Winner of the New Statesman SPERI Prize in Political Economy 2016

Tuesday, 31 May 2016

Why the political centre needs to be radical

In a recent article on Tony Blair, George Eaton wrote:
“[Blair] said of Corbyn’s supporters: “It’s clear they can take over a political party. What’s not clear to me is whether they can take over a country.” It was Blair’s insufficient devotion to the former task that enabled the revival of the left. As Alastair Campbell recently acknowledged: “We failed to develop talent, failed to cement organisational and cultural change in the party and failed to secure our legacy.” Rather than effecting a permanent realignment, as the right of the party hoped and the left feared, New Labour failed to outlive its creators.”

I beg to differ. The rise of Jeremy Corbyn is not a result of Blair failing to “cement .. cultural change in the party”. It is a result of the financial crisis, of everything that has followed from that, and the centre’s failure to offer a radical response to that momentous event.

Echos of the financial crisis are everywhere for those that care to listen. Even in the EU referendum, which at first sight is about free trade areas and sovereignty. The main reason Brexit has such wide popular support is concern over immigration, and that in turn is driven by a belief that immigration reduces real wages and puts pressure on public services. Yet the main reason public services are under pressure is austerity, which in turn was a reaction to the financial crisis. Immigration improves the public finances. The main reason for the decline in real take home pay for the low paid is not immigration but stagnant productivity following the financial crisis (and increasingly austerity measures).

The financial crisis was a major event not just in its consequences, but because it raised crucial questions about our current economic system. For most on the political right that question was too threatening to contemplate, so they doubled down by reducing the size of the state using deficit deceit as a means. But as many people did not want less spent on the things the state does, and a smaller state did nothing to immediately inspire the private sector, that only intensified popular frustration with the economic status quo.

Rescuing the banks should have been a prelude to radical reform of the financial sector, yet the centre only seemed to be concerned with putting the pieces back together again and making minor changes that are very vulnerable to being unravelled by political pressure from the banks. In many countries the centre seems paralysed by the glare of populism, whether that populism is used by governments (austerity) or the far right.

For the UK’s centre-left this paralysis comes in a particular form called ‘electability’. Radical policies almost by definition upset the status quo, who will attempt to frame such policies as anti-business or anti-aspiration. If electability becomes synonymous with avoiding anything that might be framed in this way, that rules out radical solutions. Yet radical events or profound changes in society and the economy may well require radical solutions, and if the centre avoids them they let people like Donald Trump or Boris Johnson in.

In a recent article Dani Rodrik wrote about populist politics in response to the impact of inequality and globalisation, but it could equally apply to the financial crisis. The two are connected of course: it was the globalisation of finance rather than anything happening in the UK economy that destroyed UK banks.
“The appeal of populists is that they give voice to the anger of the excluded. They offer a grand narrative as well as concrete, if misleading and often dangerous, solutions. Mainstream politicians will not regain lost ground until they, too, offer serious solutions that provide room for hope. They should no longer hide behind technology or unstoppable globalization, and they must be willing to be bold and entertain large-scale reforms in the way the domestic and global economy are run.”



Saturday, 28 May 2016

Neoliberalism, Mirowski and me

Philip Mirowski is a historian who has written a great deal about both the history of economics as a discipline and about neoliberalism. He knows much more about the history of both subjects than I do. I was therefore somewhat dismayed that, in responding to some comments on his 2014 paper “The Political Movement that Dared not Speak its own Name: The Neoliberal Thought Collective Under Erasure” (pdf), he chose to start by making some comments on my recent blog post discussing neoliberalism.

He didn’t like it, for two main reasons. First, he disagrees with my definition. I have no problem with that, because I would never have the nerve to try and offer a definitive summary of the term. As I wrote in that post, I was just saying what I mean by the term when I use it. I’ll come to why he thinks that it was - to use his own words - ‘untutored’ later.

The second “more glaring error is to counterpose the beliefs of orthodox economists, who judiciously accept or reject various doctrines on the basis of their empirical relevance without bias, to those of the Neoliberals, grounded as they are in an impetuous ‘ideology.” In particular, he takes objection to my suggestion that economics can be used to critique neoliberal ideology. Here unfortunately there seems to be little correlation between his criticism and what I actually wrote.

He suggests that what he calls the ‘Neoliberal Thought Collective’ (NTC) has many more representatives in the economics profession than I could imagine. But how does he know what I imagine? At no point do I say that all economists are free of neoliberal ideology, and in the past I have argued exactly the opposite. But the fact that some economists might be neoliberal in outlook does not mean that economics cannot be used to critique neoliberalism. It is a category error that anyone who understood economics should not make. More on this below.

He also rather oddly says that I provide no example of how economics can be used in such a critique. It is odd because I give an example in the post. What he might be suggesting is that this actual/potential critique has not been effective politically, but that is something very different. It may just reflect that economists tend to be ignored when what they say is inconvenient, which is something I have talked about elsewhere.

Having said all that, in a tit for tat style, let me revert to Daniel Dennett’s rules, and say that I actually agree with some key points from Mirowski’s paper referenced above. First, we both agree that neoliberalism exists! Second, one of the key points I wanted to make in my post was that neoliberalism was not the same as mainstream economics. On page 8 of the paper he writes: “First, and this cannot be stressed enough, however much they sound alike, Neoliberalism and neoclassical economics are two completely different schools of thought.”

The way he sometimes describes it the NTC can sound like a great conspiracy, but another way of putting it would be to say that many neoliberal thinkers see themselves as part of a very political project. That is a third area of agreement: in my post I described it as a political movement or ideology. Fourth, I also agree that the lack of any self-identified group calling themselves neoliberal is not an issue.

What about definitions. In the paper (page 22) he outlines 11 ideas that the NTC believes in. I suspect one problem he had with my short definition (“hates ‘big’ government, dislikes any form of market interference by the state, favours business interests and opposes organised labour.”) is that it sounds libertarian. But I put ‘big’ in inverted commas for precisely that reason: neoliberals can be quite happy to use state power to achieve their objectives. They are not libertarian, which is a fifth point we agree on.

I have no wish to argue with his 11 statements, partly because I do not see neoliberalism as being particularly “coherent and consistent”. If there is a difference of emphasis between us, it is that he stresses support for the market and I stress dislike of the state interfering in (or undertaking what could be) market activities. One reason I would give for this difference is the corporation itself. It is possible (although not desirable, for reasons outlined many years ago by Ronald Coase) to set up ‘internal markets’ within corporations, or even break up corporations into a set of markets activities. This is not part of the neoliberal agenda: item (9) of his list of neoliberal beliefs is “Corporations can do no wrong—by definition.”

Another reason may be more personal, and that is austerity. Once you use basic macroeconomic theory (theory which Mirowski describes in his response as “just a sequence of faddish enthusiasms”) to see why the various reasons used to justify austerity make no sense, you are left with two explanations for why neoliberals would want to champion it. One is a dislike of the idea that state action might be needed to ‘mend’ the market, and the other is what I call ‘deficit deceit’: using austerity to shrink the state. At least a majority of academic macroeconomists, and possibly a clear majority, now view 2010 austerity outside the Eurozone periphery as a mistake, which does not fit well with the idea that economists are part of the heartland of the NTC?

Austerity is an example of where economics is really important to any critique of neoliberalism. It is here where I fundamentally disagree with Mirowski. Indeed, it is difficult for me to see how any effective critique of neoliberalism could not be based at least in part on economics. Take Mirowski’s second neoliberal belief: " “The market” is an information processor, and the most efficient one possible—more efficient than any government or any single human ever could be." Any economist should distinguish between an ideal market and any actual market. An important part of economics involves outlining the conditions under which markets are ideal in organising exchange, and the consequences of any departures from that ideal. That distinction is something an ordoliberal would recognise (at least in the case of the degree of competition/monopoly), but is generally ignored by neoliberals.

So if you want to analyse, for example, why setting up internal markets in the NHS, or privatising NHS activities, might or might not work, you need economics to understand when markets work well and when they do not. They might not work well, for example, if information about quality is difficult to obtain. (Economics is not the only discipline you would require: you would want to talk about motivations, and how a market ethos can damage shared goals, for example.) More generally the idea that you can critique an ideology which puts such faith in all markets without using the discipline that studies market efficiency seems strange to me.

Another example concerns the minimum wage. The neoliberal view would be that this a bad policy which will only reduce employment. It is economists who have both gathered the evidence and developed the theory to show otherwise. If economists were hopelessly embroiled in the NTC, why would this happen? I’m not arguing that it is not possible for economists to be influenced by neoliberal or ordoliberal ideology (the apparent opposition of most economists to the introduction of the minimum wage in Germany might be a case in point), but just that it has not happened to the extent Mirowski imagines, and it certainly has not become embedded in economic theory. When he says at the end of his response here that “it seems likely that opposition to neoliberalism will not arise from within modern economics, either” he almost has to be wrong.

Let me end with the example I gave in my original post and he appeared to ignore: capital requirements for banks. A substantial increase in capital requirements is a simple way of avoiding another financial crisis, and furthermore, because of its simplicity, a way that can hope to survive against relentless political pressure from banks. That the idea makes sense in terms of basic theory means that even economists like John Cochrane support it. In his time at All Souls in Oxford he would certainly have talked to the economist who has recently been pretty vocal in his calls for higher capital requirements in the UK. Mirowski overestimates the extent to which neoliberal ideas have become “embedded in economic theory”, and underestimates the power that economic theory and evidence can have over even those academic economists who might have a neoliberal disposition. If the tide of neoliberal thought is going to be turned back, economics is going to be important in making that happen.    

Friday, 27 May 2016

Bonus culture

Diane Coyle has an excellent article in the FT about an apparent puzzle. Why do executives get incentive bonuses (extra pay on meeting some target), but most workers do not? Her article is based around a classic paper by Bengt Holmstrom and Paul Milgrom. Their basic argument is that incentive pay linked to specific targets works (it increases effort) when tasks are simple and effort can be easily measured. However if tasks are complex, and only some aspects of performance can be accurately measured, incentive pay can distort the allocation of effort between those tasks, leading to undesirable outcomes. As Diane says “pay structures not only incentivise effort and direct risk-taking, they also determine the worker’s allocation of effort between different tasks.”

So target related bonuses make sense for workers conducting simple tasks where effort can be easily measured, but are a bad idea for workers undertaking complex tasks where only some aspects of performance can be measured. To quote Diane:
“Indeed, the best arrangement would seem to be the opposite of the pattern we observe now. Corporate executives and senior bankers doing complex jobs involving many impossible-to-monitor activities are the last people who ought to be paid via an incentive scheme; while bonuses for fast-food workers or shop-floor employees make more sense.”
The implication she draws is straightforward: the bonus culture for corporate executives and senior bankers should end. But this leaves us with a puzzle: why did this bonus culture arise in the first place? Perhaps bonuses created something beneficial that we are missing.

Here is a simple conjecture, based on another paper by Piketty, Saez and Stantcheva which I discussed here. They note that increases in executive pay are strongly correlated with reductions in the top rate of income tax. Their explanation notes that executive pay is the result of bargaining between the executive and the firm. The executive has a lot of bargaining power (what successful firm wants their CEO to quit), but whether they choose to use it depends on the reward from doing so. If top tax rates are low, the rewards are high.

The executive still has to convince their firm to pay them more. What better way to do this than to suggest they get paid a lot more only if the company is successful. In the climate of the 1980s and 1990s in the UK and US (when the income share of the 1% took off) that argument would have seemed pretty convincing. My conjecture therefore is that bonus pay became endemic among executives and senior bankers not because it was more efficient for the firm, but because it was a useful tool in a bargaining game. [1]

This argument completely reinforces Diane’s conclusion. Executive bonuses are a way for senior management to extract rent from their firms, which is a quick way of saying that these high salaries redistribute money from everyone else to themselves. A consequence was that they reduced efficiency by diverting the executive’s attention to just hitting specific targets. One final thought, as we in the UK are obsessed with Brexit right now. It was the EU that passed laws limiting bonuses in the financial sector, and it was George Osborne that spent the UK public’s money trying to stop that law coming into effect.

[1] Bonuses can play a useful role in small firms where revenues are volatile, as Chris Dillow notes. That argument hardly applies to the CEO of a large multinational.  

Wednesday, 25 May 2016

Household debt and house prices

In previous posts I have talked about why I am suspicious of (but not completely opposed to) the idea that the UK (or US) has a serious problem because there is too much personal debt. Too much popular discussion goes as follows: booms and busts are often caused by excess lending and borrowing, household debt to income ratios are currently high compared to a few decades ago, and so we must be on the verge of a new personal debt crisis. The first two points are true, but the third does not follow because of one thing: house prices.

I thought I would illustrate the key point with a graph, based on data from the OECD’s Economic Outlook.


The yellow line is house prices relative to income: the absolute level is arbitrary. The red line is mortgage debt as a ratio to personal income, and the blue line is the total debt to income ratio. The green line is the difference between the blue and red i.e. non-mortgage debt relative to income.

The key point is that most of total household debt is mortgage debt, and this follows house prices. That the two should track each other over the long term is not surprising, but the fact that mortgage debt seemed to fall exactly with house prices is. (If house prices fall, this changes the value of new mortgages, but not the value of existing mortgages.) The reason may be that in the short term the interaction is two way. A fall in the demand for house purchase (and hence mortgages) will impact on price. Non-mortgage debt is now a little lower relative to income than before the crisis.

The basic story is therefore very simple. The main reason people go into debt is to buy a house. The more expensive houses get, the more they have to borrow. If there is a problem, it is not that we have all gone on unaffordable spending sprees. It is that house prices have been rising. Rising house prices increase not only household debt but household wealth, which is a key reason why wealth was also rising rapidly before the financial crisis.

The picture for the US is similar, except that non-mortgage debt has returned to pre-crisis levels.


This suggests no near term risk of any private debt crisis. Indeed for the UK, as Chris Giles reminds us, 2008 itself was not a crisis about personal debt, but a crisis about UK banks overseas lending. As a result, talk about private debt nearing ‘2008 crisis levels’ in the future is highly misleading.

There are two reasons why house prices have been rising in the UK: not enough houses are being built and real interest rates have gradually declined (secular stagnation). As governments have relatively little control over long term real interest rates, you will only reduce mortgage debt by reducing house prices by building more houses. To put it very simply, the aggregate private debt problem in the UK is a reflection of our longstanding inability to build houses.

That is a serious problem, and not just because it prevents a lot of potential first time buyers from being able to afford to buy. It means that, if interest rates were to rise significantly, households with mortgages would be spending much more of their income paying off the mortgage, and they would be more vulnerable to shocks to income as a result. One of the problems with the recent relatively slow growth in nominal wages is that the real burden of a fixed nominal mortgage has not been falling much as the mortgage grows older.

Worse still, if real interest rates did start to recover (secular stagnation proved to be less permanent than many people currently think) this would in itself tend to reduce house prices. That could leave many relatively new home owners with a mortgage larger than their house was worth. In the UK people cannot walk away from this negative equity. Equally lenders could have loans that were no longer covered by the value of an asset. Deflation coupled with rising real interest rates is a toxic mix. But all of these problems reflect the fact that house prices are currently too high. [1]

I think the simple takeaway is this. Anyone who talks about the growing problem of total private household debt without also talking about what has and what will happen to house prices is missing the elephant in the room.

[1] It is tempting to write that high levels of private debt are a symptom rather than a cause of these problems. That is too strong: people choose to take out a mortgage to buy a house rather than rent. However as most people only own one house, it has an element of truth. It seems odd to argue that an irresponsible debt fuelled increase in the desire to own houses is pushing up house prices.

Tuesday, 24 May 2016

Is the Eurozone dying?

In a recent article, Larry Elliott from The Guardian wrote this about the Eurozone:
“The eurozone is economically moribund, persists with policies that have demonstrably failed, is indifferent to democracy, is run by and for a small, self-perpetuating elite, and is slowing dying.”

He describes this as the elephant in the room in discussions over Brexit.

I have some sympathy with this, but with one crucial difference. I do not think the Eurozone is slowly dying. I also differ from many who think it will escape death by morphing into a full fiscal and political union any time soon. Instead I think the Eurozone will continue in something like its present form for some time (decades rather than years): a monetary union with fiscal and most political decisions at the national level.

In terms of macroeconomics there is no obvious crisis that will lead to its demise. As I have noted recently, I think it is more likely that we will see reasonable (or better) growth over the next couple of years. Yes unemployment will remain too high and this is a shockingly unnecessary state of affairs, but as the UK discovered in the 1980s it is not one that threatens the existing social and economic order.

The Eurozone’s treatment of one of its own members, Greece, is intolerable: I have compared the Troika’s treatment of Greece to British actions during the Irish famine. But that does not mean it will not continue. I was surprised at Germany’s willingness to countenance Grexit and the desire of the Greek people to remain. As an economist might put it, the resulting situation may be incredibly suboptimal (even in a Pareto sense), but it looks like an equilibrium. In simpler language, virtually everyone could be better off by doing something different, but unfortunately the only people who might be better off by continuing the status quo are the politicians in control.

The biggest threat facing the Eurozone right now is not economic but political. It is dealing with migration and the associated rise of the far, and often Eurosceptic, right. That challenge will ensure that no one will risk further union, even though it is indeed the prefered option of many in the governing elite. The threat to liberal democracy posed by not only these groups, but also the current governments in Hungary and Poland, is worrying indeed. But so is the possibility of Donald Trump as POTUS.

What does the likely survival of the Eurozone in something like its present form imply for Brexit? My own view is not much, because our opt out from the Euro is safe. On other matters? I have spent much time on this blog and elsewhere criticising German macro policy, but that largely influences the Eurozone. On issues that do influence in the EU, German policy often puts the UK to shame, such as on the environment or migration. It was also the EU that legislated to cap bankers bonuses, a measure which George Osborne tried everything to reverse. On issues like this political cooperation across borders is vital because we live in a globalised world where capital is highly mobile.

Saturday, 21 May 2016

Economists are losers so ignore them on Brexit

That essentially is the argument of the Telegraph’s Allister Heath, expressed as Donald Trump might. Heath says we have a been failures for over a century, “yet they now have the chutzpah to behave as if they should be treated like philosopher kings, an all-knowing “profession” that we are all supposed to bow down to uncritically.”

Actually right now I think we would settle for being heard. Ironically the only people in the media who seem to have noticed our Times letter are those supporting Leave. This matters. Recent polling evidence suggests voters have taken on board the Bank of England’s view that we will be worse off in the short term. But when it comes to the economy in 10 to 20 years time, as many voters think we will be better off by leaving as think otherwise. That the overwhelming majority of academic economists think there are significant long term costs to leaving might therefore be useful information for voters: information many currently do not have. So much for “philosopher kings”.

Of course economists have many faults and do make mistakes. But it remains the case that economists do know more about what determines trade and foreign investment and the impact of migration than most. We certainly know more than political journalists.

Should our expertise be ignored? Let’s look at some of the evidence Heath uses to suggest we nearly always get it wrong. The first is a poll conducted by the Economist in 1999 about whether the UK should join the Euro. Here the split was basically 2 in favour for every one against. But there is a crucial difference from Brexit. In the case of the Euro every economist would acknowledge (see the Economist article) that there were good arguments for and against. In the case of Brexit the only matter to discuss is how big the costs of leaving are. Our trade can only decrease following Brexit. Foreign direct investment can only decrease. Migration, which is also a plus for the economy as a whole, is likely to decrease following Brexit.

The main argument those supporting Brexit use to suggest the economy will do better is that we can get rid of all those pesky regulations that are holding business back. Which was exactly the argument the Conservatives and those in the financial sector made when they championed reducing regulations on finance before 2008. It worked for a few years, and then we had the financial crisis that led to the biggest post-war recession. Mr. Heath has the chutzpah to lay all the blame for that on economists.

But let’s roll the Euro story on to 2003. The government had to make a decision, and this focused on the economics. It commissioned a huge amount of work looking at all the evidence, consulting widely among academics. These studies flagged up some (not all) of the vulnerabilities of the Eurozone that became evident in subsequent years. This persuaded first Gordon Brown and then Tony Blair to say no. I would count that as a definite win for economists.

Of course he mentions what he calls the ‘infamous’ letter from 364 economists in 1981 criticising the Conservative deflationary budget. We are told that the 364 got it wrong because the economy started growing shortly afterwards. This is mediamacro logic, just like when we were told austerity was a success in the UK because the economy grew in 2013. As Steve Nickell pointed out in this speech, unemployment peaked not in 1981 but 1986. The combination of monetary and fiscal contraction in 1981 was overkill, and on that fundamental point the letter was right.

But I will concede this. Mr. Heath and his colleagues on the neoliberal right are much better at PR than economists. They have managed to create the perception in the media that the letter was wrong and Mrs. Thatcher was right. Their strategy is that if the evidence is against you, distort the evidence.

This is the real beef that Mr. Heath has against economists: we mostly follow the evidence and not an ideology. Most economists were indeed wrong about the Great Depression, but that led to the creation of macroeconomics as a separate discipline under the guiding light of Keynes. This helped produce a golden age of growth after WWII, a fact that Mr. Heath ignores. It was brought to an end by stagflation, but that was not the surprise to economists that Mr. Heath imagines.

The irony is that the ideology Mr. Heath follows is itself based on economics: economics as understood by a first year student who only listened to a third of their lectures. For Heath economics is fine as long as it is explaining the virtues of the market and competition, but if economists look at market imperfections then they are “obsessed”.

When I see Heath and his compatriots extol the virtues of the regulation free world that will be possible once they are freed from the shackles of the EU, I am reminded of the Troika and Greece. The Troika has been effectively running Greece for 6 years, yet unlike Ireland or Spain the economy remains in depression with no signs of hope. But rather than question what they have done, they blame the Greeks for not pursuing the prescribed policies rigorously enough. The UK is one of the least regulated OECD economies, and has recently had 6 years of government spending cuts and corporation tax cuts, but productivity growth since the crisis has been painfully slow. Rather than question the efficacy of the medicine, the ideologues blame the EU from preventing them doing even more.

It also reminds me of the Scottish referendum, where those in favour of independence just did not want to hear the bad news about the short term fiscal outlook. Some decided that those bringing that news were part of some Westminster conspiracy, and all preferred to believe the wishful predictions of the SNP. I’ll repeat now what I said then: do you really want to be ruled by people who prefer make believe stories to evidence, and who are so desperate for votes they tell you to ignore an entire academic discipline.