Friday, 31 July 2015

Corbyn's popularity and relativistic politics

This is just a short gripe about some of the commentary around the Labour leadership contest. So many who write about this express their puzzlement about how someone from the left of the party can suddenly appear to be so popular. This can only mean, they suggest, that the Labour party membership must have moved to the left. (For example this, from the FTs Jim Pickard.)

This mistake reflects something that Paul Krugman has remarked upon in the US: the tendency of commentators to define the centre as simply today’s mid-point between the two main parties. So as Labour moves towards the Conservatives, according to this way of looking at it the centre also moves to the right.

Now if that is how you want to define the centre, so be it. Such is relativistic view is very post-modern, I guess. But when that idea is then used to say that Labour party members must have moved to the left, its limitations become self-evident. In reality all that might be going on is that the views of Labour party members have not moved at all, but they have become left behind as Labour MPs and other prospective leaders have moved to the right. I think we have clear evidence that this is more likely to be what is happening. [1]

The most obvious example is the welfare bill, and Labour’s shameful decision to abstain on this. But another that is close to my heart is austerity. Talk to some, and being anti-austerity has become synonymous with being well to the left. Of course in reality it is just textbook macroeconomics, but if we stick to measuring everything on a left right axis, then remember that it was only as far back as 2009 that the need for fiscal stimulus rather than deficit reduction was the position advocated by a centre/left Labour party in the UK, and the Democrats in the US. It cannot be surprising, therefore, that among a relatively well informed electorate that is the Labour party membership an anti-austerity position is still seen as a sensible policy. With an extreme relativistic view you could say that by sticking to this position these people have moved to the left, but please don’t appear surprised that this has happened.

[1] It is equally fallacious to think that those who vote for Corbyn agree with every one of his policies. Some of his popularity may be a form of protest not just at the policies of his competitors, but also their style: see the clip in the middle of this typically amusing article by Mark Steel.

Thursday, 30 July 2015

The wheels on the bus

I have an image in my mind. Its a bus running downhill, and its brakes have failed. There are four men in the front cab. The two men in the middle are both trying to control the steering wheel to keep the bus on the road. The man to their right has control of the accelerator, and is pushing on the gas hoping this will crash the bus to the right. The fourth man to their left controls nothing, but as his pleas to stop pressing the accelerator fall on deaf ears, he begins to wonder whether it would be better for the passengers to grab the wheel and crash the bus to the left. The three other drivers do not agree on very much, except that it is all the fault of the guy on the left, and now appear to be thinking about throwing him off. As the bus hurtles downhill swerving from side to side, its passengers are battered, some injured, and a few are jumping off.

I do not need to explain the symbolism. I tried to change the image to explain why the man on the right refuses to stop pressing on the accelerator of growing primary surpluses, but gave up because the real reason is that he wants to crash the bus anyway. (The argument that the Eurozone’s rules do not allow debt write-offs is just nonsense.) Otherwise I think the image works well. The two men in the centre represent Tsipras and maybe Hollande. Hollande is saying that if only you would let me have the wheel (‘structural reform’) all would be well, but in truth the main reason the passengers are being injured (unemployment and welfare cuts) or are jumping (migration) is the speed of the bus.

The central question is whether the men in the middle are delusional. By keeping the Greek economy on the road that is the Eurozone are they only going to prolong the agony with the same inevitable crash which is Grexit?

There is only one reason for optimism that I can see, although it assumes yet further reductions in Greek living standards. The hill the bus is travelling along will begin to flatten out and the road might even start to rise as Greece becomes more competitive in terms of price. I outlined here why that has not yet boosted the Greek economy to the extent it has in Ireland, but if unemployment remains at or above 25% Greece should get even more competitive. Instability and unwise Troika interventions may delay the process, but eventually the tourists will come. The Eurozone does contain a natural correction mechanism: it is just slow and painful.

If this does eventually lead to sustained growth in Greece, it does not excuse what has gone before: recoveries do not justify recessions, and government profligacy does not have to imply a 25% fall in GDP! However this correction mechanism is not bound to succeed, if it is countered by another dynamic, which is one that has been and continues to be imposed by the Troika. That dynamic is austerity chasing primary surpluses when that austerity makes the economy shrink. Macromodels would probably tell us which dynamic will win out, but they will not factor in a deterioration in the financial position of banks (already not good as Frances Coppola points out) as the economy stagnates, and the deteriorating social and political situation that austerity brings.

So the eventual outcome still depends on the decisions of the Troika. It always has of course. The truth that their apologists find so uncomfortable is that the Troika has been in charge of the economy since 2010, and therefore is responsible for the mess we are now in. The idea that all would be well if only Greece had undertaken every item of structural reform they specified (and a lot was done) is just silly. Now it appears as if it is all the fault of the former Greek finance minister, because he dressed funny, or kept wanting to talk about economics, or did some contingency planning - it is so absurd you couldn’t make it up.

One ray of hope offered by Anatole Kaletsky is that now “ritual humiliation” has been achieved, the Troika will be more forgiving. I wish he was right, but this argument fails to account for the German finance minister who clearly believes that exit is the best option. He wants the bus to crash for the sake of the other cars on the road. An optimistic view would be that the shock [1] of what was done to Greece a few weeks ago will bring others to their senses, and Schäuble’s influence on the Eurogroup (and strangely the IMF) will decrease. I fear the larger truth is that the non-German bloc in the Eurozone does not have an alternative economic vision to offer (although it clearly exists), and will never face Germany down.

[1] Link added 31/07

Tuesday, 28 July 2015

An optimistic view: a UK investment led recovery

Someone wrote to me the other day to complain that my posts were always negative in tone. I understand where they were coming from, as there is a lot going on here in Europe to be negative about. However just to show that I can do positive, here is how the next few years could be relatively cheerful ones for the UK economy.

The important point about today’s GDP figures, showing 0.7% quarter on previous quarter growth (not annualised), is that this has happened despite what looks like being a relatively poor quarter for employment. The combination means that UK labour productivity growth may have finally resumed after its six year pause. This while nominal wage growth shows clear signs of increasing.

What we could be seeing is an investment led UK recovery. It all goes back to my favourite explanation for the UK’s productivity puzzle: that after the recession, high unemployment (both in the UK and Eurozone) pushed down UK wages, which led firms to put investment that would have led to labour productivity growth on ice, and just employ more people instead. (There may also have been direct labour for capital substitution of the kind beloved by macroeconomists.) With reasonable growth in demand this generated rapid employment growth, cutting the unemployment that helped cause stalling productivity.

It was my favourite productivity puzzle story, not because I was sure it was right, but because it was optimistic. It was optimistic because, as unemployment fell and labour shortages began to become common, the process would stop and investment would resume. Provided demand continued to increase, both actual growth and growth in productivity might continue above trend and we would find that at least some of that output which pessimists thought was lost forever after the recession would return. I also thought there were some grounds for this optimism: stories about the pre-2007 trend being artificially inflated by debt were, well, inflated, and productivity innovations do not take six year holidays.

The caveat about demand remaining strong was crucial, of course. Fiscal policy and you know who will not help beyond 2015, and neither has the recent strength in sterling. However lower oil prices go the other way. The big unknown is monetary policy. If nominal wages start rising before productivity growth resumes, that would be a trigger for the MPC to start putting on the monetary policy brakes too soon. They could still make that mistake, of course, but rising productivity growth coupled with core inflation below 1% should make them wait.

I should add in passing that if this does all happen, it in no way excuses what has gone before. Strong growth after a long recession does not make the recession OK! The cost in terms of lost output (at first compounded by the costs of high unemployment) has been huge, and you know why I think much of it could have been prevented.

I should also stress that this is an optimistic scenario, not a forecast. I know enough about unconditional macro forecasts not to do them. All manner of things could go wrong. But if this is how things do pan out, it will not just be good news, but it will also be fascinating from a macroeconomic point of view. It will show how you can have a prolonged demand deficient recession without persistent high unemployment, partly as a result of what economists call flexible labour markets. This was always something that could happen in theory, but I’m not sure we have many examples where it has happened. However, I should not allow my optimism to count chickens before they are hatched.

Monday, 27 July 2015

Should central bankers stick to talking about monetary policy?

Few disagree that the recent remarks on corporate governance and investment made by Andy Haldane (Chief Economist at the Bank of England) are interesting, and that if they start a debate on short-termism that would be a good thing. As Will Hutton notes, Hillary Clinton has been saying similar things in the US. The problem Tony Yates has (and which Duncan Weldon, the interviewer, alluded to in his follow-up question) is that this is not obviously part of the monetary policy remit.

Haldane gave an answer to that, which Tony correctly points out is somewhat strained. Perhaps I could illustrate the same issue by going down a better route that Haldane could have used. He could say that the causes of low UK productivity growth are clearly under his remit, and one factor in this that few dispute is low investment. If he was then asked by an interviewer what might be the fundamental cause of this low investment, Tony would argue that his reply should be that he couldn’t really comment, because some of those reasons might be too political.

I have in the past said very similar things to Tony when talking about the ECB, and their frequent advice to policymakers on fiscal rectitude and structural reforms. My main complaint is that the advice is wrong, and I puzzle over “how the ECB can continue to encourage governments to take fiscal or other actions that their own models tell them will reduce output and inflation at a time when the ECB is failing so miserably to control both.” But I have also said that in situations where fiscal actions have no impact on the ability of monetary policy to do its job (which is not the case at the moment), comments on fiscal policy are “crossing a line which it is very dangerous to cross”.

However I am beginning to have second thoughts about my own and Tony’s views on this. First, it all seems a bit British in tone. Tony worked at the Bank, and I have been involved with both the Bank and Treasury on and off, so we are both steeped in a British culture of secrecy. I do not think either of us are suggesting that senior Bank officials should never give advice to politicians, so what are the virtues of keeping this private? In trying to analyse how policy was made in 2010, it is useful to have a pretty good idea of what advice the Bank’s governor gave politicians because of what he said in public, rather than having to guess. (Of course private advice to politicians is never truly private, but this hardly helps, because with secrecy it allows politicians to hint that advice of a particular kind was given when it might not have been.)

The issues of MPC external member selection that Tony worries about are real enough, but perhaps that illustrates problems with the selection process. My guess is that the Treasury would be inhibited about choosing an MPC member who had previously been strongly critical of the government on other issues anyway. As I said my main complaint about the ECB is the nature and context of the advice they give, and at least by making it public we know about this problem.

It is often said that central bankers need to keep quiet about policy matters that are not within their remit as part of an implicit quid pro quo with politicians, so that politicians will refrain from making public their views about monetary policy. Putting aside the fact that the ECB never got this memo, I wonder whether this is just a fiction so that politicians can inhibit central bankers from saying things politicians might find awkward (like fiscal austerity is making our life difficult). In a country like the UK with a well established independent central bank, it is not that clear what the central bank is getting out of this quid pro quo. And if it stops someone with the wide ranging vision of Haldane from raising issues just because they could be deemed political, you have to wonder whether this mutual public inhibition serves the social good.

Sunday, 26 July 2015

The F story about the Great Inflation

Here F could stand for folk. The story that is often told by economists to their students goes as follows. After Phillips discovered his curve, which relates inflation to unemployment, Samuelson and Solow in 1960 suggested this implied a trade-off that policymakers could use. They could permanently have a bit less unemployment at the cost of a bit more inflation. Policymakers took up that option, but then could not understand why inflation didn’t just go up a bit, but kept on going up and up. Along came Milton Friedman to the rescue, who in a 1968 presidential address argued that inflation also depended on inflation expectations, which meant the long run Phillips curve was vertical and there was no permanent inflation unemployment trade-off. Policymakers then saw the light, and the steady rise in inflation seen in the 1960s and 1970s came to an end.

This is a neat little story, particularly if you like the idea that all great macroeconomic disasters stem from errors in mainstream macroeconomics. However even a half awake student should spot one small difficulty with this tale. Why did it take over 10 years for Friedman’s wisdom to be adopted by policymakers, while Samuelson and Solow’s alleged mistake seems to have been adopted quickly? Even if you think that the inflation problem only really started in the 1970s that imparts a 10 year lag into the knowledge transmission mechanism, which is a little strange.

However none of that matters, because this folk story is simply untrue. There has been some discussion of this in blogs (by Robert Waldmann in particular - see Mark Thoma here), and the best source on this is another F: James Forder. There are papers (e.g. here), but the most comprehensive source is now his book, which presents an exhaustive study of this folk story. It is, he argues, untrue in every respect. Not only did Samuelson and Solow not argue that there was a permanent inflation unemployment trade-off that policymakers could exploit, policymakers never believed there was such a trade-off. So how did this folk story arise? Quite simply from another F: Friedman himself, in his Nobel Prize lecture in 1977.

Forder discusses much else in his book, including the extent to which Friedman’s 1968 emphasis on the importance of expectations was particularly original (it wasn’t). He also describes how and why he thinks Friedman’s story became so embedded that it became folklore. The reason I write about this now is that I’m in the process of finishing a paper on the knowledge transmission mechanism and the 2010 switch to austerity, and I wanted to look back at previous macroeconomic crises.

If it wasn’t a belief in a long run inflation unemployment trade-off, what was it that allowed inflation to gradually rise during those two decades? Forder has a lot to say on this, but the following is my own take. I think two things were critical: the idea that demand management was primarily designed to achieve full employment, and that full employment had primacy over the objective of price stability. Although more and more economists over that period began to see the policy problem within a Phillips curve framework, many still hoped that other measures like prices and incomes policies (in the UK in particular but also in the US) could override the Phillips curve logic. The primacy of the full employment objective meant the problem was often described as ‘cost-push inflation’ rather than a rise in the natural rate of unemployment.

If you find this hard to imagine, think about historians discussing the current period in a possible future in 2050. By then nonlinearities in the Phillips curve and the power the inflation target had in anchoring inflation expectations were firmly entrenched in mainstream thinking. Imagine that partly as a result in 2050 the inflation target has been replaced by a level of nominal income target. With the benefit of hindsight these historians were amazed to calculate the extent to which resources were lost decades earlier because policy had become fixated by a 2% inflation target and budget deficits. They will recount with amusement at the number of economists and policymakers who thought that the way to deal with deficient demand was by ‘structural reform’. Rather than construct folk tales, they will observe that even when most economists realised what was required to avoid being misled again policymakers were extremely reluctant to change the inflation target.

Friday, 24 July 2015

Apprenticeships and Conservative Governments

The UK budget included the creation of an employer levy to help finance a large increase in apprenticeships. It is a key part of this government’s belated attempts to deal with poor productivity growth, although lack of workforce skills has been a UK problem for as long as I can remember. I hope the goals are achieved, but this is not my area so I cannot comment on whether they will be. Instead let me tell an anecdote, and reference two good sources.

After I left H.M.Treasury, I found myself in a forum discussing Mrs. Thatcher’s economic policies. The person defending the government was a Treasury economist that I had worked for, and who was no fool. Most of the questions raised were macro, so I had no problem making critical comments. But then a question on apprenticeships came up. In the 1970s there was an apprenticeship levy covering most of British industry, administered by tripartite bodies. The Thatcher government had just begun dismantling that levy.

As this was hardly my field, I feared I would have nothing to contribute. But all my former colleague could say to defend the government’s dismantling of the levy system was that the government believed that individual employers were far better placed to do their own training. I could not believe what I was hearing. Even with the little microeconomics I had, I could see the flaw in that argument. Training employees with non-firm specific skills involved an obvious problem for the employer - the employee can be tempted to move to another firm, and the original firm gets nothing back from their investment. Firms that did pay for apprenticeships would always be vulnerable to others that attempted to free ride and poach their skilled labour.

Yet this ‘why should governments interfere’ mantra was the only justification the government could find for getting rid of the levy. Mrs Thatcher’s policies might have improved UK productivity growth for some reasons, but this was not one of them. As I often say, a neoliberal agenda (or whatever else you want to call it) is anathema to economics, a large part of which is about market imperfections, and how governments can sometimes be instrumental in fixing them. (Not always, as perhaps the German approach to apprenticeships illustrates.)

Two good recent pieces on apprenticeships are this short piece from Hilary Steedman, and something more detailed from Alison Wolf.

Thursday, 23 July 2015

Raising the minimum wage

It is fascinating when two highly respected, internationally known economics professors at London universities (LSE and UCL) disagree about a policy on which they are both experts. The policy is the increase in the national minimum wage (NMW) contained in the last Osborne budget. The disagreement is not the one you might expect, and nor do I think it reflects underlying differences (if any) in the politics of the two individuals. 

The debate is often between those who appeal to standard theory that says raising the NMW must reduce employment, and those who appeal to the evidence which says this hardly happens. But in this case the theorist, Alan Manning, is arguing for the policy of a higher NMW, while it is the empiricist, Steve Machin, who disapproves of the policy.

Let’s start with Machin. As well as having published work on the impact of minimum wages, he also sits on the Low Pay Commission (LPC) which before the budget was responsible for setting the minimum wage. In a letter to the FT, together with another academic member of the LPC Robert Elliot, he writes:

“The path of the NMW has until now been determined by careful and considered recourse to the evidence. The chancellor has at a stroke removed the rationale for the LPC and ensured that the path of the NMW will be determined by the priorities of whichever party forms a government.”

Although the argument here is essentially about the politicisation of setting the NMW, you could argue that he is also implicitly suggesting that by setting a NMW substantially above levels recommended by the LPC Osborne will do more harm than good.

Alan Manning is a pioneer of the theory of monopsony applied to the labour market. The idea here is that the employer has considerable power over the employee. The example normally given is that of a large employer in a small town, where the opportunities to the employee to find alternative work are limited or very costly. However Manning argues that monopsony is more generally applicable. In his book on the subject he writes

“The existence of [labour market] frictions gives employers potential market power over their workers. The assumption that firms set wages means that they actually exercise this power.”

The kind of frictions he has in mind are the time, effort and costs involved in finding a new job. Of course the employer faces similar costs, but Manning argues they matter more to the worker than to the firm. This means that wages can be above or below the level they would be under perfect competition with no frictions, and the greater power of the firm means that in practice they will be below. As a result, the outside imposition of a higher wage will not necessarily lead to lower employment, but may simply alter the way the ‘rent’ caused by labour market frictions is split between employee and employer. [1]

This theory does not, of course, suggest that minimum wages can be set without limit, but Alan Manning is suggesting that the evidence is not strong enough to say that Osborne’s proposal goes beyond those limits. He does not pretend to know that the LPC has been wrong to set a lower NMW. Instead he argues that sometimes it is good to experiment. He writes:

Evidence-based policymaking does require experimentation with policies whose effects are unknown otherwise one simply preserves the status quo. It is as important to try new policies that one thinks have benefits as to have stringent ex-post analysis of those policies. I think the new policy is one well worth trying but I don’t pretend to know that there will be no substantial adverse effects.”

He argues that this experiment will give the LPC a new lease of life as it evaluates the results of the experiment.

I have no clear idea who is right. However we can make some progress by looking at which industries employ most on low pay. James Plunkett has a nice diagram here, and he argues that most sectors can easily afford to pay higher wages without reducing employment (or more precisely, that at the moment the rents that come from labour market frictions are mostly taken by the employer): sectors like retail or food and beverage services. An exception is residential care, but as he and Manning note, the price for these is largely determined by the government.

I agree with Machin that it is good to delegate complex economic issues like setting the NMW to expert bodies like the LPC. However it is also difficult to imagine such institutions ever saying why don’t we take a risk and do an experiment. It is also significant that the political intervention in this case does not fit the natural inclinations of the political party in power. In this case who turns out to be right will depend on whether this intervention is a one off or becomes a habit, and the reaction of whoever is Chancellor if the LPC judges the experiment to have failed.  

[1] An alternative argument is that both employer and employee will reap benefits from higher wages, because these will encourage higher retention and productivity. These efficiency wage arguments are discussed by Ben Chu.