Friday, 31 January 2014

Why the Fed should not taper alone

My latest post at Forbes endorses Raghuram Rajan's call for there to be permanent co-operation between the central banks of the G20. Business is global: financial markets operate across borders. Countries no longer have genuinely independent monetary policy. Monetary policy needs to be co-ordinated internationally, with the Fed as "first among equals". Whether intentionally or not, the Fed has become the de facto central bank of the world. It is time it behaved like it.

Read the whole post here.

Related reading:

Why the Fed cannot taper - Coppola
Don't blame the Fed for the turmoil in emerging markets - Aziz, The Week
Fed to emerging markets: "Our currency, your problem" - for now - Verma, Euromoney
Emerging markets' victimhood narrative - Rodrik & Subramanian, Bloomberg
Dilemma not Trilemma: the global financial cycle and monetary policy independence - Rey, VoxEU
Trilemma looks ok to me (Mundell-Fleming model still works) - Guy Debelle, Reserve Bank of Australia
Unravelling the global effects of mad money - Mardle Capital

Wednesday, 29 January 2014

Laffer and the Yeti

My post "Oh no, not again" about Ed Balls' 50p tax rate policy sparked something of a debate. This post at Pieria disagrees with my view that the 50p rate is pointless and argues that it is justified as a response to growing inequality. I have now posted a response, also at Pieria, which focuses on the morality of taxation - and debunks both the Laffer curve and "trickle down economics". Here's a taster:
"In this recent post, I argued that Ed Balls’ policy of reversing the Conservatives’ 5p cut in the top rate of tax was pointless. My argument was principally an economic one.  Balls had stated that the tax increase would be used to reduce the deficit, but research from both HMRC and the IFS suggests that such a small increase would make little or no difference to tax revenues. Deficit reduction cannot possibly come from minor adjustments to tax codes. What is needed is growth. 
"But this is not to say that higher taxes on the rich are necessarily a bad idea. Beliefs about the relationship between tax rates and tax revenues (the so-called Laffer curve) are largely unsupported by evidence.
"The Laffer curve is rather like the Yeti...."
Read on here.

Sunday, 26 January 2014

Oh no, not again

At the Fabian conference yesterday, Ed Balls announced the Labour Party's intention, if elected in 2015, of restoring the 50p tax rate that was abolished by the present Coalition government. It is the central plank of his deficit reduction plan. But it is by no means clear that it is capable of bearing the weight he would like to place upon it.

The 50p rate had a short and inglorious life. It was announced by the previous Labour government in the 2009 Budget and took effect in April 2010, only a month before Labour's defeat in the May 2010 election. The Conservatives announced the reduction of the rate to 45p in the 2012 Budget, to take effect in April 2013.

Both the OBR and HMRC have shown that there was a substantial behavioural response ("forestalling") to the announcement of the 50p rate, with HMRC estimating that £16-£18bn of income was brought forward into the 2009/10 tax year to avoid the 50p rate. The announcement of the 45p rate elicited a similar behavioural response: final figures for "reverse forestalling" (delaying income receipts in order to take advantage of the tax cut) are not yet available, but ONS estimates that deliberate delays caused bonus payments to increase by 4% in April 2013. Consequently it is actually impossible to know what tax revenue the 50p rate would have raised. It has become a political football, with Labour insisting that it would have raised more tax if it had remained long enough for forestalling effects to unwind, while Conservatives point to increased tax revenues in Q2 2013 as evidence that the 50p rate was counterproductive and the new 45p rate raises more. Both are arguing from at best thin and at worst non-existent evidence.

The simple fact is that we do not know, and can never know, what the 50p rate would have raised. HMRC did their best to create counterfactuals, and tested them with an impressive amount of Monte Carlo simulation. Although the Monte Carlo results suggest the counterfactuals are far from robust, HMRC's conclusion is that the 50p rate wouldn't have raised much if anything, and could even have lost them money (my emphasis):

"Although there is uncertainty around these estimates, sensitivity testing demonstrates that
is difficult to construct a plausible outcome consistent with a yield estimate as high as those original
forecasts. The conclusion that can be drawn from the Self Assessment data is therefore that the 
underlying yield from the additional rate is much lower than originally forecast (yielding around £1 billion or less), and that it is quite possible that it could be negative."

I suppose it could be argued that this report is hardly neutral, produced as it was by HMRC in March 2012 under the governance of a government intent on abolishing the 50p rate for political reasons. But the same cannot be said of the IFS, which also warned that expectations of high revenue from the 50p rate were likely to be disappointed.

The Labour Party are arguing that as tax revenues actually rose by £9.5bn during the period of the 50p rate, it is worth reintroducing it. But they have the same counterfactual problem as HMRC. We do not know whether tax revenues would also have risen with a lower tax rate. Nor do we know whether they would do so in the future, either. Hanging a deficit reduction strategy on something so horribly uncertain looks unwise, to say the least. But is this really about the deficit?

When the 45p rate was introduced, I criticised Osborne for using it as an electioneering strategy. Now, it seems, Ed Balls is doing the same. He has thrown down the gauntlet on an issue where economics has no answers and the decision must be made on political grounds. Deficit reduction be hanged. This is about the Labour party getting its ball back.

And that, frankly, is a tragedy. We do need to have a discussion not just about the economics of high rates of taxation, but about their morality. Piketty and Saez are suggesting a return to 1970s-level tax rates for the very rich. But where is the evidence that these are an effective redistributive mechanism? Very high marginal tax rates are a serious disincentive not only to work, but even to remain in the country. And international cooperation can't be relied on to ensure that the very rich cannot avoid tax by moving around. There will always be a little island somewhere in the world that will seize the opportunity to build its GDP by cutting tax rates for the very rich.

Nor are high tax rates a problem only for the very rich. Benefits withdrawal creates very high tax rates for certain groups. In the UK, people on just over £100k have higher tax rates than those on £150k, due to withdrawal of the personal allowance. People with children face increased marginal tax rates due to withdrawal of child benefit when one adult in the household earns over £60,000. And people on very low incomes can have even higher marginal tax rates when they start paid work, over 90% in some cases. Universal Credit is supposed to reduce this to 65%*, though even that is a shockingly high rate for people on low incomes. But at least the Coalition government is attempting to bring down the tax burden on the poor. I see no such attempt from Labour.

Why isn't Labour addressing the immorality of means-tested benefits? Why are they focusing only on a small tax increase for the very rich, and not eliminating the unfair and inconsistent tax and benefits rules that result in such very high marginal tax rates?

I find myself - utterly bizarrely - more in agreement with the Adam Smith Institute over tax and benefits than with any mainstream political party. Introduce a universal basic income and do away with this plethora of expensive and inconsistent tax reliefs and benefits. And stop taking from the poor with one hand and giving it back with the other. Labour's talk of enforcing a "living wage" simply distracts attention from the fact that the tax system takes from people the money they need to live on, then gives it back grudgingly in the form of means-tested benefits. Now we don't want to pay the benefits, but we still want the taxes - so it seems the solution is to force businesses to pay higher wages. Higher wages may indeed be a good thing, but not for this reason: if enforcing the "living wage" means workers receive less in benefits, it will benefit workers not at all, since the increase will go straight to government. And as I suspect that enforcing a "living wage" would raise unemployment, I'm not even convinced it would reduce the deficit.

Reintroducing the 50p rate is probably pointless. And the deficit reduction programme is unlikely to work, because it hangs on "austerity-lite" without any clear policies to stimulate growth. How many times do I have to remind politicians that austerity measures in a stagnant economy do not reduce the deficit? This is pale blue politics. Does Ed Balls really think watered-down Conservative policies will win the election? I sincerely hope they don't. If Labour are so short of policies that they have to borrow from the Tories, they don't deserve to win.

If Labour really want to win, they have to be much more radical than this.

* Seems Universal Credit's marginal tax rates can be far higher than the advertised 65%. The BBC's Paul Lewis has crunched the numbers and come up with a top figure of 83% for some people and many households at 81%.

Tuesday, 21 January 2014

Banks do not lend reserves

Me, at Forbes. No, banks don't lend out reserves. They don't lend out deposits, either. And excess reserves due to QE don't "crowd out lending". We are not "paying banks not to lend".

With sincere thanks to Sober Look, whose work I love. Sadly he did get this one wrong. But he's certainly not the only one.

Facts we should remember

At Pieria, Euronomist and I remind everyone - and especially Eurozone policy makers - of a few economic truths: "people consume out of income, not wealth" (duh), "supply depends on demand in a financial crisis" (here's looking at you, Hollande), and of course ""relying on exports doesn't make for a vibrant economy" (guess who that's aimed at?).

Read the whole article here.

Monday, 20 January 2014

Time to say goodbye, Co-Op Bank edition

On 14th January, the Board of the Co-Op Group approved the Terms of Reference for an independent review of the governance of the Co-Op Group. The review is to be led by Lord Myners, who was appointed to the Board as an independent director in December with the remit to conduct such a review. This is now the fourth review of the Co-Op's problems, the others being the Kelly review of the circumstances of the Britannia takeover, the Treasury Select Committee's inquiry into the circumstances of the Verde deal collapse, and the Bank of England's forthcoming enforcement investigation into the conduct of the Co-Op Bank. And the Chancellor of the Exchequer has announced that there is to be yet another independent inquiry. I do wonder if this is overkill. There is only so much navel-gazing a company can stand. In the end, they have to get on with being a business and providing a service to their customers and, in this case, their members.

Also on 14th January, the Co-Operatives Movement held a conference in Manchester on "Ways Forward" in the light of problems in the Co-Op Group and in particular the loss of the Co-Op Bank.

I've used that term carefully. "Loss" is exactly how it is seen by the Co-Operatives Movement. I attended that conference, and what struck me above all was the pervasive sense of grief, hurt and betrayal. The Co-Op Bank is no longer a co-operative or mutual. It is simply a public limited company which is 30% owned by a co-operative, the rest of the shares being in the hands of a variety of investors ranging from pensioners to hedge funds. Even though it has successfully been rescued, to the Co-Operatives Movement, the Co-Op Bank is lost.

To be sure, it was not actually a co-operative prior to its rescue, either. But it was wholly owned by a co-operative. It is the loss of that sense of ownership that has upset the Co-Operators.

There seem to be a variety of reactions to this. There are still a few diehards who think that it should have been bailed out by the government and restored to mutual ownership. And there are even one or two who think that the original proposal should have gone ahead, even though it was terrible for small investors, because it would have preserved 100% mutual ownership. But judging by comments at the conference, these are now in a minority. Most people accept that a government bailout was never going to happen - under a government of any colour - and that in the short term at any rate a private sector rescue was really the only viable option. Beyond that, opinion polarises. Some people are determined to "save their bank". But others want to write it off and move on.

John Mann MP, in a fiery speech, said categorically that "The Co-Op Bank is dead". And in one respect he is right. The Co-Op Bank is indeed dead, as far as the Co-Operative Movement is concerned. It is not a mutual, and in my view it is unlikely ever to be in mutual ownership. To their credit, the campaigners at "Save Our Bank" are trying to raise the funds from customers to buy out the private sector owners. But since the customers of the bank (unlike the Group) are not, and never were, its owners, it seems unlikely that they will want to place their money at risk to "restore" a mutual status that it never really had.

So those people who want to write it off and move on are right. There are many other financial institutions out there that already operate on mutual principles, and many more could be created. The Co-Operatives Movement really doesn't need to tie itself to the past. It should learn from this experience and move on.

But what does the future hold for the Co-Op Bank itself? John Mann didn't just mean that the Co-Op Bank was dead to the Co-Operative Movement. He meant really dead, in that he thinks it will actually collapse. I disagree. I think it will most likely continue as a small private sector retail bank.

The present situation is that the Co-Op Bank is shrinking. Britannia Building Society is at last being integrated, eliminating idiotic duplication of branches and even head offices (yes, Britannia still has its own head office!). And the Co-Op is trimming its operations back to plain vanilla retail deposit-taking and lending for households and SMEs. It is no longer going to provide banking services to large corporations. Clearly these changes are going to mean considerable job losses. And they have other implications too.

Historically, the Co-Op Bank has provided banking services to large public sector bodies, notably local authorities and housing associations. In the 2013 interim accounts, these suddenly appeared in its "Non-Core" division. Now we know about "Non-Core" divisions: all the banks that were damaged in the financial crisis have them. They are dumping grounds for assets and business lines that are no longer seen as "strategic" and are therefore marked for sale or wind-down. So it seems that the Board of the Co-Op Group decided even before the private sector rescue that the Co-Op Bank would no longer serve larger public sector bodies. Blaming hedge funds for this decision is wide of the mark. This is a decision by Co-Op Group management.

The Co- Op Group has also decided to replace the Co-Op Bank's IT architecture. The amount of money allocated to this is pitifully small for a complete system replacement - only £500m. Clearly they are going for a simple, no-frills solution, seemingly with considerable emphasis on digital and on-line provision (more on that shortly). This might explain why they have decided to end banking services for larger private and public sector bodies. Large corporate banking services are far more complex than household and SME banking services. In short, they are expensive.

But I don't think that's the only reason why the Co-Op Group has decided to end banking services for larger corporate customers. I think the real issue is competition. It cannot compete with larger players, and particularly with investment banks, for the lucrative corporate market. It could go into partnership with an investment bank, as some other small providers to the large corporate sector do. But this would be to miss a major opportunity. The Co-Op Group has an astonishingly loyal customer base, not only in its bank but also in its retail services. It looks as if its strategic aim is to persuade many of those people to use its banking services as well as its supermarkets and pharmacies. Leveraging the loyalty of its customers in this manner is similar to the strategies adopted by other "retailer" banks such as Tesco and Sainsbury's. It does mean that the fortunes of the bank will depend on the performance of the retailer, but this is perhaps no bad thing. After all, the Co-Op Group management are not going to want the bank to get into difficulties again, so it might encourage them to manage their retail services with more of an eye to the interests of their members. This is really the key objective of the Myners review.

The Co-Op Bank's focus on SMEs is clearly an attempt to align itself with the Government's objectives of increasing SME lending and improving competition in the sector. Concentration in the SME lending market is viewed as a problem. RBS was formerly the market leader (40% of the SME lending market in 2007), but its under-performance since its nationalisation creates opportunities for other providers to step in. And SME lending still attracts a funding subsidy (FLS). All of these are no doubt key drivers for the Co-Op Group's decision to focus on SME lending. But it should be welcomed. After all, we need more banks that are willing to lend to SMEs.

What is perhaps more worrying is the Co-Op Bank's new-found love of digital banking services. Online banking is considerably cheaper to run than branch-based, but the competition is becoming cut-throat, and the Co-Op Bank has limited credibility in that marketplace because of its historic IT problems. And its loyal customer base includes a fairly high proportion of people who do not or cannot use online or mobile-phone-based services. Branch networks are expensive to run, but I wonder if this is possibly a strategic error. The Co-Op Bank might do better to look at providing banking services within its existing retail outlets, rather than trying to move into an increasingly crowded digital space. Following the herd doesn't make for a distinctive offering.

For better or for worse, the Co-Op Bank as we have known it will be no more. It will become a small private sector retail bank, mainly serving online and telephone customers from its associated retailer but with a focused SME lending franchise as well. Its association with large corporations and public sector bodies is over, and it seems its association with trade unions is too: it was announced on 13th January that it is selling its stake in Unity Trust Bank. I wonder how much longer it will retain its political affiliation with the Labour Party.

And I also wonder how long it will keep its name. The Secretary of State is still to decide whether a private sector bank can be called "co-op". It may be that he will decide that the name must be changed. Personally I would agree with him. Losing its name would enable both the Co-Operatives Movement and the bank itself to move on.  So maybe it is time to say goodbye to Co-Op Bank. Welcome, Britannia Bank?

Related reading:
Under the Radar
The "ethical" Co-Op
Stand By Your Bank
The lure of gold, the deceit of silver
In praise of hedge funds - Pieria
The plausible executive and the ruined bank - Pieria
Who should run banks? - Pieria

Hat tip to Richard Murphy for suggesting the new name.

Tuesday, 14 January 2014

Banks are not fund managers

New post at Forbes

BANKS DO NOT LEND OUT DEPOSITS. They really don't. And they don't "invest" customers' money, or "keep it safe". They lend, and they use customers' money to fund that lending. And that's what we want them to do. 

Oh, and there's a little bit about that Libor rigging matter, too. 

Three posts on basic income

I don't think I've ever before posted three articles on three different sites in the same day. But I have now. And what's more they are all related to each other. So for those who are interested in all things related to basic income, here are the links to the three posts with a brief explanation of each.

At Pieria, my study of the Speenhamland system of poor relief, which was actually an experiment in basic income. It was vilified for depressing wages, creating labour shortages, encouraging unsustainable population growth and requiring ever-higher taxes to support it. But as I show in the post, none of these is true. It actually worked well, and the things it was blamed for were largely caused by other factors. But when it was abolished, it was replaced with the cruellest form of welfare ever devised - and it looks ominously as though we may be heading down that same path again.

At Forbes, my discussion of why we need a minimum wage. If we are going to have in-work and out-of-work benefits, and governments are going to try to compel people to work, then a minimum wage is essential to protect taxpayers from rising benefit bills as employers bid down wages. But a basic income that didn't compel people to work would be much better.

At Coppola Comment, my technical discussion of uncertainty and safety in labour markets. The labour market is bifurcated into high-skill workers with safe jobs, and lower-skill (or rather, less marketable) workers with insecure jobs. But high-skill workers don't want or need safe jobs - it is their employers that need them to stay. It is lower-skill workers that need safe jobs, but their employers want to be able to replace them whenever they want. How do we resolve the asymmetric needs of workers and employers? If the relationship of this post to basic income isn't obvious, read the comments. Cig gets it.

More on the pricing of the "safety asset" to follow. After all, that's what basic income is.

Sunday, 12 January 2014

Risk pricing in labour markets

This is a long overdue response to Nick Rowe's question about whether some kind of "taboo" makes employers less willing to exercise their right to dismiss than workers to exercise their right to leave, thus making it more difficult for them force down wages in response to adverse economic circumstances.

The argument that unemployment happens when wages fail to adjust sufficiently to changed market dynamics is a well-aired one. But explanations of "sticky wages" tend to focus on structural rigidities such as employment protection legislation. Nick wonders whether the explanation is more psychological.

Just because something is a psychological effect doesn't mean it can't be quantified. Pricing intangibles is something of a black art, but as we move into a post-industrial society it will become increasingly important; you may not even be able to explain what your asset is, let alone kick it, but you go to considerable lengths to obtain it and keep it - or, in some cases, to avoid or get rid of it.* Defining the nature of intangible assets is halfway to pricing them. In this post, therefore, I suggest a way of looking at the pricing of labour that takes into account the intangible benefits and risks of employment both for employers and employees.

Firstly, we need to acknowledge that we have a bifurcated labour market. Employers report skills shortages and complain about being unable to fill vacancies at the same time as there is high unemployment not only among the unskilled, but also among those with advanced qualifications but little work experience. It seems that employers value experience more highly than qualifications. This has serious implications for those who are currently delaying entry to the workforce by doing qualification after qualification, and becoming more and more indebted in the process, in the hope that jobs will become easier to obtain in  the future.

Relevant experience, then, is an asset that is intrinsically of more value than a Ph.D. But that does not mean that the Ph,D doesn't have value. It does - but only when combined with relevant experience. Without that experience, a Ph.D may be worthless. In fact it may even have NEGATIVE value. People can be turned down for jobs because they are overqualified. But the combination of a Ph.D with relevant experience is a highly valuable asset.

So far I'm not saying anything remotely odd. The value of the combination of a Ph.D with relevant experience can be quantified pretty easily. What cannot be quantified so easily is the cost to the employer of that person leaving. But the lengths to which employers will go to retain key staff suggests that losing workers they can't easily replace is a very significant cost to them. The right of a valued worker to leave is a business risk. Labour market flexibility at the high-skill, high-value end is definitely not something that employers want.

At the other end of the scale, people who have few marketable skills and little experience have not much in the way of valuable assets to sell to employers. This makes it harder for them to find employment, and makes them much more easily replaceable. For them, secure employment is far more valuable than it is to more marketable workers - but it is not something that employers really want to offer.

So we have two asymmetries. In the first, workers' right to leave is very likely to be exercised, since they can easily find another job, but employers' right to replace is very unlikely to be exercised except for underperformance or misconduct, because replacing the worker is difficult. In the second, workers are unlikely to exercise their right to leave, because they face unemployment, but employers may be more likely to replace on a whim, because replacing workers is easy. And this all boils down to who is holding an extremely valuable negative asset called "uncertainty".  

The negative effect of uncertainty is perhaps more obvious in the second asymmetry, so I shall talk about that first. When there is both a real risk of unemployment AND a stigma associated with unemployment (the more spells of unemployment you have, the harder it is to find work), the buyers of labour have considerably greater power than the sellers. We can say that employers have security - since workers are readily replaceable - but workers have uncertainty. We can regard that uncertainty, which is the threat of unemployment, as an extremely valuable negative asset on which employers have a put option (the power to dismiss). The value of that negative asset is inversely related to the employability of the worker. For those with little experience and/or poor skills, the threat of that option being exercised is sufficient to encourage them to accept both rubbish wages and complete insecurity. Of course the employer can exercise the option at any time at his discretion, but there is at least a delay in the exercise of that option, which creates the temporary illusion of security. For the not-very-employable, the fear of unemployment is very real.

In the first asymmetry, the skills and experience of the worker - their marketability - gives them security, but the employer uncertainty. So the power balance is reversed. The right of a skilled and experienced worker to leave can therefore be regarded as an extremely valuable "negative asset" whose price is positively correlated with the employability of the worker (the more "in demand" the worker is, the more likely they are to leave and the harder they will be to replace). This time it is the worker who has the put option, and the employer who will go to considerable lengths to prevent that option being exercised. We can say that the worker's implied threat to leave disciplines the employer who can't easily replace him in much the same way as the implied threat of dismissal disciplines less marketable workers who face unemployment.

So the notion that labour market flexibility is a good thing depends on your point of view. Workers that are "in demand" are very happy with their freedom to change jobs whenever they want, not least because it gives them the power to bid up wages. But employers of these workers constantly try to reduce the elasticity of their skilled workforce - perhaps by creating contingent (uncertain) assets on the employee's side, for example by paying part of their remuneration in deferred bonuses, company shares or stock options. Or they simply pay them more to encourage them to stay - which might explain why "safe" jobs tend perversely to be more highly paid than insecure ones.

Conversely, workers that are not "in demand" don't like flexible labour markets, since losing their job is bad news for them. But employers of these workers want to be able to replace workers at a moment's notice. If employment legislation prevents employers dismissing on a whim, employers evade it by diluting the "employed" status of the worker. This last is becoming increasingly frequent, particularly for the young and the less skilled - probably, as the IFS says, because they have the least bargaining power.

The trouble is that if employers and high-skill employees get what they want, it has untoward economic effects. People who think they are going to lose their job any moment and have no idea when, or if, they will get another one don't plan for the future and don't make spending commitments. They may spend - sometimes rather a lot - but it's ad-hoc. If a lot of workers are living like this, demand is volatile. Businesses, too, find it hard to plan for the future if they are faced with the possibility of losing key staff at a moment's notice, and this is likely to depress investment and reduce risk appetite. So when the labour market (high AND low skill) is highly elastic, the pattern of behaviour from both employers and workers is driven by uncertainty and the risk of negative shocks: it's volatile and reactive. That doesn't make for a stable economy - as this paper from the ECB suggests. It finds (see p.40) positive correlation between highly elastic workforces and both frequency and intensity of financial crises.

Given the economic instability that highly elastic workforces create, it is surprising that governments are so wedded to the idea that labour market rigidities are universally bad. Tomas Hirst argued that sticky wages perhaps weren't as bad as people thought. I would add that sticky employment isn't all that bad either. Admittedly, the existence of out-of-work benefits does reduce the financial uncertainty caused by the threat of unemployment, while welfare-to-work programmes are a (feeble) attempt to address the stigma of unemployment and improve people's marketability. And I certainly don't advocate the sort of employment protection that creates well-paid jobs-for-life for older men while leaving women and the young in very insecure, poorly paid jobs. Gridlock is no better than instability. But we really need to do better than this.

There is an implied "safety asset" in labour markets just as there is in financial markets, and we are mispricing it. Consequently although we regard safe jobs as "good" jobs, we aren't paid more for doing less safe jobs. In fact many people are paid less. These days, the most insecure workers tend to have the lowest incomes. It looks as if safety is no longer regarded as valuable, but I don't think that's true. I think the problem is that it is far too valuable, so employers are restricting its availability rather than paying those with insecure jobs the value of the safety they have foregone. And because those with insecure jobs have little bargaining power, they are unable to claim fair pay for the risk they take.

In the financial world, higher returns come from taking higher risks. Applying the same logic to labour markets suggests that if employers want to benefit from flexible workforces, they should pay more for them. And perhaps high-skill workers should pay employers compensation for their right to leave. Pricing the "safe asset" correctly should nicely hedge the "uncertainty option", to everyone's benefit.

Related reading:

Buyers and sellers, bargaining power and recessions, and asymmetric taboos - Worthwhile Canadian Initiative
Weird is Normal - Pieria
Wages and the Great Recession - Pieria
Stochastic Dynamic Inefficiency, Secular Stagnation and the Natural Discounted Growth Rate - Harless
What can wages and employment tell us about the UK's productivity puzzle? - IFS (pdf)
Can intangible investment explain the UK's productivity puzzle? - Jonathan Haskell (Pieria)
Booms and Systemic Banking Crises - ECB
Why we need a minimum wage - Forbes

* Accountants please note that I am not using the accounting definition of "asset".

Monday, 6 January 2014

Stravinsky and the problem of mathematics

It has been a horrible week. A post on Pieria was the cause of a series of really rather nasty personal attacks both in the comments on the post and on Twitter. It seems that some people didn't like me criticising one piece of sloppy work by an academic econometrician whose other work they admire.

I find this bizarre. One piece of poor work does not invalidate someone's entire output. When I was at the Royal College of Music, I attended a Stravinsky Festival at the South Bank. It went on for weeks and covered Stravinsky's entire instrumental output. By the end of it I never wanted to hear another piece of Stravinsky ever again. But one of the things I learned in the course of this was that great composers are fallible. Igor Stravinsky is a great composer. The Rite of Spring is one of the greatest orchestral pieces ever written. But that doesn't mean that every piece he wrote is great. Far from it. Some of his output is frankly rubbish and should be consigned to the dust of history. And quite a bit of the rest is mediocre. There are a few wonderful pieces, and it is these that make him great - not his extensive output of potboilers, experimental sketches and dead ends.

Now suppose that, rather than sitting through every piece of instrumental music Stravinsky ever wrote, I attended a single performance that happened to be an experimental twelve-tone piece that really needs to be quietly buried. I might write an entire essay about the piece that I heard, explaining in detail exactly what is wrong with it. I might even conclude at the end of the essay that Stravinsky is a rubbish composer. I would be correct within the limits of my knowledge of Stravinsky, but incorrect in relation to Stravinsky's entire output. Would Stravinsky fans tell me that I am ignorant of music (even though I was a music student)? Would they attack my musical understanding? Perhaps - but not if they are responsible critics. Stravinsky is a great composer, but not all of his music is great. A responsible Stravinsky fan would surely say to me, "Frances, this is a poor piece by Stravinsky, but he's written some really wonderful pieces - listen to these" and send me recordings of The Rite of Spring and The Firebird.

So it is with the critics of my post. They could simply have said to me "Frances, this was not one of Milas's better efforts, but some of his other work is excellent" and sent me some links. But that's not what they did. Instead of accepting that my criticisms of his piece might be valid, they attacked my mathematical ability. Instead of informing me about Milas's better work, they accused me of saying things I did not say. They even said that since I had not done a similar piece of work myself, I was in no position to criticise. That's like saying that because I had not written a piece of twelve-tone music myself I was not in a position to criticise Stravinsky's piece. Is the educated listener unable to judge the quality of a piece of music? Clearly not. Nor is the educated reader unable to judge the quality of a piece of mathematical analysis.

Of course, to my critics I am not an "educated" reader. I did not use the right terminology, and therefore - to them - I lack understanding. Not using econometric terminology is no more an indicator of lack of understanding than not using twelve-tone terminology necessarily indicates lack of understanding of the twelve-tone system. But all too easily we mistake linguistic fluency for comprehension.

 But worse, my failure to use the right language marked me as an "outsider". My principal critic was perfectly reasonable to the person who translated my post into econometric-speak, even though that person was really only repeating what I had said. Use of the right jargon is a tribal identity, a badge of "belonging": if you use our jargon you demonstrate that you are "one of us" - but if you don't use our jargon you aren't one of us, you are potentially an enemy and if you criticise one of us we will attack. Academics and econometricians are as guilty of tribal behaviour as anyone else, and my critics today demonstrated this in spades. I am neither an academic nor an econometrician, and I criticised one of their number. They went for the jugular.

My criticism of Milas's work was severe, because it was in my view a very poor piece of work: bad statistical analysis by econometricians has led to some very bad policy decisions, with serious consequences for welfare. It may be that I went too far in my criticism, since I was not familiar with his other work. And I accept that the way I presented my criticism could be interpreted as an ad hominem attack, though it was not intended in that way. But the personal attacks on me in the comments were every bit as bad, and in some cases far worse, than my comments about Milas. This was no credit to anybody. Fighting fire with fire achieves nothing. However loyal people are to the person whose work I am criticising, and  however much they may disagree with me, vindictive personal attacks are always unjustified.

I made the mistake of admitting in the post that I am not confident about maths - a point that one critic explicitly used as a reason to criticise my mathematical competence. But it has dawned on me that this is ridiculous. I am no less competent in maths than I am in music. I have an MBA with a specialism in financial risk management, for heaven's sake. You don't get that without being a competent mathematician. So never, ever again will I suggest in a post that I am not confident about my mathematical ability. And never, ever again will I accept criticism of my mathematical competence from people with axes to grind.

What I will do, though, is think about how I "do" maths. In this post I have mentioned twelve-tone music, which is the most mathematical form of music. It has had an enduring fascination for composers as diverse as Schoenberg, Webern, Berio, Dallapiccola and even Benjamin Britten. Many composers, including Stravinsky, experimented with twelve-tone music but moved on beyond it, finding their own unique musical voices. And I have in the past written twelve-tone pieces myself, though I don't find it easy - it feels like a foreign language. I understand the system and the terminology, but it isn't how I "do" music. I too have had to find my own musical voice. So it is with maths. I think logically and mathematically, but standard mathematical terminology feels foreign to me. I need to find my own mathematical voice.

UPDATE. The Pieria post has now been taken down at my request, as dealing with a continual stream of adverse comments was becoming a major distraction from other work. This post will remain up though.

Related reading:

The problem of mathematics

A selection of Stravinsky's music: 
The Firebird
The Rite of Spring
Epithaphium (serial)
Threni (serial)

Wednesday, 1 January 2014

The Twelfth Commandment

In recent years there has been an enormous interest in "happiness". Scientists think they have worked out what "makes us happy" - the chemical interactions in the brain that create the subjective feeling of "happiness". Though they seem to confuse it with "pleasure", which is not the same thing. Confusing "pleasure" with "happiness" is like confusing an energy drink with a balanced meal. The energy drink gives you a short-term sugar rush which soon wears off and may be followed by a hypoglycaemic crash which makes you feel even worse, whereas the balanced meal doesn't cause a "high" but gives you energy for a whole day. Similarly, we may get pleasure in the short-term from activities that in the longer term make us unhappy - recreational drug use leading to addiction, for example. Or we may use pleasure-giving activities to numb the the pain of broken relationships, unemployment, financial distress and general misery. We may escape for a brief while, but it doesn't solve the problem. We can experience pleasure without being happy.

Politicians have become increasingly interested in "happiness". To be sure, misery is expensive. Research shows unhappiness is associated with unemployment, marital breakdown, health problems and shorter lifespans, all of which are costly to the State. So to solve these problems, the answer is clear, at least to politicians. We must make people happy: then their marriages won't break up, they will find and keep good jobs and live long and healthy lives.

The trouble is, you can't "make people happy". Happiness is an individualistic emotional response to circumstances. The problem is defining what the circumstances are that may create happiness. Humans are complex: what may result in happiness for one person may cause misery for another. Indeed people are capable of feeling both happy and unhappy at the same time: I may feel happy that I am able to spend time with my children but unhappy that this is because I have lost my job. From a policy-maker's point of view, this is a nightmare: if they help me to find another job, I no longer have time for my children, so I end up feeling equally unhappy. Happiness is a matter of balance: we are "on balance" happy or "on balance" unhappy. Unalloyed happiness is an abnormal condition and may even indicate mental illness.

Some of the literature on happiness makes illogical causal assumptions. For example, here's Ed Diener (quoted by the BBC): "Happy people are more likely to get married, stay married and have fulfilling relationships". So in order to reduce marital breakdown and destruction of social networks, you need to make people happier, apparently. This is clearly absurd. If someone is unhappy because their marriage is in trouble, making them happier could involve ending the marriage.

But despite these difficulties, policy-makers are intent on making people happy. Over the last decade, successive UK governments have considered, and in some cases adopted, policies suggested by eminent academics that are supposed to improve happiness. These policies involve preventing people from doing or seeing things that might make them feel bad - for example, discouraging people from drinking, smoking or eating junk food even if these bring them short-term pleasure, or banning advertising of high-value things that most people can't afford.

And worse, they involve forcing people to do things that academics and policy-makers believe will make them happy, even if there is little justification for this belief. For example, the unemployed are unhappy. So, obviously, the solution is to force everyone into work - even poorly paid, unfulfilling work - and they will be happy, won't they? If only it were that simple. Nearly half of working people worldwide claim to be unhappy in their work.

Nor is work necessarily associated with better health, longer life or stable relationships. Indeed a pattern of working very long hours in poorly paid, insecure jobs is associated with poor health and broken relationships, not least because people working like that don't have the time or the money to eat properly, take exercise or spend time with their families. People who have bad jobs can be as unhappy as those who have no jobs. And people who have very good jobs (in material terms) can also be unhappy. The international executive who spends his life on a plane, rarely touching earth anywhere for longer than a day: the celebrity who lives out of a suitcase, seldom seeing friends or family: the top manager who works 12 hours in the office and a further 4 at home every day, and only spends time with his family on the few weekends in a year that he isn't working. We assume that their "champagne lifestyle" must be marvellous, and complain that they cannot possibly understand the problems of the poor. But in important ways these people have similar stresses to much poorer people working several part-time jobs to try to make ends meet, and the consequences for their marriages, their friendships and their health can be similar. Some enjoy this lifestyle (though it's not clear that their families do, necessarily). But a lot do not. We could describe them as "expensively unhappy". Many (myself included) step off the escalator to the high-flying lifestyle, because the personal cost is just too great. Lovely jobs can be just as lousy as lousy ones.

Chris Dillow observes that concentrating policy-making on measures of well-being rather than the somewhat nebulous "happiness" would be far more effective, but would unfortunately mean that policy-makers might actually have to address things like the real causes of unemployment and the quality of work. It's far cheaper to fund cognitive behavioural therapy (CBT) for those suffering from anxiety and stress due to unemployment or job difficulties than it would be to eliminate job insecurity and improve the design of work. And it also plays to the "blame the poor for being poor" lobby. If people are unhappy, it's not because of their circumstances, it's because there is something wrong with them. So fix their heads with therapy and they will feel much better, even though they still can't get a job that pays enough to live on or lasts for longer than a few weeks. Aldous Huxley foresaw this in Brave New World: CBT is becoming our version of Soma.

Policy-makers' commitment to creating prosperity through happiness amounts to a commandment. "Thou shalt be happy, that thou mayest prosper" is the Twelfth Commandment.* This is understandable. Powerful people like "commandments". Telling people what to do - or what not to do - is very much more attractive than empowering people to make their own decisions. Empowering people runs the risk that they will make decisions of which the powerful do not approve; decisions that are bad for them, or bad for society, or both; decisions that may make them unhappy. But people have the right to make bad choices. When we remove people's ability to make their own decisions, we make them sub-human. When we decide FOR "the poor", that what they need is food, shelter and warmth, and we provide these things in the form of food stamps, hostel places and blankets, we make them no better than farm animals - cared for, but controlled.  Does this make them happy? No, it does not. It may relieve their material discomfort, but it destroys their freedom - and that is more valuable than gold. The job of policy-makers is not to "make people happy", but to remove the obstacles that prevent them from being happy if they so choose - and then to accept that some people choose unhappiness, not because of material deprivation but because they are content with misery. To deny people the right to be unhappy is a denial of their humanity.

The ills of society are not fundamentally caused by people being unhappy. Nor, it is fair to say, is unhappiness necessarily caused by the ills of society. Happiness involves choice - which is why trying to "make people happy" is dehumanizing. However, I think the researchers that find a correlation between strong relationships and happiness are right: our relationships maintain our sense of self-worth, of being in the "right place", which is at the heart of happiness. People whose lifestyles make their relationships at best tenuous and at worst disrupted are likely to suffer from a distorted sense of self-worth and an insecure identity, and that makes for unhappiness. But there is something more fundamental here, too.

There has never been a connection between material prosperity and happiness. Traditional songs tell us "riches-to-rags" stories of people who choose poverty in order to be with the person they love. John Galt chooses poverty rather than relinquish control of his creativity. Our real wealth does not lie in material possessions - it lies in our ideas and our relationships. Working in mind-numbingly boring jobs for long hours destroys creativity. Financial stress and job insecurity destroy relationships. Poverty erodes intelligence. This is how we squander our wealth. This is how we destroy people's chances of real happiness.  If policy-makers really want to make people happy, they should look at ways of enabling people to express their creativity, use their intelligence, and develop satisfying relationships. Sadly, they are currently very far from doing anything so constructive.

Related reading:

The Precariat - Guy Standing (book)
Brave New World - Aldous Huxley (book)
The death of John Galt - Pieria
Hypocrisy - Still Life With Paradox

* The Ten Commandments require no explanation. But the eleventh, as every fule kno, is "Thou shalt not get caught". So "Thou shalt be happy" is the twelfth.