Wednesday, 27 May 2015

How do you say "dead cat" in Latvian?

This, my third post on Latvia, looks at its recovery from the 2008-9 recession.

Latvia is often held up as the "poster child" for harsh austerity measures as the means of returning to strong economic growth. In order to hold its currency peg to the Euro, it embarked on a brutal front-loaded fiscal consolidation in 2009, sacking public sector workers, slashing public sector salaries, cutting benefits and raising taxes. Between 2010 and 2013 it cut its fiscal deficit from 10% of GDP to a respectable 0.8%, a remarkable achievement by any standards.

Much of this was due to an equally remarkable rebound in GDP. After experiencing the deepest recession in the Western world in 2009 and an IMF programme, Latvia emerged from recession in 2010 and thereafter grew strongly. By 2013, the IMF's chief economist Olivier Blanchard, who had criticised Latvia's decision not to devalue, was eating his words. Latvia was out of intensive care and well on the road to recovery.

Austerians like to claim that Latvia's strong recovery was entirely due to its harsh austerity measures. But this, I fear, is the "post hoc ergo propter hoc" fallacy. Without adequate counterfactual evidence, we do not know what if any difference the fiscal consolidation made.

What we do know is that unlike most Western economies, Latvia experienced a fast rebound in bank lending after the crisis. The Bank of Latvia's bank lending survey for January 2010 notes that the "marathon" of tightening credit standards in the wake of the financial crisis had come to an end. By July 2010, this had led to a dramatic increase in loan demand by both non-financial corporations and households:

source: Bank Lending Survey July 2010, Bank of Latvia

The increase in credit to households generated recovery in the housing market, although it stayed well below its previous dizzy highs:

source: Arco Real Estate

The increase in lending to non-financial corporations was good news. In its Bank Lending survey in July 2011 the Bank of Latvia noted that Latvian corporations were borrowing primarily for investment:
A higher non-financial corporations' demand for loans was mainly on account of rising fixed investment as well as inventory and current asset financing needs, while the driver behind the rising household demand for loans was their improved confidence. Bank expectations regarding the demand for loans in the second half of 2011 remained optimistic for both non-financial corporation and household segments, suggesting a positive outlook for further recovery of the economy. 
Blanchard, Griffiths and Gruss in their 2013 analysis of the Latvian miracle note that there was a large increase in productivity. They ascribe this primarily to labour shedding, and indeed Latvia's very high unemployment and high emigration rate support this argument. But increased investment also seems likely to be a contributory factor.

Increased productivity enabled industrial production to recover from its pre-crisis slump:

The combination of domestic demand collapse with improved industrial production resulted in a sharp correction in Latvia's external balance:

But none of it lasted. The current account surplus quickly dissipated, leaving Latvia with a small but persistent external deficit. Industrial production declined in parallel. And the recovery in house prices was similarly short-lived. By the end of 2013, Latvia's GDP growth had sunk to just above zero. And there it has remained ever since. Latvia's remarkable recovery was in truth a "dead cat bounce".

So what caused a promising recovery to fizzle out? The Bank of Latvia's July 2012 bank lending survey contains disappointing news about credit standards:
According to the survey results, the credit institutions' forecasts of July 2011 about a moderate easing of credit standards did not materialise. In the second half of 2011, credit standards of credit institutions remained broadly unchanged: in comparison with the previous half-year, the number of credit institutions reporting slightly easing credit standards contracted notably; moreover, some credit institutions even pointed to slightly tightened credit standards (see Charts 1a and 1b). It is noteworthy that for the first time since January 2010, not a single credit institution reported easing of lending standards with respect to loans to households for house purchase. 
The extent of credit standards tightening is shown clearly in these charts:

And this followed through into reduced loan demand both from corporations and households:

What is particularly disappointing about this forecast is the expectation from banks that loan demand would fall. They knew that tightening credit standards would cause lending to decrease. And as we know that for small economies with limited access to capital markets it is bank lending that drives economic activity, the banks' forecast therefore amounts to a prediction of economic slowdown - caused by their own behaviour in tightening credit standards. Since then there has been no further relaxation of credit standards and no resurgence in loan demand.

But why did banks start lending again so quickly after Latvia's collapse? And why did they then restrict credit? To explain this, we need to understand the nature of Latvia's banking sector. It is largely foreign-owned, mainly by Scandinavian banks. Of these, the most significant are Swedish banks.

The Swedish bank bailout in 1992 has been widely admired as a model of how to deal with a banking crisis. Depositors and bondholders were protected, shareholders were diluted or wiped and banks were forcibly restructured, in some cases through nationalisation. Perhaps because of this swift and effective action by Swedish authorities, Swedish banks did not build up the dangerous leverage of other global banks. The market freeze in 2008 forced them to stop lending, and the falling value of Baltic real estate assets after the crisis damaged their balance sheets, but they recovered quickly and were soon able to commence lending again.

Though they didn't have to lend in Latvia. So why did they? I think Latvia's fiscal consolidation played a part, not because it imparted confidence - though it may have done - but because the government's insistence on holding the currency peg to the Euro at all costs encouraged restoration of cross-border lending. Foreign banks could lend with impunity both in Euro and Lat because they knew the government would not devalue. So Latvia is indeed a poster child for the benefits of austerity in a fixed-currency regime, if what you want is restoration of foreign capital inflows after a sudden stop.

But why did Latvia's banks subsequently reduce lending? I don't think this has anything do to with Latvia. An analysis of Sweden's banks by the IMF in 2012 showed that after an initial post-crisis increase (from which Latvia benefited), they progressively reduced cross-border exposures, no doubt under regulatory pressure to reduce balance sheet risk:

By 2012, Swedish bank lending to the Baltics had fallen from 11% of their total cross-border exposure to 8%. This is a larger fall than it appears, given that the banks were also reducing total cross-border exposures as a proportion of their balance sheets. The Baltics are small countries: this reduction is unquestionably significant. And for Latvia, the fall in corporate lending is particularly worrying, because that is what is really needed to generate long-term growth.

To me, Latvia resembles a puppet whose strings are controlled by large Scandinavian banks. The 2004-8 boom was caused by excessive lending by Scandinavian banks: the "sudden stop" in 2009 was caused by the failure of Scandinavian banks:the short-lived recovery was driven by Scandinavian bank lending: and the present stagnation is due to credit rationing by Scandinavian banks. Latvia is not going to experience any further recovery while its financial sector remains dominated by foreign banks who don't want to lend cross-border. The Balkanisation of the European banking system has severe consequences for the Baltic states.

Latvia has little or no control of its monetary conditions, and now it has joined the Euro it doesn't have much control of fiscal policy either. Its prosperity is entirely determined by the commercial interests of foreign banks and the attitude of their regulators. Is this really what the people of Latvia want?

Related reading:

The Latvian financial crisis
Property, inequality and financial crises

Tuesday, 26 May 2015

Reflections on death and immortality

This week saw the deaths of the great mathematician John Nash and his wife Alicia in a car crash and the suicide of terminally-ill businessman Jeffrey Spector in Switzerland with the help of Dignitas. This post is written in their memory, and also in memory of my friends and musical colleagues Gavin Williams, who died last week, and Lindsay Purcell, who died at the beginning of April. May they rest in peace. 

This post is unashamedly long. After all, death is forever. 

From time immemorial, humans have been obsessed with death. Or, more correctly, with the mess that death leaves in its trail. We fear death, not just because of our own extinction (or not, depending on your belief system), but also because of the consequences for those we love. There were so many things we meant to do, so many things to sort out, so many relationships to heal……But whether we are prepared or not, death will brook no delay. “It's too soon!” cried my aunt, on being given a diagnosis of terminal oesophageal cancer that left her with only a couple of weeks to live. After a lifetime of hoarding, she had no time left to clear out the loft.

For our forebears, “too soon” was indeed the risk. Life could be cut short at any moment by disease or accident. And the consequences for loved ones could be severe. The death of a breadwinner left his family destitute – and many men worked in hazardous occupations. The traditional song repertoire is full of women worrying about whether their husbands, away at sea or at war, would ever return. People had reason to fear death.

But in the developed world, we do not have such terrors now. We have widow’s pensions, life insurance, government safety nets. Few people work in hazardous occupations, and if they do, health & safety procedures minimize the risk of fatalities. Diseases such as tuberculosis and typhoid no longer decimate whole populations. Accidents still happen, of course. But we do not now live with constant fear of sudden death. Nor do we fear destitution for those left behind.

The longing for immortality

So do we still fear death? Perhaps, though in our increasingly secular society the conversation seems to be turning to anger. As we lose our faith in life after death, death is becoming the “final insult” in a futile life. Designers talk about helping people “create meaning” from death, but really all they are trying to do is replace the gap left by the decline of religion. Religion has always been about finding meaning in something as apparently meaningless as death. Death either must have purpose, or it must lead to new life. Evidence from science that there is neither purpose in death nor life after it is abhorrent.

Of course, it depends what you mean by “purpose” and “life”. When humans die, their bodies naturally decay just as those of other animals do: their vital elements go back into the ecosystem and provide nourishment to new forms of life. In this sense, therefore, the purpose of death is to enable new life to grow. Death is essential if the ecosystem is to renew itself. But that is scant consolation to the individual facing death. We still do not know the extent to which individual consciousness remains after death.

Nonetheless, people are becoming aware of the vital ecological role of death and increasingly wishing to be part of it. Exploiting the popularity of “green” burials, designers are inventing novel ways of becoming “part of nature” after death. The winner of a recent design competition was a coffin that grows into a tree; also highly placed in the same competition was a capsule that scatters cremated remains high in the atmosphere, from whence they fall to earth in raindrops. Immortality is to be achieved through integration with nature.

Yet there is nothing new about this. Burial in an unlined coffin is integration with nature. So is the scattering of ashes. The ashes of the writer and fellwalker A.W. Wainright were scattered on top of Haystacks, his favourite mountain in England’s Lake District. The ashes of my singing teacher Tony Hocking, who died in 2009, were scattered on the sea near his favourite beach bar on the Portuguese Algarve coast, which he had made his home. The places where people are buried, or their ashes are scattered, become sacred to their memories. Those who opt to have their remains scattered as raindrops make the whole earth their place of remembrance. The permanent association of people with places after death helps to “fix” them in the memories of those they leave behind. This too is a form of immortality.

And there are other forms of immortality. Those who have children have ensured their own immortality, as far as they are able: as long as the line continues, their genetic material is passed on, ever more diluted of course but still present.  Those of us blessed with creative gifts are privileged to create our own memorials, as Robert Louis Stevenson explains:

Bright is the ring of words when the right man rings them:
Fair the fall of songs when the singer sings them.
Here they are caroll’d and said, on wings they are carried,
After the singer is dead, and the maker buried.

The songs we make, the words we write, the designs we create live on after our deaths. In a way, they are our children: even if our genes do not survive us, our memes do.

If we have no children, and no creative talent, we still leave our signatures on the world. Those whose lives we have touched, with whom we have shared laughter and love, pain and anger: those with whom we have worked, with whom we have played: those who have interacted with us in any way, however fleeting: even if they have no conscious memory of us, we leave an impression on their lives. Without us, they would be different. Without us, the world would be different. Even those who die alone and are buried in an unmarked grave leave some trace, somewhere.

For some of us, there is the comfort of belief in a new life after death. For others, such belief is futile. But even if we do not believe in heaven or hell, or nirvana, or any other form of “life after death”; even if we have come to believe that all that happens when we die is that the lights go out, permanently; still we have immortality.

Of course, some are not satisfied with this. Just as people of the past embalmed bodies in the expectation that the owner would be back in due course to claim them, so now the rich and narcissistic preserve their bodies in the expectation of future resurrection. Cryogenics have never been so popular.

Scientists, too, hope to eliminate death. But they have not considered the consequences for the ordering of society. Science may eventually enable us to remain fit and well forever, but will we want to? An eternity of work does not sound an attractive prospect. It would be quite something for death to become the privilege of the rich, would it not?

The fear of dying

I wonder if it is not so much death that we fear, but the process of dying, increasingly drawn out over days, weeks or years. Premature death is now rare: life expectancy is rising fast as medical advances enable us to prolong life, perhaps longer than we would really like. For us, the risk is no longer death too soon – it is death too late.

We certainly fear pain, and dying has always been associated with pain. But this is a feedback loop: we fear pain, and fear increases pain. Cardinal Henry Newman, in his great poem “The Dream of Gerontius”, graphically describes the terror felt by a dying man:

“And worse and worse, some bodily form of ill
Floats on the air with many a loathsome curse
Tainting the hallow'd air, and laughs,
And flaps its hideous wings,
And makes me wild with horror and dismay….”

In Newman’s framing, death is agony. Not just physically, but emotionally. The dissolution of the self is horrifying. This is how we believe our forebears regarded death. So now, we aim to end the “agony” of death. And we are to a considerable degree successful. We can relieve physical pain as never before. We have counselling services to help people work through emotional distress. And the extension of lifespans means people have far more time to prepare for their deaths.

 The current obsession with death smacks not so much of fear, but of people with time on their hands. And, of course, commercial interests looking to take advantage of a projected large increase in demand for “death services” as the baby boomers grow old and die.

A host of applications and services is growing up to meet people’s demand to “design their own death”. Some of them are frankly ghoulish: for example, the Tikker app, which audibly counts down the seconds remaining to the date of death (chosen by the user) is horrifyingly reminiscent of Logan’s Run. And do people really want to meet in a café whose sole purpose is to facilitate discussion of death over a cup of tea? The success of “death cafés” suggests that yes, they do. And some go further. Hosting your own wake is becoming increasingly popular. Tom Sawyer weeping at his own funeral, and Finnegan turning up alive and well at end of his wake to the consternation of his (by then very drunk) friends, are no longer simply creations of fiction.  These days, we celebrate death before it comes to us, not afterwards.

The anger about death that I noted earlier seems to stem partly from loss of control. People who design their own death tend to expect death to occur as they planned. “We didn’t get the death we wanted”, say their relatives when it doesn’t work out quite like that. But death is no more under voluntary control than birth. Just as a woman may find that the home birth she planned is impossible because of medical complications, so a “death plan” too may have to be abandoned, if Death has other ideas. This is not to say that people should not prepare for their death: on the contrary, people who have thought about their own mortality do tend to approach death in a better frame of mind than those who have not. But over-planning carries the risk of disappointment. However meticulously you plan, in the end you may not get the death you want.

However, it is also true to say that the medicalisation of death, like the medicalisation of birth, creates a “spiral of intervention” that may not be in the dying person’s best interests. Death is not an illness to be treated: when death is inevitable, what is the justification for ever more invasive medical and even surgical intervention? It is as if the medical profession regards death as failure. “We did all we could”, they say defensively. But “doing all they could” is not necessarily doing what they should. Easing someone’s path out of life by relieving pain and emotional distress while avoiding unnecessary and intrusive medical interventions may often be better. This is the approach taken by the hospice movement, now widely respected as a beacon of good practice in palliative care. Creating calm, homely environments – or even better, making it possible for people to die at home, in their own environment – goes a long way to turning death from a foe to be feared into a friend to be welcomed.

Re-imagining death as a friend is nothing new. Schubert’s song “Death and the Maiden” does exactly this: the frightened girl, faced with an untimely visit from the “wilder Knochenmann”, tells Death she is too young to die. But Death reassures her: “Sei gutes Muts! Ich bin nicht wild: sollst sanft in meinen Armen schlafen.” However, it seems we need constant reminders of Death’s friendly nature. J.K. Rowling’s embedded story of the Three Hallows in her Harry Potter epic re-invents Death as a friend. So does Terry Pratchett’s wonderful depiction of Death propping up a bar and discussing, among other things, his own death. The feared Black Rabbit in Watership Down is welcomed by the tired Hazel.

The message of all these writers is that if we fight Death, our end is painful and traumatic: but if we allow Death to take us by the hand and lead us into the unknown, the process of dying is likely to be much more peaceful. Perhaps the way to get the “death we want” is, rather than planning every detail, to be open and relaxed about the possibility that it might not happen as we might like: dying peacefully at home surrounded by friends and loved ones is perhaps an ideal to aspire to, but it is not, and never will be, the reality for everyone. Much of the work of today’s “death designers” is, or should be, about reducing stress and creating an atmosphere of calm acceptance whatever the circumstances. And since despite our best efforts a significant minority of people will always die in hospital, making hospitals less stressful for patients would be a good place to start. Technology can help with this, of course. But do we really need a host of apps and gimmicks?

For people facing long debilitating and painful illnesses, death may indeed be a friend eagerly awaited, though the taboo against assisted suicide in most Western countries means that the wait may be very long. The controversial work of Dignitas, enabling people to embrace death at a time of their choosing, is a welcome relief for some. But for others, it is a bridge too far: actively helping people to die has important moral, social and religious implications, and carries the potential for abuse.

The wastefulness of death

But of course comments like “we didn't get the death we wanted” come not from the person who died, but from those left behind. Death is a social event.

The living have as much if not more to say about the management of death than the dying. Expectations can be raised, and dashed: the loved one dies horribly, perhaps in pain that cannot be fully relieved or in very medicalised, clinical surroundings. Perhaps death comes too quickly, and they die alone. When the living are denied the opportunity to participate in the death of a loved one, they can be deeply hurt, feeling that they “never got the chance to say goodbye”.

Death is messy. Disposing of the actual remains is the job of undertakers: this is a completely dysfunctional market, of course, because no-one wants to be bothered with shopping around for funerals when they are grieving. Anyone suggesting that the funerals marketplace could do with more competition needs their head examining. It needs regulation, not competition. But there is far more to clearing up the mess that Death leaves behind. Sorting out the personal effects of the deceased is a difficult and painful task. Distributing valuables can be even worse, especially if no legal provision has been made. People who don’t make wills can unwittingly leave very unpleasant surprises for those left behind. We owe it to those we love to prepare adequately for our death.

The advent of the digital age has complicated the task of clearing up after death. People’s online personalities can live on long after their death: it is oddly uncanny to receive a spam email from the account of someone who has died, or see a Facebook post a year after their death. It is probably worth closing down email accounts, and there are now companies that will undertake clearing out of digital records on behalf of grieving relatives.

But these ghostly appearances can be a new form of memorial. Facebook, in particular, is becoming a sort of digital mausoleum. Not only is it used to notify friends and relatives of a death (I found out about Lindsay Purcell’s death from a status update on her Facebook account, placed there by her son), people post photographs and memories on the walls of those who have died, particularly on anniversaries. No doubt there are companies which will create “digital memorials” for those who wish to purchase them: but people spontaneously using Facebook to remember their loved ones seems to me more poignant and meaningful.

Indeed, creating memories is something that technology does all too well. Messages can be sent from the deceased to their loved ones on important dates such as birthdays for many years after death. Photographs can be stored and organised for easy access: videos and audio recordings too. We can, at the touch of a button, bring back our loved one again, and for a moment, be “as we were in May”. Grief can be eased by such technology: but it can also be prolonged. Living in the past is all too easy when the past is so easy to access. Does this really help the process of healing?

And of course these digital memories are still just that – memories. The loved one is gone. We see and hear them as they were, not as they would be if they were still here. All that they have learned in their lives, their personalities formed from heredity and experience – those are gone. Indeed for an increasing number of people, those are gone long before death. Dementia progressively destroys the memory and the personality. Clever apps that remind dementia patients to eat may keep their bodies alive for longer, but they do nothing to restore the person. Dementia is hell, both for those who experience it and for those who witness it. I would rather see funding for scientific research directed towards ending the living death of Alzheimer’s disease than sunk into seeking the elimination of death itself.

Rather than eliminating death, perhaps we could aim to end ageing. Enable people to remain fit and well to the end, then die at a time of their choosing. They would become cyborgs, of course, as the various parts of them that wear out are replaced with synthetic equivalents: eventually, I suppose, all humans would be cyborgs to a greater or lesser extent. We have already created what we will become.

Perhaps also science could find a way of ending the really wasteful aspect of death – the loss of the knowledge and experience that people acquire over their lifetimes. Only a fraction of what people discover, and think, and learn is ever transmitted to the next generation. If we could find a way of capturing what people have locked up in their heads, perhaps we would be able to break out of the cycle of repeated mistakes and painful lessons into which we are locked because collectively, we cannot remember….

Related reading:

Broken windows, broken lives – Coppola Comment
A strange memorial – Coppola Comment
Reinventing death for the 21st century – Design Council

Image from Mashable. 

Monday, 25 May 2015

Property, inequality and financial crises

At the end of my previous post, I posed the question: why did Latvia experience the deepest recession in the world in 2008-9?

The first puzzle is that Latvia's banks were in no worse shape than anyone else's and better than some. Among small countries, Iceland, Ireland and (in 2013) Cyprus all experienced bigger banking collapses relative to the size of their economies than Latvia. Larger countries did too, notably Germany and the UK, both of which suffered widespread damage across their large and arguably over-developed banking sectors. In the US, the big banks were bailed out, but literally thousands of small ones failed.

To be sure, Latvia did not escape unscathed: its second biggest bank, Parex, failed and was nationalised, and three other banks needed liquidity support. But that's really not sufficient to cause a recession of such magnitude. The 1995 crisis was much larger, but did not have anything like so great an economic effect.

The chart below shows Latvia's long-run GDP growth rate (source: World Bank). Don't be distracted by the extraordinary fall in GDP in 1992: I've included that for context. We may think the 2008-9 recession was terrible, but Latvia had experienced far worse within living memory.

Towards the end of the 1990s, Latvia embarked on a growth phase. This was steady to start with, but after Latvia joined the EU in 2004, GDP rose fast, peaking at over 10% per annum in 2006:

What drove Latvia's growth? Firstly, consumption, which drew in imports. Latvia's trade deficit, already large and persistent, increased sharply after it joined the EU:

Consumption was driven by fast-rising wages:

And industrial production declined, particularly from 2006 onwards. So it's not just that Latvians were consuming more, they were producing less:

So where did they get the money?

It's an all too familiar story. Inflows of foreign capital, mainly from Scandinavian banks, attracted by low interest rates and a population hungry for credit - credit advanced, of course, against property. Latvian house prices soared and there was a construction boom. Easy credit, wealth effects and incomes from construction and real estate activities also fuelled a consumption boom: suddenly Latvia, one of the poorest countries in Europe, was flooded with Porsches and Bentleys.

But Latvia was not the only Baltic state to experience a house price boom. All three states did. And  the "housing affordability" index (house prices versus GDP per capita) for all three suggests that the property boom was on a similar scale in all three states - indeed Lithuania's was slightly larger:

(source: Wikipedia "Housing Affordability Index for the Baltic States") 

It is evident from this chart that Latvia's property bubble burst more explosively than either Lithuania's or Estonia's. Property prices fell by 60% between 2009-10. We now know that such enormous property market collapses have devastating economic effects. This is of course the cause of Latvia's dreadful recession.

But why did the bubble burst so explosively? The answer is in this chart, which shows the house price to rent ratio:

(source: Wikipedia "House Price to Rent Ratio for the Baltic States") 

There was evidently a large wedge between house prices and rents in Latvia, which did not exist in the other states. The "housing affordability" chart is thus misleading. The house price rises were actually far more "unaffordable" in Latvia than in the other two states. This suggests that Latvia had higher inequality.

And indeed it did:

(source: Gini research, 2012)

All three states had high inequality, a legacy of  their abrupt transition to a market economy in 1990. But Latvia's was the highest.

This explains why a property and construction bubble driven by excessive cross-border lending by Scandinavian banks was so devastating. Many Latvians were much poorer than the GDP per capita figures suggest, and it is these poorer Latvians to whom the Scandinavian banks were lending. But these generally poor Latvians were highly sensitive to interest rate rises and tightening of credit conditions. When they stopped borrowing, they stopped spending, and the economy collapsed.

I have never seen anyone draw a connection between inequality levels and severity of financial crises when property bubbles burst. Yet it is clear to me, at any rate, that Latvia experienced the worst recession in the Western world because of high inequality in a generally poor country. Had income been better distributed among the population, and credit less well distributed, the damage would not have been so great.

And this raises a question. Is the association between inequality and severity of recession peculiar to Latvia, or is it robust across other countries too?

If it is, then it raises a serious question about our approach to economic reform. Reducing inequality and stabilising household incomes may be at least as important for financial stability as limiting the availability of credit.

Clearly, more research is needed on the relationship between inequality, poverty and financial crises.

UPDATE: It seems I haven't been keeping up. In their paper "Inequality, Leverage and Endogenous Default", IMF researchers Kumhof, Ranciere & Winant consider exactly the same issue in relation to the US. This chart says it all, really:

And for those who don't want to believe that there is any connection between inequality and leverage, the authors have also produced the same chart for the US up to the Wall Street Crash:

The US suffered an even larger GDP contraction than Latvia (29%) in the ensuing Great Depression. 

For those who don't want to read academic papers, the authors have helpfully provided a blogpost on VoxEU as well. 

Sunday, 24 May 2015

The Latvian financial crisis

This is not what you think it is. And it is not what I intended to write about, either. I was going to write about Latvia as it is now, after the deepest recession in the world in 2008-9 and an excruciatingly painful front-loaded fiscal consolidation. Has it really recovered, or is it just marking time?

But in looking at Latvia now, I find myself drawn to its history. Latvia's unusual response to the kicking it got in 2008 was because of its history. It had a deep recession 1991-3 and a severe financial crisis in 1995. These experiences undoubtedly coloured its response to the 2008-9 disaster. We should not assume that the harsh medicine Latvia swallowed in 2009-13 would either work or be appropriate elsewhere.

So, Latvia. For those who have never heard of it (apart from bad Eurovision songs), it is a tiny country sandwiched between Lithuania and Estonia, bordered on the East by Russia and Belarus and facing Sweden across the Baltic Sea. Here's a map:

Although Latvia has an ancient pedigree, its present independence has been hard-won. It was the subject of constant territorial wars from the thirteenth century onwards, finally being incorporated into the Russian empire in 1710. After a long campaign it was granted independence from Russia in 1920, only to be seized and forcibly incorporated into the Soviet Union in 1940. It was invaded and occupied by Nazi Germany in 1941 then recovered by the Soviet Union in 1944-5. It was then brought under close Soviet control and progressively "Russified": factories were built, farms collectivised and large numbers of Russian speakers relocated to operate them.

Latvia began a new quest for independence in the 1980s. The Latvian Supreme Council declared independence in May 1990: this was initially resisted by the Soviet Union but finally granted in August 1991. After independence, Latvia quickly became a member of the UN, the IMF and the World Trade Organsiation, and joined the European Free Trade Area in 1992. In 2004 it became a member of both the EU and Nato. It converted to the Euro in January 2014. 

But its independence has not only been hard-won, it has been extremely painful. Immediately after independence Latvia set about the task of converting from a command economy to a market economy. The effect on the Latvian economy was harsh. Soviet-supported heavy industry entirely collapsed, as the website Latvian History explains:
 In the Soviet period Latvia was the industrial center in the USSR. Soviets build a large amount of factories in Latvia and sent thousands of workers from whole union to Latvia. This caused mass immigration and downsize of Latvian majority. This leads to speculate  that massive industrialization was intended to assimilate Latvian nation. Large industrial enterprises worked only for Soviet market and were associated with main company bodies in Moscow. Also they were deeply connected with the Soviet military complex and half of the civilian industrial production was actually used for military purposes. After the fall of USSR these factories could no more compete with free market and lost contact with state and Russian military.  Large enterprises such as State Electronics Factory, Red Star, Alfa and others bankrupted. State officials done little to prevent whole industry collapsing. Today is still hard to answer could industry be saved and what should be done. However many say that it was impossible to save it. But the loss of large enterprises made a large amount of unemployed people. 
Re-establishing private property rights also caused agricultural production to fall:
Reforms hit hard also on agriculture. In Soviet era all agricultural property was in state hands. Collective farming (kolkhoz)  was the main subject in the country. When private property was established kolkhoz’s failed as the land was privatized.  In Soviet times all farm land was sowed and farms were rich, now because of poor handling of private property land became poor and undeveloped.
And, of course, Latvian branches of Soviet-owned banks suddenly found themselves cut off from their parents. Latvia's new central bank collected them all under its wing and allowed them to continue lending on a business-as-usual basis, largely unsupervised, while the Government decided on a privatisation strategy. Safely backed by the central bank, and accountable to no-one, they carried on lending to the collapsing industrial sector. Non-performing loans rose at an astonishing rate: an audit performed with the assistance of the Swiss government revealed NPLs of 25m Lat (about $250m).

In parallel with this, Latvia permitted uncontrolled creation of new, lightly regulated commercial banks. Unsurprisingly, banks proliferated: between 1991 and 1993 over 60 new banks were created. Some were "pocket banks" owned by state enterprises, some were created to raise deposits for on-lending to their owners, while others were solely intended to raise finance for specific functions: Olympija Bank, was created to fund the Latvian Olympic team. These banks grew very fast. By December 1994 85% of bank assets were in the new commercial banking sector. But the new banks, lacking adequate regulation or even - as it turned out - honest and competent management, were fragile and vulnerable to shocks.

In 1993 most of the former Soviet branches were sold to some of the largest of the new commercial banks. The remainder were consolidated under new management into a new state-owned savings bank, Unibank: the NPLs were removed from its balance sheet into a "bad bank" and replaced with government bonds.

In March 1995 the largest of the new commercial banks, Bank Baltija, collapsed, apparently due to lack of confidence after it was unable to provide the Bank of Latvia - or even its own auditors, Coopers & Lybrand - with accounts that complied with IASB standards. Bank Baltija was high-risk by any standards, expanding its deposits very fast by offering interest rates in excess of 90% when other lenders were offering a more restrained 14-20%. But no-one was paying attention to risky behaviour by banks. Consequently, when rumours started that Bank Baltija was in difficulties, there was a slow bank run not only on Bank Baltija but on other commercial banks too, most likely because of concerns that private deposit guarantees would turn out to be worthless.

The Bank of Latvia initially provided liquidity. But it soon became clear that providing liquidity was simply pouring money down the drain. Bank Baltija was deeply insolvent. Its negative net worth was estimated to be $320m, about 7% of Latvia's projected 1995 GDP. Bailing this bank out was not an option: Latvia was running a fiscal deficit of about 3% of GDP, rather high for an economy in transition, and it was barely recovering after the deep recession caused by the post-Soviet restructuring. The bank had to be resolved.

Initially, the owners and managers suggested a merger with the Latvian Deposit Bank and Centra Bank. This may have been a delaying tactic to enable them to salt away Bank Baltija's assets, principally via a Russian "pocket bank", Intertek, incorporated in Moscow and apparently owned by Russian oil and energy interests. By the time Bank Baltija was declared insolvent in July 1995, over half of its assets had mysteriously disappeared. Eventually, it was taken over and restructured by the Bank of Latvia.

But it is just as well that the merger did not proceed. The Latvian Deposit Bank and Centra Bank also failed. In total, seven banks failed in the Latvian crisis:

Other banks also required liquidity support.

Alex Fleming and Sam Talley at the World Bank, in a fascinating paper (from which the above table is taken), drew five lessons from the Latvian crisis. I reproduce them in full here for reasons which will become apparent.

1. The banking systems of transitional countries are inevitably exposed to major strains and stresses, particularly during the first several years of the economic reform process.  This is for three reasons:
  • Restructuring and privatisations of state-owned enterprises limit their borrowing capacity and ability to service their debts. Privatisations are often a major part of reforms designed to liberalise a sclerotic economy, but eliminating state support for enterprises can pose serious risks to banks. This problem is as far as I know seldom if ever considered in the planning of economic reforms.
  • Reduction in inflation due to major economic restructuring, which is usually accompanied by (sometimes deep) recession, reduces the ability of businesses and households to service their debts, again with potentially disastrous effects on banks.
  • Economic liberalisation tends to result in largely privately-owned banking systems that lack adequate regulation, insurance or lender-of-last resort facilities. We would now call these "shadow banking" systems. 
2. If banking systems are exposed to stress, the government must take strong actions to protect against this vulnerability. This means:
  • establishing a sound legal framework for banking, developing effective regulatory and supervisory functions, and implementing good bank disclosure, accounting and auditing standards 
  • developing effective mechanisms for handling problem banks and closing insolvent banks promptly. The World Bank writers observe: "In Latvia, it was not just that Bank Baltija, the largest bank in the system, failed, but that when it was finally closed it was so deeply insolvent that the government essentially lost the option of bailing out this key bank in order to protect depositors and the payments system". When a bank is failing, delay is costly.  
3. State-owned banks can serve a useful function as "buffers" in a systemic crisis, as Unibank did in Latvia, provided they are well managed and are "relatively free from political influence".Perhaps we should not be quite so quick to privatise everything, or to assume that only the private sector can run banks efficiently and effectively?

4. Supervisory authorities should look carefully at banks which are 'outliers" in the banking system. "Banks that are expanding their assets or branch networks exceptionallv quickly, or banks that are offering particularly high deposit rates, should be subject to intense supervision. Activity in specific banks which is outside the norm may be an indicator of a problem in the bank concerned."

5. Fraud, managerial incompetence and excessive risk-taking can have devastating effects on a banking system, particularly if they occur in the largest banks. The solutions to this are:
  • Screen carefully those who want to work in banking
  • Impose frequent thorough on-site examinations on all banks: allocate the best examiners to the banks that pose the greatest systemic risk
  • Annual audits should be required for all banks regardless of size, and auditors must have a legal duty to report significant irregularities to supervisory authorities
  • Where banks are in trouble and there is a hint of fraud, authorities should act decisively to deal with the banks AND those responsible for the problem. 
Written in 1996, these are supposedly lessons for transitional economies. This is probably why they have been ignored. No-one imagined that the very same problems could occur - several orders of magnitude larger - in mature Western economies. But we now know better, don't we?

The lessons from Latvia's 1995 financial crisis resonate today as the Western world attempts to reinvent its dysfunctional banking system in the aftermath of the worst financial crisis since the 1930s. They seem eminently sensible: perhaps, if we had applied those lessons to developed as well as transitional countries, the course of history might have been very different.....

But there's a problem. In the 2008-9 crisis, Latvia suffered more than any other country despite its extensive bank reforms after the 1995 crisis. Yet only one of its banks failed (Parex): the rest were bailed out by their foreign owners. So the question is, if Latvia's banks were actually in better shape than those in other countries, why did Latvia suffer the worst recession in the world?

To be continued......

Riga, capital of Latvia. Photo credit: Wikipedia

Wednesday, 20 May 2015

Redefining retail banking

Yves Smith at Naked Capitalism takes issue with me over my attempt to derail the "Banking should be boring" bandwagon. She claims that new research by the IMF proves that banking should indeed be boring:
The IMF paper is generally in line with the argument that banking should be boring, meaning that complexity, opacity, and leverage typically work far more for the benefit of the financier and at the expense of customers and society at large. Frances Coppola tries to turn that argument on its head and say that banking should be fascinating. Hun?
I am astounded by this interpretation of the IMF paper. These are the paper's actual conclusions:
First, financial development is multi-faceted and should be measured by looking at many indicators. Second, financial development can be promoted by putting in place a strong business, regulatory, and supervisory environment. Of the 93 regulatory principles, the critical principles that matter for financial development and financial stability are essentially the same. This means that better—not more— regulation is what promotes financial stability and development. Third, since the weakening effect on growth at higher levels of financial development stems from financial deepening, raising access or efficiency at any level of financial development would be beneficial. Fourth, to mitigate economic and financial stability risks, as well as reduce the likelihood of a crisis, too fast a pace of financial development should be avoided. Finally, there is no “one-size-fits-all” in terms of sequencing the development of financial systems, but the relative benefits from institutions decline and those from markets increase over time. 
How on earth do you get from these to "banking should be boring"?

Yves' interpretation directly contradicts what the head of the IMF said about this research, too. At the INET conference in Washington DC on May 6 -  which I attended -  Christine Lagarde took issue with Elizabeth Warren for saying “banking should be boring”. Giving a heads-up on this research, Mme. Lagarde emphasised the crucial importance of deposit-taking, lending and payments services for economic development and human well-being. And like me, she questioned how providing financial services to the real economy could possibly be regarded as boring.

I was particularly struck by Mme. Lagarde's concern for those, especially women, who are directly disadvantaged by lack of access to banking services:
Financial systems around the world are quite sizeable, but they exclude many individuals and firms from financial services. For example, data released during this year’s IMF-World Bank Spring Meetings suggest that 2 billion adults worldwide remain without a bank account. That represents a 20 percent drop in the number of “unbanked” over the last three years, but it is still a massive number.
Moreover, financial exclusion is far from being solely a low-income country or emerging market issue. For example, even here in the United States, surveys find that some 8 percent of U.S. households are “unbanked” and some 20 percent are “underbanked”.
Studies show that broader access to the financial system can boost job creation, increase investments in education, and help people manage risk and absorb financial shocks. Our own analysis that will be released later in the fall finds that financial inclusion is particularly important for women, empowering them economically. Indeed, the numbers suggest much scope for improvement in this area.
Globally, a staggering 42 percent of women lack access to basic financial services, compared to 35 percent for men. This gap is even bigger if we consider the role of women in the provision of financial services. In a world-wide sample of banks, less than 20 percent of board members are women, and only 3 percent of bank CEOs are women. Clearly, we need to do better.
We do indeed. But how, in heaven's name, can we improve financial inclusion while we are doing our level best to put people off providing essential banking services by describing them as "boring"?

Mme. Lagarde's comments were written up approvingly by Rona Foroohar in TIME magazine:
I do think that Lagarde was spot on to disagree with the notion that “banking should be boring.” This CW is often thrown around to indicate the idea that banks should do “plain vanilla” lending rather than complex deals with sliced and diced securities. Fair enough. But as the IMF chief pointed out, “Why should lending to the real economy be boring?” The shifts that need to happen to bring finance back in service to the real economy are myriad and complex. They include changing tax policy that rewards short-term gains over longer-term ones, reforming corporate governance, increasing personal liability, changing the structure of banks themselves and making our system of shareholder capitalism more inclusive. But the original mission of banking — finding new innovations and funding them to create growth in society at large — is anything but boring. The regulatory and cultural journey back to that, which will no doubt take several more years, should be interesting too.
I couldn't agree more. Intrinsically, retail banking is NOT boring. It has become boring because we have made it so.

Yves' observation that retail banks have become “stores”, with de-skilled workers whose job is simply to move products, is correct, but I was way ahead of her. I have now been writing for over four years about the deep structural problems in retail banking.  The transformation of retail banks into shops is the theme of  the post "Supermarket Banking" that I wrote back in 2012. This post was based upon my own experience of working for Midland Bank while it was turning its branches into shops, the first UK bank to do so. You see, unlike Yves, I worked in retail banking. I really do know what it is like.

In pursuit of profits in a low-margin, cut-throat industry (yes, this is RETAIL banking I am talking about), retail banks systematically downgraded the skills of front-line retail staff, removing from them all real responsibility and virtually all need for engagement with their customers. They turned them into salespeople, giving them impossible sales targets with severe penalties for failure. The jobs of retail staff became boring, hard work and poorly paid. Talent drained from retail banking into the better-paid, more interesting and sexier investment banking.

The consequences of making retail banking "boring" have been terrible. Transforming banks into shops and their staff into salespeople led directly to the swathes of mis-selling and outright fraud that have plagued retail banking in recent decades. Mundane, tedious, poorly-paid retail banking is now not even respectable. No wonder talented people don't want to do it. As Mme Lagarde says, we must do better.

Somehow, we have to make lending, deposit-taking and payments services to ordinary people and ordinary businesses interesting again. There is excitement to be found in financing innovation that generates growth, and satisfaction in supporting people's financial needs through their lives. Describing this as “boring banking” does not in any way help to achieve this.

Tuesday, 19 May 2015

Mirrors and Glass: the role of design in a time of change

W.H. Auden’s epic poem “The Age of Anxiety”, written during the dark fragmentation of the Second World War II, was widely acclaimed as defining the spirit of our time. Few claim to have read it, but everyone knows the title: as Daniel Smith put it in an op-ed in the New York Times, “as a sticker on the bumper of the Western world, “the age of anxiety” has been ubiquitous for more than six decades now.” Anxiety – and its cousins introspection and depression – is widespread, disrupting relationships, destroying connection and replacing happiness with fear.

Or is it? Smith goes on to point out that people in earlier ages in many ways had more reason for anxiety than we, and that “anxiety” as a condition was not even recognised before Freud. He argues that our anxiety stems from growing self-awareness. Indeed, this is consistent with Auden, whose poem opens with one of the principal characters gazing at his reflection in a mirror: just as the Queen in Snow White calls upon the mirror to reassure her of her outstanding beauty – betraying her underlying anxiety about being supplanted – so Auden’s character’s question to the image in his mirror betrays his sense of unreality and falsehood:
Does your self like mine
Taste of untruth? Tell me, what are you
Hiding in your heart?
The editor of the critical edition of Auden’s poem notes that in 1942, Auden wrote an essay for the Catholic journal “Commonweal” which starts thus:
Every child, as he wakes into life, finds a mirror underneath his pillow. Look in it he will and must, else he cannot know who he is, a creature fallen from grace, and this knowledge is a necessary preliminary to salvation. Yet at the moment he looks into his mirror, he falls into mortal danger, tempted by guilt into a despair which tells him that his isolation and abandonment is [sic] irrevocable. It is impossible to face such abandonment and live, but as long as he gazes into the mirror he need not face it; he has at least his mirror as an illusory companion. . . .
The mirror is the symbol of the “Age of Anxiety”, which is characterised by introspection, obsession with self-image, and distortion. At its extreme, it encompasses thinkers such as Ayn Rand, who rejected all forms of collectivism and regarded selfishness as a virtue, and politicians such as Margaret Thatcher, denying the existence of “society” and trumpeting the primacy of the individual.

It was not always so. In the immediate aftermath of World War II there was a sense of shared purpose. Social design was the hallmark of the time: housing projects, transport systems, the NHS…linking together the patchwork of existing social provision, rebuilding places and communities damaged by war and depression. But as Western countries rejected the Marxist-Leninist “collectivism” of the Eastern bloc and embraced Hayekian “individualism”, designers abandoned social enhancement and became drawn into shallow consumerism, building ever better mousetraps to meet consumer demand. Even today, “designer” is associated with expensive consumer products.

Frans de Waal’s 2009 book “The Age of Empathy” dismissed the notion that selfishness is natural for human beings. De Waal demonstrated that humanity’s closest relatives the Great Apes, together with other high-order social mammals such as dolphins and elephants, are predisposed to take care of one another, come to one another’s aid and in some cases, take life-saving action. De Waal argues that humans too are innately empathic and compassionate. If de Waal is right, then perhaps the “Age of Anxiety” has been an anomalous period. Perhaps the terrible cataclysms of the 20th Century, especially the “Cold War” that divided the world for three decades, traumatised humans to such an extent that they no longer trusted each other and instead turned inwards, relying on their own, albeit distorted, mirror images for comfort and guidance.

As the memories of the Great Wars fade, the introspective mood of the last thirty or so years is beginning to change. Supported by technology that enables openness and sharing as never before, a new generation is re-imaging “society” as a collaborative enterprise formed through trust and transparency. Selfish materialism is being replaced with concern for the wellbeing of others and for the environment. The mirrors of the “Age of Anxiety” are giving way to the windows of the “Age of Empathy”. The glass buildings of today symbolise our new-found openness.

The importance of connection

Empathy generates connection. And we now know from research by psychologists and neuroscientists that connection also generates empathy. The “Age of Empathy” could perhaps be called the “Age of Connection”. Re-connecting with others, with nature, with reality….this is the process of recovery from trauma.

Perhaps unsurprisingly, therefore, connecting with others is becoming crucially important for designers. Mariana Amatullo of Designmatters at Art Center says that the age of the “genius inventor” working alone is over: today’s designers work collaboratively as part of multi-disciplinary teams. Co-creation, co-design, unlocking the creativity of others, connecting diverse inputs into a coherent architecture: these are the roles of today’s designers.

To be sure, designers have always been empathic. Understanding “user needs” is the starting point for any design. But today’s young designers are more interested in inclusivity, public service design and social innovation than in developing the latest consumer gadget. Of 14 recent graduates from the Helen Hamlyn School of Design at the Royal College of Art, only one wanted to work in business. As Mat Hunter of the Design Council puts it, “public service design is what the cool kids are doing”.

Whether the new focus on inclusive social design is driven by the students themselves or by their teachers is hard to say. Rama Gheerawo, Deputy Director of the Helen Hamlyn School of Design, emphasises wellbeing as the principal goal of design. He sees people as “living – moving – connecting”. Living space, the ability to move around, connecting with others: these are the features that together make up wellbeing.

Focusing design on improving wellbeing can have surprising results. For example, a recent project run by the Design Council jointly with NHS England explored the causes of aggressive behaviour in A&E departments, a seemingly intractable problem. Mapping the processes that defined how the department worked showed that aggression was often associated with high anxiety levels in patients who could not find their way around in an unfamiliar environment designed to suit staff rather than patients. A simple solution was to provide improved signage so that patients knew where they were in the system. Prototyping with real A&E departments showed that signage was needed on ceilings, since patients on stretchers could not see conventionally-located signs, and in the car park, since even finding the entrance to the A&E department caused anxiety for many people. The design focused on improving the wellbeing of patients rather than reducing risks to staff – but because it addressed the causes of aggression, it was far more cost-effective than security measures to protect staff from aggressive patients.

Making life easier for people has been a principal goal of design since time immemorial. Even the consumerism of the 1970s and 80s was linked to lifestyle: Terence Conran’s Habitat famously promoted the “continental quilt” or duvet as a labour-saving device to make life easier for the “Superwoman” epitomised by Conran’s wife Shirley. Design enables people to spend less time doing boring and mundane things and more time doing things they enjoy.

Design can also make unpleasant but unavoidable things more bearable, such as the dreaded security checks at airports. After the 9/11 disaster, airports imposed intrusive and indiscriminate security checks. This raised anxiety and aggression levels among passengers, which perversely made it harder for staff identify genuine security threats. In conjunction with America’s Transport Security Agency, IDEO created a calmer environment at the checkpoints, redesigning physical spaces and retraining staff. Once the general stress level among passengers was reduced, people with “hostile intent” became easier to spot.

Despite the move towards co-design and co-creation, traditional attributes of designers are still important: creativity, which Amatullo defines as “the ability to create novel and useful designs”, and concern for aesthetics. Beauty in design is important not just as an end in itself, though this is important: people engage more with designs they find aesthetically pleasing. But beauty is also important as a means of understanding functionality. Elegant designs tend to work better.

But although empathy is important, design cannot be wholly democratic. Designers need to direct as well as facilitate, imagine as well as listen. And they must “own” their ideas. Empathic they may be, but they are not simply passive compilers of the ideas of others. Design is not limited to meeting wants and needs. It can involve challenging them.

Bold designs – even disruptive ones - may have their origin in a throwaway remark in an informal conversation, or in a seemingly minor incident. Gheerawo cites Mahatma Gandhi, whose lifelong commitment to social justice stemmed from being thrown off a train in South Africa. “Base your boldness on empathy and understanding”, says Gheerawo, “otherwise where are your business decisions coming from?”

The dark side of technology

The intrusive nature of big data collection and analytics raises concerns about privacy and the rights of the individual. Internet applications collect data without the knowledge of their users, parsing that data to determine people’s browsing habits in order to sell them more stuff. We may now value interconnection more than introspection, but that doesn’t mean we have entirely given up on consumerism. If you buy a mousetrap online, you will be helpfully presented with lots of adverts for better mousetraps. Your activities have been observed, interpreted and used to influence your future actions. But should advertisers - or anyone else, for that matter - be able to collect and use data in this way without people's knowledge or consent?

Similar ethical questions are raised when design is used to “nudge” people into “desirable” behaviours. For example, the Design Council’s Active by Design project aims to encourage active lifestyles through design or redesign of indoor and outdoor spaces, thus reducing the health problems caused by inactivity among the general population. Although the cost savings for the NHS could be considerable, some question whether behavioural change of this kind is a legitimate goal of public service design. Surely people have the right to be couch potatoes if they choose?

The idea that services should be “designed” is new, radical and potentially hugely beneficial for society. But it carries dangers. Public service designers risk being hijacked by political interests, whether those who see design as a way of minimising the cost of state services – or eliminating them completely – or those who see design as a way of preserving and entrenching traditional fiefdoms.

Mat Hunter spells out the dangers of technology-led design:

We can do amazing things with all this powerful new technology. But we haven’t lost what we learned about its darker side. We’re aware that it won’t automatically lead to good outcomes so we have to be more intentional about what we do. The question is now: “we’ve created all this [technology], now what do we want to do with it?"
The growing power and intrusiveness of technology raises important questions about the ordering of society that we have not yet adequately addressed. Just because we CAN monitor every part of human life and nudge people into behaving in certain ways, doesn’t mean we should.

When every action is subject to scrutiny, the risks of failure become very large. Mistakes are costly, not in financial terms but in reputation. And yet designers need the freedom to fail. Gheerawo describes the genesis of innovation as a “lightbulb moment” which removes fear of failure: once the problem is obvious, so is the solution. But informal discussion may result in the wrong lightbulb being turned on, especially if it involves the wrong people. Indeed, failure is inevitable: after all, how do you empathise with millions of people?  The freedom to get things wrong is essential to creativity. Thomas Edison (inventor of lightbulbs) famously said that he did not fail, he just found 10,000 ways that wouldn’t work. Nassim Taleb describes his trading approach as making many, many small losses which are outweighed by occasional very big gains. Throwing away something that doesn’t work is not failure, it is learning. The best designs may be found through trial and error.

So as empathy comes to dominate the design process, and technology pervades the most fundamental structures of society, we need to ask ourselves “what are the limits of connection?” Should every wrong decision, every silly idea, every inadequate design be subject to public scrutiny? Or do we need the glass windows of the Age of Empathy to be, at times, opaque?

What do we really value?

Measuring success or failure of design projects is a challenge in itself. Success is traditionally measured by the value added in financial or social terms: but today’s emphasis on wellbeing disrupts traditional measures of value. GDP, for example, is widely seen as an inadequate measure of human satisfaction: increasingly, governments are seeking to measure such nebulous concepts as “happiness”.

The effect of technology on work also demands that “value” be redefined. Time, for example, is becoming increasingly scarce - and hence valuable - for many.  Activities we have valued in the past – especially those concerned with production of goods – are becoming worthless due to automation, while activities we have undervalued – especially those concerned with creativity and caring – become more important.

Narrow financial measures of “value” are becoming increasingly inadequate. But we have yet to identify what we really value, let alone devise a coherent way of measuring it.

Attempts by those who hold power and wealth in the current paradigm to hang on to the old and resist the new result in what President Obama calls the “empathy deficit”. The Age of Empathy is being countered by a mass outbreak of callousness. But this is itself an opportunity for disruptive and radical redesign of public services and social enterprises.

Redefining value, redesigning work, reinventing the social infrastructure that supports enterprise, and above all rediscovering the importance of social connection, collaboration and sharing in a post-technological world – these are the new design challenges. The Age of Empathy is also the Age of Change.

Originally posted at Image from Sinoy Mirror Inc.

Did Osborne Pause Austerity in 2013?

No, says The Times' David Smith. He says that the notion that there was a pause in austerity is an "austerity myth".
He points to this chart from the Office for Budget Responsibility that shows fiscal consolidation as a percentage of GDP (relative to the 2008 Budget) continuing on throughout 2013 and 2014 and 2015:
But the OBR's chart doesn't actually show what I would define as austerity. It shows the size of the government budget as a percentage of GDP relative to previous budgets. That's a good deal of moving parts. And that creates a good deal of ambiguity. Under such a definition, if the economy grows and government spending stays constant, there has been fiscal consolidation. In fact, if the size of the budget grows but the economy grows more, there has still been "fiscal consolidation". 
What I am referring to when I claim that Osborne paused austerity in 2013 is the pause in the slashing back of government spending. Simply, up 'til 2013 the government was year on year cutting spending in real terms. The bottom came in 2013. In 2014 and 2015 — prior to the election — the government stopped cutting spending. 
This graph (via shows that's true in real terms. In fact, in real terms UK government total spending is estimated to increase in 2014 and 2015: 
There seems to be a similar pattern of a small uptick in real per capita terms, at least for fiscal year 2014 (there appears to be an error in the data for 2015 and 2016, so I left those years off the below chart): 
ukgs_line.php-3Another interesting picture — via the St. Louis Fed's David Andolfatto — shows government spending per working age person, alongside government revenue and transfers: 
This shows much the same thing. During the Coalition years, revenue and transfers per capita remained relatively static. Spending fell throughout 2010, 2011 and 2012, bottomed out in 2013 and remained static through 2013 and beyond. 
In other words, shake your fist all you like about the OBR's picture of fiscal consolidation, but the actual data on spending and transfers relative to revenue shows a pause in the austerity after 2013.
And no, that doesn't mean Osborne literally abandoned austerity altogether. He didn't reverse the cuts, if that's what someone might mean by "abandoning austerity". And the Tory manifesto promises more cuts henceforth. If that's what Osborne and co deliver in the coming parliament then that is the very opposite of "abandoning austerity".
But it does mean that the uptick in growth during 2014 is correlated with the pause in austerity. And it does mean that Paul Krugman is correct to say that the UK government "paused", and Simon Wren-Lewis was correct to talk of a "suspension" in austerity.

Banking should not be boring

Since the financial crisis, some people have argued that “Banking should be boring”. The idea is that banking should be limited to simple deposit-taking, lending and payments services. We don’t need the trappings of modern investment banking: structured lending schemes, derivative products, complex risk metrics, synthetics and the like. They may be fun to create, and highly lucrative to trade, but they aren’t socially useful. Let’s get back to basics. All we need is little banks, simple products and local bank managers operating the 3-6-3 rule: “Borrow at 3%, lend at 6% and be on the golf course by 3pm”. Banks are so much better when they are boring.

Of course, this depends on what you mean by “boring”. A friend of mine is a civil engineer. She is fascinated by sewers. No, this is not a joke (and yes, I know about the “Yellow Pages” advert for civil engineers that said “Boring: see civil engineering”). She really is. Peering into smelly sewers all day is not my idea of an interesting job: I’d much rather work in a bank. But to her it is fascinating. So those who regard vanilla banking as boring probably don’t want to be bankers. Bankers themselves may well see it differently.

In fact when I asked people on Twitter what they meant by “boring” in relation to banks, it became clear that they didn’t really know what they meant. Some people used “boring” to mean “not immoral or illegal”. Hmm. Just think about that definition of “boring” in relation to, say, sex….

Others used “boring” as a synonym for “safe”. Oh dear. Bankers who are obsessed with safety are anything but safe. They lend at risk (because that is what banks do), then they offload the risks on to someone else, wash their hands and move on to the next risky loan. Where those risks end up is not their concern. The trouble is, when everyone is playing “safety”, the risk ends up with some poor sucker who can’t afford to pass it on. When the time comes to pay out, those poor suckers can’t afford the payout either and the government has to step in. This is how financial crises happen. Risk aversion among bankers is a BAD thing. Their job is to manage risk, not to avoid it.

There is of course another way of playing “safety”, and that is not to lend to anything that looks even slightly risky. This has an extremely unfortunate economic effect. People who need finance for house or automobile purchases can’t get it. Businesses needing loans for expansion or working capital finance can’t get them. Businesses that already have loans or overdrafts may find their facilities reduced or cancelled. We have seen all of these since the financial crisis. And we hate it. We complain that “banks aren't lending”. We call lack of low-deposit mortgage lending a “market failure”. And we blame lack of bank lending for the slowest recovery since World War II. So we don’t really want bankers to play safe, do we? If “boring” means “safe”, then we actually don’t want banking to be boring at all.

One commenter insisted that excitement in banking is a bad thing. He wanted banking to be so dull that it is soporific. But soporific banking was exactly what we had prior to 2008. Bankers were so convinced that everything was fine that they weren’t paying attention to the risks. They were asleep at the wheel, along with their regulators, auditors and insurers. So were ratings agencies, politicians, economists, business leaders and the general public. There was a mass outbreak of narcolepsy, and it caused one of the largest car crashes in history. More sleepiness in the banking world is the LAST thing we need.

Ah, say some, but what we don’t want is all the creative stuff that nearly blew up the world in 2008. You know, the fancy derivatives, structured products, complex funding structures….

I do indeed think we could do with less of the fancy stuff. There must be markets in risk – after all, for everyone who is trying to reduce risk, there needs to be someone else who is willing to increase risk for a fee. And we do need depth and liquidity in financial markets. But we probably don’t need these markets to be as huge as they have become.

The trouble is that by defining the fancy stuff as “exciting” and basic banking as “boring” we are sending completely the wrong message. If we really want to attract more people into basic banking and fewer into derivatives trading, we need to change the narrative. Trading is boring. It really is. All traders do is move money around. It’s unutterably dull. Lending to small businesses, though….now that’s interesting. They are all different, and to establish whether or not they are sound, you have to find out quite a bit about them.

In fact I am totally bemused by the idea that “banking should be boring”. How can lending to small businesses that are doing exciting and important things possibly be “boring”? How can providing state-of-the-art payments services to support spending decisions by people and businesses be “boring”? How can helping people satisfy the financial needs that arise from their complex lives be “boring”? I don’t get it. This is fascinating stuff. It’s endlessly varied: it demands lively intelligence, rapid assimilation of knowledge, empathy with people’s concerns, creativity in fulfilling unexpected and unusual customer needs, advanced technological knowhow. Basic banking – lending, deposit-taking, payments services - should be one of the most interesting jobs in the world. Why on earth do we want to define it as “boring”?

Banking must be interesting if it is to be effective. Do you want to work in a boring job? I don’t. Nor would anyone who has enough talent to do something more interesting. But we need talented people to want to work in banking – not the fancy stuff, but the bread-and-butter business of lending, deposit-taking and payments. As the economist Anna Hedge explains:
Until and unless we eliminate scarcity, can simultaneously produce all goods everywhere and have no barriers to labour migration, we are going to need banks and a medium of exchange. I do not want those functions performed by dullards.
It’s also terribly dangerous for such an important job to be boring. Boring jobs create bored people. And bored people don’t do a good job. They are careless, they cut corners, they are indifferent to customer concerns. They may be cavalier about regulation designed to protect customers and maintain financial stability. They may even do insanely risky things just to relieve the boredom. We really don't want bored people managing our financial system. Banking must be interesting, or it is unsafe.

It is a tragedy that lending and managing money in the real economy has come to be regarded as “boring” while much less important functions are apparently “exciting”. And it is even sadder that well-meaning people reinforce this topsy-turvy view in the name of banking reform. Somewhere along the line our priorities and our values have become seriously distorted. We desperately need to reframe.

Related reading: 

How Women Will Fix The Economy - Rana Foroohar, TIME

Image: "Bored banker" from