem to be able to deal with, leading to dissatisfaction, cynicism and ultimately disengagement.  Democracy may not be the best system of government but it is the best system to avoid getting the worst system of government.

Economics as a subject is in as much a turmoil as the phenomena it studies. There are many who think the global financial system created over the past 30 years is inherently unstable. If this is the case there is much to fear in the future as it is this system which animates an underlying economy which itself now appears to have a series of structural challenges to overcome. One ray of hope is a renewed interest in the notion of political economy. A view point which does not think The Economy is “a thing”subject to laws of rational agent utility maximisation. Rather it is a space which is rational and irrational to shifting degrees. Where different groups contest for power and advantage and where  today’s orthodoxy can quickly become yesterday’s prejudice. Perhaps most important of all it is an area susceptible to rational policy interventions. It is not and should not be ruled by the TINA theory because there are alternatives.

“Secular Stagnation: Facts Causes and Cures” is an excellent review of key current issues in economics. It is available on line at:  http://www.voxeu.org/content/secular-stagnation-facts-causes-and-cures

 

 

 

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Constitutional Deckchairs

The votes are in and Scotland has given a clear answer, however, given some last minute offers of the unionist parties, it is not quite clear what the question was. The ballot paper could not have been clearer – Should Scotland be an independent country? However, following polls indicating that the Yes and No campaigns were coming together that very simple question morphed into something along the lines of do you want independence or an increased level of devolution yet to be fully specified (terms and conditions apply…).

There is consensus amongst the main parties that the whole constitutional settlement for the UK has been thrown into the melting pot. If Scotland is getting Devo Max then the position of Wales, Northern Ireland, and most challenging of all England needs to be looked at.

Whilst the debate in the media and amongst politicians of all parties is about structural reform it is possible that this is profoundly misplaced.

Is it likely that the Scottish people voted for a a different structure for making political decisions? Or is it more likely that they voted for some different decisions?

In common with the rest of the UK and indeed most of the advanced economies in the world the living standards of the bulk of the population in Scotland have at best stagnated. Furthermore that process long predates the Great Recession. For some thirty years the share of GDP going to “hard pressed working people” has been going down.

Since the credit crunch the process has accelerated as the public benefits of the welfare state have been cut hitting hardest many of the most vulnerable in society. Interestingly the Yes vote in Scotland appears to have been strongest amongst those on low incomes. But for those in work the position has deteriorated also, Low pay, zero hour contracts, underemployment characterise the economy for many.

Going forward the prospect of secular stagnation is worrying many economists with the links between technological innovation, growth and rising living standards breaking down. When growth leads to rising living standards for all then inequality might be a moral concern but not a political issue. If growth stops, or it’s link to rising living standards is broken then inequality becomes “the” problem.

If constitutional reform leads to a different set of institutions and actors saying we have to “do more with less”, “live within our means”, “make difficult choices” then I suspect we are going to spend a whole lot of time, energy and money to get to where we started. A population becoming more and more alienated from the orthodox politics of austerity.

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It’s NOT the economy stupid.

In the run up to the 1992 US election Bill Clinton’s campaign strategist James Carville coined the phrase “It’s the economy stupid” as an aide memoir for campaign staff. It is credited by some with playing a significant part in Clinton’s election. At the time such a brief shorthand probably had a great deal of relevance. There is however a question about its potential to drive voters in the next UK election.

Back in 1992 it was probably possible to look back and see a clear and positive link between economic progress as measured by GDP and increasing standards of living. In truth even then it may be argued that these things were beginning to diverge however the picture was not clear.

Since then two broad changes have taken place which challenge the previous linkages. Firstly, there are all kinds of issues about the extent to which GDP is an effective measure of economic activity. In a “weightless” economy more and more economic activities are missed by the standard definitions of GDP which were created in a very different time.

Further, as David Cameron has pointed out there are issues about “happiness” and technological evolution that are simply not considered by GDP but which are of increasing interest to policy makers.

Minor definitional changes can change significantly the picture of the economy that GDP produces. The recent changes demanded by the EU including income from prostitution and drugs were estimated to add £10bn to the UKs’ GDP in 2009 (I would love to see the tax returns claiming these expenses!). Such changes could transform what was previously seen as a period of negative growth as positive with all the political consequences that flow from this. No wonder predicting the future is difficult when the past doesn’t keep still!

The other major change is that the link between economic growth and general increase in well being and wealth appears to have been broken. Over the past thirty years median incomes have made little progress indeed in the US have declined in real terms.

The Great Recession has accelerated a. Process whereby the plight of the vast majority of those in work has got significantly worse as their pay has been held at below inflation levels, part time working and under-occupation have increased, zero hour contracts have become endemic in some industries notably retail and hospitality, and a whole generation of graduates are languishing in jobs that make no use of the expensive education they have no chance of being able to pay for.

It is because of this there was little rejoicing in the general population when growth returned to the economy. The Chancellors’ claim that fiscal austerity was working (wrong for so many reasons) sounded a bit like the claims of the surgeon that the operation was a great success it was just a shame the patient had died!

Increasingly people are asking who economic growth is for? As the economy gets better will our living standards improve? At the same time they see some for whom 6 years of public austerity have seen massive increases in private wealth.

There is a lot of history going on at the moment. Western politics in the US, UK and Europe are experiencing a general malaise with a worrying level of cynicism growing about what are called the political elite. The Tea Party, UKIP, the Scottish referendum, a host of ultra right and left wing parties across Europe are symptoms of deeper issues which have their roots in a decline in the living standards of people and little belief that they will change when the economy recovers. This is a toxic mix.

If politicians continue to the old picture of the economy they are set to fail and add to the sense of their being out of touch. They need to address wider issues about the distribution of wealth which present some of the real “difficult choices” that the Prime Minister and the Chancellor so often talk about.

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What is good about the UKIP results?

For the main UK political parties the 2014 UKIP local election results are a challenge which they are unsure how to deal with. Do they cast UKIP as racist and risk being attacked as out of touch with the problems of ordinary people. Or do they attempt to recognise the valid concerns UKIP is thought to have identified? When asked about UKIP politicians from all the main parties choose their words with the same level of lawyerly care that Bill Clinton did when asked about his relationship with Monica Lewinksy. They also look about as comfortable as he did.

Crudely one might ask whether UKIP has tapped into a rich vein of base racism which they transform into a respectable concern about the strain on public services and dilution of British culture? Clearly they do seem to have found a mother load of electoral support however I believe it is more profoundly driven than a concern with too much immigration. I fear there is a much deeper malaise in British society, one which is connected to global as well as national trends where fears about immigration are symptoms not causes. Trends which are making life more and more uncertain for millions of people.

For something  over thirty years now there has been a process of growing inequality in the UK. Thomas Piketty’s recent book charts what he sees as a global process concentrating wealth and income in the hands of fewer and fewer individuals. This has largely been at the expense of the middle classes whose living standards have at best stagnated over this period of time.

One of the processes which is seen to have contributed to this concentration is the development of the “winner take all” model in more and more areas of life, and the growth of the “super managers” particularly in the financial sectors of the economy. In  the 1970’s the top 1% of earners captured 10% of national income in the US, now their take is around a third.

It is, of course, this highly paid cadre of super intelligent financiers who developed the sophisticated financial instruments which were intended to diversify away risks on securitised loans. Collateralised Debt Obligations, Credit Default Swaps and such like. For those of us that did woodwork the clue was in the names of these instruments – “debt” and “default”. At bottom if you lend money to people who cannot afford to pay it back the wheels are going to come off however complicated the financial alchemy is you build upon that foundation.

When the wheels did come off in 2007/08 the groups who had to pay the price were the taxpayers, by that I mean the PAYE tax payers and more specifically the ones without an army of lawyers and accountants between them and the inland revenue. Western economies were brought to their knees, hundreds of billions of pounds had to be provided to bail out financial institutions and the term austerity was elevated to a policy reigning back the welfare state that had done so much to improve equality over the 20th century. Contrition amongst those who were most responsible was thin, accountability virtually non existent. No sooner had the crisis been stemmed than bankers were telling us that we needed to “move on”. “Moving on” meant getting back to annual bonuses equivalent to the lifetime earning of those on the average wage.

Even as it became clear that the people who had created these financial weapons of mass destruction had failed to consider the “black swan” risks that might be associated with them, and those that had allowed them to be applied at scale had very little understanding of what they were or how they worked, the level of public outrage appeared strangely muted.

Since the credit crunch scandal after scandal has come to light as we discover that LIBOR, Forex and Gold markets were rigged. Unnecessary insurance products sold to millions of people, sophisticated interest rate swaps sold to businesses which were then driven into liquidation by the rising costs of the products and in some instances, it is claimed, bought at distressed values by the very banks that sold them the swaps. Banks were even found to be laundering the money of drug barons!

Even after all this the impetus for re-regulation of the banks is being undermined by arguments about the need to protect one of our most important industries, we must not kill the golden goose. Beggar-my-neighbour tax reductions for corporations and those on ultra high salaries we are told will reward talent, inspire innovation and attract jobs to the UK. Whilst it is rarely challenged in the popular press it should not be assumed that the population miss the fact that whilst rich people need more money to be motivated poor people need less. And it is strange that lower taxes should inspire companies to come to Britain when they arrange their affairs so that they don’t even pay them.

One might think that the public are suffering from shock fatigue. You worry that if financial analysts were found to be discerning the trends in the markets from the entrails of freshly sacrificed babies it would generate no more than a weary shake of the head. The stoicism with which the cuts to the welfare state have been accepted must have surprised even George Osbourne. The limited challenge that has been mounted to date should not, however, be seen as acceptance. These issues are moving the tectonic plates of public opinion. On the surface little may appear to be happening but deeper there are strains building which will at some point be released.

Ukip have created a fault line. They speak to the pain that the population are experiencing now and the deep unease that they feels about the future. For the elderly it is the fact that their savings are being eroded by effectively negative real interest rates, for the middle aged the date they can retire is receding, for those who work in the public sector redundancy looms, for those in the private sector their terms and conditions worsening with zero hour contracts,  all are finding their incomes declining in real terms, and young people if they can get a job certainly cannot get a house in large parts of the country.

To change my metaphor, there is a lot of tinder lying around and Ukip are providing a spark. Furthermore I think the major parties should not assume that the first past the post voting system for the 2015 general election will douse the Ukip torch. People are hurting and want out and Ukip seem to be offering them a route. Ironically they are tapping in to precisely what Nick Clegg tapped into 4 years ago.

This is not just an issue in the UK. It might seem strange to put UKIP, Occupy Wall Street, the Tea Party, and sundry proto fascist and extreme left groups on the continent together but they are all expressions of growing frustration with the way the economy is being shaped and the social and political consequences of this. The catalyst may be immigration but as I have argued the causes are far more pervasive and deeply rooted. Unless these are addressed closing our borders will provide a temporary and unedifying distraction. To be clear Ukip does not have the answer indeed they are not even addressing the right question.

Technology and globalisation are setting life defining challenges for us. Some argue that these are forces which it is pointless, indeed counterproductive, to try to shape. They accept they can often cause “dislocation” but go on to argue that the evidence from the industrial revolution and the developing economies is that eventually everyone is better off. Unfortunately, there are increasing signs that innovation is not always tied to productivity increases nor grow to the increase in new quality jobs.

One example,  I accept crude, of the future we may face is provided by Citigroup. They have advised clients to structure their investment portfolios around the growing consumer power of the super rich. They think “…the world is dividing into two blocks – the Plutonomy and the rest.” They see the economy as an hourglass with a smaller and smaller number of super rich consumers of luxury items,  (yachts and jets) at the top. And for a the rest…? The future is Poundland.

This picture of the future is not good for anyone. What we lack are politicians that have the nerve to articulate a different vision. One which challenges some very powerful vested interests and indeed at times contradicts some of the bar room certainties of public opinion. To be clear, I believe, a future which needs to remain committed to a free market system with private property rights and inequality of rewards. However, inequality within bounds that are rationally debated. The clock is ticking for a considered and structured response to these issues the alternatives are in no ones interest.

Back to where I started, what on earth can be said in favour of people voting for Ukip?  Grasping a positive from this it shows that, despite regulations and laws being made which seem to be tailored in the interests of the minority, despite the obscene salary levels being paid to an industry that nearly destroyed the western economy, despite the frailties and venality of some of todays politicians some people still have faith in democracy.  From what I have said it will be clear that I think the faith in Ukip is totally misplaced however the recourse to democracy when you are hurting is something we must strive to support.