Stumbling and Mumbling

Reinhart & Rogoff: true Keynesians

Any Keynesians who are rejoicing in the debunking of Ken Rogoff's and Carmen Reinhart's claim that high government debt reduces GDP growth should stop. I suspect Reinhart and Rogoff are, in fact, guilty of a Keynesian error.

To recap, they claimed (pdf) that ratios of government debt to GDP over more than 90% are associated with significantly lower average GDP growth. However, when Thomas Herndon, Michael Ash and Robert Pollin tried to replicate this result, they found that it was due largely to excluding Australian, Canadian and New Zealand experience in the late 40s, and an Excel error - which Reinhart and Rogoff admit was a "significant lapse"  - which led to good Belgian growth being excluded.Fixing these errors shows that high government debt has been compatible with decent growth.

So, why do I say Reinhart and Rogoff are Keynesians? Simple. The issue here is not really one of policy; insofar as Reinhart and Rogoff's result has been used by policy-makers, it is in the way that drunks use lamp-posts - as support rather than illumination.

Instead, the issue is about the culture of economics. And here, Keynes (among others) had an unfortunate if perhaps inadvertent effect. 

What leaps out of his General Theory is that it is entirely unencumbered by empirical evidence. Keynes thus helped to promote an ideal of the economist as a brilliant man capable of solving problems from his armchair by dint of superb intellect*. What got undervalued in this was the importance of the mundane grunt work of careful fact-gathering.

Reinhart and Rogoff's errors, I suspect, reflect a culture which prizes brilliance - and no-one doubts that Rogoff is brilliant - over dull pedantry.

When I started work, I realized that the job of the practical economist was not so much about theorizing but more concerned with gathering and understanding data - something which academe had wholly unprepared me for. For me, the difference between the professional economist and the amateur is that the former knows the numbers not in the sense of understanding high econometric theory, but in the sense of knowing where they are, what they mean and what they don't. This is no small skill. An ability to navigate the ONS website without recourse to language you wouldn't use in front of your mother requires a mastery of the arcane which is not given to many mortals.

I suspect things have changed a little since I was a student; a lot of good recent work in economics has involved using big data or generating facts by experiment - for example in the work of Mark Grinblatt, Mattias Sutter or Esther Duflo to name but three of many. But I'm not sure it's changing enough. Diane Coyle has reported that many employers want economics students to have "a better practical grasp of quantitative methods including collecting and understanding data (as opposed to more sophisticated econometric techniques)." Perhaps, then, the tendency to elevate the brilliant theorist over the empiricist lingers.

Traditionally, many economists have tried to model themselves on Isaac Newton - albeit emulating his autistic misanthropy better than his genius. But perhaps Darwin would be a better model. His greatness lay not so much in the theory of evolution - something quite trivial he took from economics - but in the years of careful fact-gathering that preceded it. Perhaps if this were so, the sort of mistake made by Reinhart and Rogoff wouldn't have happened.

* There's a contrast here between Keynes and Kalecki; the latter did develop hypotheses which he tested against data, which is is why I hold him in higher esteem than Keynes.

Moral panics & the threat to freedom

Bertie Wooster was once fined £5 at Bosher St magistrates for stealing a policeman's helmet on boat race day. However, nobody, except for the Fascist sympathiser Sir Watkyn Bassett, regarded this as a reason to rebuke him.

However, when a Millwall fan did the same at the weekend, we got media outrage and an apology from him - I hope in bad faith - claiming to be "disgusted" at his actions.

It would be tempting to attribute this contrast to the traditional class bias which sees upper class antics as high jinks but similar working class behaviour as thuggish hooliganism.

But I suspect there's more going on. We should interpret the headlines about Millwall fans' scuffling alongside the furore over Paris Brown's tweets and (some) Tories' outrage over the effort to get "Ding Dong the Witch is dead" to the top of the charts. In all three cases we have a moral panic. I reckon there are at least two motives behind this.

One is simple incentives.Newspapers have no incentive to undersell stories, and every incentive to grab eyeballs. So "outrage", "disgust" and "fury" displace mild unease and slight disquiet.

The other is an ahistorical managerialism. Peter Ryley rightly notes that a "raucous irreverance" is a long English tradition. Rather than recognise disorder as normal and inevitable, however, the ruling class seems to aspire to some fictitious ideal in which it is eliminated. But this is pure managerialism - a belief that conflict and disharmony can somehow be managed away. (There is, of course, nothing uniquely Conservative in this; a feature of Blairism was its tendency to moral panics.)

One aspect of this managerialism is a belief in what Richard Sennett called the "myth of a purified community". We want to believe that other people are like us, that there is greater social solidarity than there really is. Disorder challenges this fiction, and we respond by exaggerating the deviance of its perpetrators; football hooligans are always a "tiny minority" and not "real fans." Such deviants then become a threat to society rather than a part of it:

Having so little tolerance for disorder in their own lives, and having shut themselves off so that they have little experience of disorder as well, the eruption of social tension becomes a situation in which the ultimate methods of aggression, violent force and reprisal, seem to become not only justified, but life-preserving. (The Uses of Disorder, p44-45)

And herein lies the danger with moral panics. They are a sign of intolerance, of a lack of the culture of liberty. In this sense, the trash newspapers - and those who share their worldview - are a threat to freedom.

In praise of imprecision

"Private firms don't hire people to make DSGE models" says Noah Smith. We should read this alongside Less Wrong's endorsement of Fermi estimates. Both, in different ways, tell us about the virtues of imprecision.

The problem with precision is that it is very often wrong. In economics, this is generally for two reasons: model assumptions don't match reality, which is true by definition of the word "model"; and data are subject to revision or sampling error.

This means there, as Thomas Mayer said, a trade-off between truth and precision. For example, the statement "GDP has been more or less flat (after seasonal adjustment!) recently" is imprecise, but quite possibly truer than the claim "GDP fell by 0.3% in Q4". And in early 2008 it was more useful to have a rough feeling that we were heading for trouble than it was to have a precise solution to a DSGE model which predicted no recession. It's better to be roughly right than precisely wrong.

Of course, economic forecasters provide precise numbers. But we shouldn't read them as being precise. The guy who's forecasting 1.2% growth this year isn't really saying GDP will rise precisely this amount. He's saying there are reasons to be slightly more optimistic than the consensus (pdf), which is forecasting 0.9% growth.

In other contexts, a rough and ready estimate is mostly good enough, at least as a starting point. Here are three examples:

1. How much does welfare scrounging cost the economy? Guesstimate the number of scroungers. Guesstimate the value-added they'd contribute if they were working. Express as a proportion of GDP. For plausible values, it's a small number.

2. What impact will the small uprating in the minimum wage have on jobs? The adult rate will rise by 1.9%. Economists forecast inflation this year of 2.5%, so this is roughly a 0.6% real fall. Let's call the price-elasticity of demand for labour 1.5. The Low Pay Commission estimates (pdf) that 5.3% of jobs are around minimum wage ones. Multiply these three numbers together and we get 0.048%. Multiply by the number of jobs in the economy (29.73m) and we have roughly 14,000.That's roughly one-eleventh of the sampling variability of employment figures.

3. How risky are shares? The long-term standard deviation of UK annual returns has been 20 percentage points. If we assume average annual real returns of 5%, this implies there's a one-in-six chance of losing 15% or more in a 12-month period.If we assume returns are serially uncorrelated, this implies a one-in-six chance of a weekly fall of 2.7% or more, and of a daily fall of 1.2%. What are the chances of a crash - say a 10% in a day? This is an 8.3 standard deviation event, which a normal distribution tells us is vanishingly unlikely. However, we know that a cubic power law fits the data better. And this tells us we should expect such a move once every 3173 days, or about once every 12 years.This isn't intended as a precise number, but an illustration of the sort of risk involved.

You can quibble with all these numbers. But what would be the point? The answers to my three questions would still be: small, small, big. And the implications for economic policy or for your personal financial planning wouldn't change much either. Indeed, we know from the crisis of 2008 that attempts at more precise risk management did not yield better results than would the back of a beermat.

My point here should be a trivial one - that rough numbers and a feel for magnitudes can get us a long way. This shouldn't need saying. But I fear it does, as it's a correction to two vices. One is a statistical fetishism which thinks that numbers must somehow be precise, and which uses them not to illuminate the truth but to hide it. The other is an academic rigour which inculcates in students an ability to give precise answers to irrelevant questions. 

Thatcherite roots of the crisis

Tim dismisses as "tosh" Owen's claim that the crisis "has roots in the Thatcherite free market experiment." I half agree with both. I suspect the banking crisis does have Thatcherite roots, but they have little to do with free markets.

I'm thinking here of two merchanisms.

First, Thatcher recognized that voters don't just create governments, but governments also create voters. In relaxing mortgage lending controls and in selling off council houses, she created a new class of property owners. This class had a vested interest in high house prices. But high house prices naturally lead to high mortgage debt and thus to banks which lend heavily and are over-extended*.

Secondly, Thatcher helped to spread the ideology of centralized managerialism. We see this, for example, in her assertion of "management's right to manage" against any conception of co-determination, and in the increase in central government control over local authorities. We might add that her image as a domineering "iron lady" helped to glamorous and legitimate an overbearing management style which is intolerant of dissent. This ideology gave us the pig-headed bosses who contributed to the collapse of so many banks. Fred Goodwin and James Crosby, more than most, are Thatcher's children.

This story agrees with Tim, in that it is consistent with the banking crisis being a crisis not of free markets, but of managerialism. The banking crisis shows us not (just) that free markets don't work, but that hierarchical organizations with bullying managers don't work.

But it also agrees with Owen, in claiming that the crisis does have Thatcherite roots.

These two claims are quite consistent, once one recognizes (as Tim and Owen half do in their different ways) that Thatcher was not a free marketeer but a class warrior.

* Intelligent economists of all colours have often called for land value taxes, more housebuilding and monetary policy to pay more attention to asset price bubbles. There's a reason why such policies have little public support. That reason is rooted in Thatcherism.

Another thing: one could also argue that Thatcher's cut in top tax rates helped to incentivize not just good entrepreneurship but also the rent-seeking and excessive risk-taking that contributed to the crisis.

Thatcherism & productivity

Simon Wren Lewis, citing John Van Reenen and Nick Crafts, says:

The Thatcher era saw the implementation of supply side reforms that ended and then reversed the relative decline of UK productivity.

That word "relative" is doing some work. Looking solely at UK data on GDP per hour worked, taken from the Bank of England, productivity growth has been slower since Thatcher than it was before.Between 1985 and 2007, productivity grew by 2.1% a year; this time period is as flattering as can be for the pro-Thatcher argument. But in the previous 22 years, it grew by 2.9% a year.

Productivity, then, has grown more slowly in the era of quiescent unions and "neoliberalism" than it did in the social democratic-corporate era.

However, if we look at the UK's performance relative to other major nations, things are kinder to the Thatcher reforms. OECD data shows that UK productivity grew 2.3% a year between 1985 and 2007. That's faster than the average for G7 countries, of 2%. By contrast, in the previous 15 year (the data begin in 1970), UK productivity grew slightly more slowly than the G7 average, by just under 2.7% against just over 2.7%.

What's going on here? There are, I reckon, two competing stories. The pro-Thatcher one is something like this:

After 1973, global growth slowed markedly. This depressed productivity through (at least) two channels. One is that Verdoorn's law - the tendency for strong output growth to generate productivity growth thanks to increasing returns - depressed such growth. The other is that a more sclerotic economy generated increased class conflict as bargaining became more like a zero-sum game. The productivity growth of the 60s, therefore, could not be repeated. We needed a new economic model, and Thatcher provided one. Had we not had the Thatcher revolution, our productivity growth would have been even worse. The fact that productivity growth fell so much in Japan, Germany, Italy and France shows the sort of slowdown we'd have had, had we not had Thatcherism.

The more critical version is something like:

The fact that productivity grew quickly in the 60s shows that strong trades unions are quite compatible with a thriving economy.Productivity slowed globally after the 1970s because macroeconomic policy globally abandoned Keynesian-style reflation in favour of policies which gave us serious recessions in the 80s and 90s and these (via Verdoorn's law) reduced productivity growth. Productivity growth isn't merely a microeconomic phenomenon, but also the product of macro policies. And bad macro policies depressed it.If the UK - and better still world - had had decent macro policies, we could have achieved good productivity growth without the huge social costs involved in bashing the unions.

As a Marxist rather than a Keynesian, I have no dog in this fight.My point is just that if you want to claim that Thatcher did improve the UK's productivity performance, you need to argue for a particular type of counterfactual.

Can there be a left Thatcher?

The retrospectives on Thatcher's political life pose a question that's central to left politics today: to what extent can individual politicians transform the economy through their own will and ideology, and to what extent must they operate within the parameters set by capitalist economics? Peter Oborne asserts the "great woman" theory, but I suspect instead that she succeeded because she had the strong tailwinds of ideology and capitalism on her side.

This question matters because it determines our attitude to the Labour leadership today. If you think a "left Thatcher" is possible, then you'll deprecate Labour's general pusillanimity and failure to oppose workfare, and invoke the "spirit of 45" to call for a more radical push.

Personally, this attitude reminds me of those halfwits who ring 6-0-6 to demand that their team show more "passion" - as if "wanting it more" is sufficient to overcome strategic and technical deficiencies.

Instead, let's just remind ourselves of the constraints Labour politicians face:

- A large section of the public are hostile to socialist policies. They are ill-informed and prejudiced about welfare and immigration, and show no appetite for workers' democracy. This is partly because capitalism generates ideologies which help entrench itself, and partly for more atavistic reasons. Granted, the recent argument about welfare seems to have increased Labour's support - but this might be because of the party's ambivalence on the matter.

- We are still dominated by managerialist ideology - the idea that, despite evidence of its failure, organizations can be improved by better management control rather than workers' control.

- The desire to get a good job in their long post-ministerial lives encourages politicians to appear attractive to prospective capitalist employers, to seem no more than half-competent managers who won't threaten them.

- Capital has immense political power. This isn't just because it has the money to lobby for its particular interests, but also because it has a (semi?) credible threat to leave the country if it see policies it doesn't like, and because employment and activity depends upon its state of confidence.

The question is: how much room is there for the Labour leadership to display radical intentions within these constraints? My fear is: not much. There cannot be a successful left Thatcher. Labour's acceptance of so much of the status quo is not therefore due (merely) to supine personalities, but to a recognition of necessity.

What can we do about this? One possibility is to play a longer game, to try and shift the Overton window; this is what free market think tanks did in the 60s. If the new leftist movement proposed by Owen is anything more than an emoting circle-jerk, it's what it will do. The other possibility, suggested by Max, is to recognize that politics is not a place for grown ups.

Personally, I vacillate between these two positions.

Thatcher: successful failure

There's one point about Thatcher's premiership that I fear is being under-rated. It's that her success was  partly inadvertent. I mean this in at least three different ways.

First, the recession of 1980-81 was not supposed to happen. The theory was that, by announcing credible targets for monetary growth, inflation expectations would fall and hence inflation would come down relatively painlessly. This, of course, did not happen. Monetary targets were overshot and we got a severe recession."Certainly it was a long way from the vision provided by the Conservatives in 1979" wrote David Smith (The Rise and Fall of Monetarism, p 103). And Tim Congdon wrote in 1982:

Monetarism was never intended as a form of corporal punishment on the British economy. No one wanted unemployment to reach three million and, as is clear from the forecasts made in 1979 and 1980, no one expected it to do so...All monetarists would have preferred the unemployment-inflation trade-off to be more favourable. (Reflections on Monetarism, p96)

But this corporal punishment had (for some!) a favourable side-effect. In clobbering labour's bargaining power, it helped increase profit margins and profit expectations and animal spirits, and thus laid the basis for stronger investment in the 1980s.

Yes, Thatcher promised to weaken the unions. But she envisaged doing so by reasserting the rule of law, not by creating mass unemployment.

Secondly, her relaxation of credit controls in the early 80s had a bigger economic impact than she intended. She envisaged these as a step towards economic freedom. But they were more than that. They permitted a consumer-driven society and economy. This was not her intention. As the Heresiarch rightly emphasises, her vision of Britain was of a property-owning democracy of savers with moral restraint. She got indebted spendthrifts. She wanted the British people to be like her father, but they turned out more like her son.

Thirdly, the closure of the coal mines did not turn out as planned. Thatcher claimed that the loss-making pits were "uneconomic." Her critics, such as Andrew Glyn, said this was mostly untrue because it was cheaper for the government to subsidise the pits than it would be to pay unemployment benefits. Thatcherites in turn responded by claiming that redundant miners would get work elsewhere. We now know that they were mostly wrong; employment in mining areas never fully (pdf) recovered (pdf) from the closures.The free market conception of a flexible labour force able to move easily from job to job was, in this respect, mistaken.

And yet the miners' strike is seen as a victory for Thatcher - as a triumph for capital or for the rule of law, depending on your taste (and, with anachronistic hindsight, a reduction in carbon emissions). The human cost of the pit closures, and the refutation of the (explicit) economic theory behind them are conveniently overlooked by Thatcher's supporters.

In these regards, Thatcher's success is another example of John Kay's obliquity - of achieving ends unintentionally. 

And this raises a wider question. If the greatest political figure of the last 60 years was a success largely unintentionally, what does this tell us about the nature of politics?

Thatcher's good

Regular readers might have guessed that I am no admirer of Lady Thatcher.But on the principle that one shouldn't speak ill of the dead - and that no-one is wholly bad - here are some things I think she deserves some credit for:

1. Pragmatism. Although both left and right like to mythologize Thatcher as a slasher of public spending, this is not true. During her premiership, the share of spending in GDP fell less than it did in the early years of New Labour, and less than it's planned to fall in the next few years. And spending was higher under her than it was during the 1964-70 Labour government*. Nor was Thatcher a great reformer of the NHS. In both respects, she was driven more by practicality than ideological zeal.

2. A recognition that politicians can effect fundamental change. During the Thatcher years, the Overton window shifted. This wasn't just because her ideology triumphed. She helped it along partly by effecting hard-to-reverse changes such as privatization, and partly by changing the electorate; selling council houses created client voters. A Labour party which spinelessly kowtows to public opinion has something to learn here.

3. The Police and Criminal Evidence Act. In the 60s and 70s, the police were corrupt, racist thugs. PACE was an attempt to rein them in. Of course, Hillsborough and the miners' strike showed that this effort wasn't wholly successful. But Thatcher deserves credit for displaying a greater scepticism about the police than many later copper-worshipping Home Secretaries.

4. "You can't buck the market." Thatcher recognized that there are some things that governments cannot do - for example, control prices and wages by legislation. And  Lawson's attempt to shadow the DMark in 1987-88, and the UK's entry into the ERM in 1990 proved her right.

5. Being lucky. Thatcher got lucky in her first term of office in at least two ways. Most obviously, the Falklands war boosted her popularity hugely. But also, the economy did not follow her script. She hoped that the mere announcement of M3 targets would reduce inflation painlessly, by reducing inflation expectations. This didn't happen. Instead, she inadvertently engineered a recession which destroyed workers' bargaining power, thus raising profit margins and (eventually) the motive to invest. In this sense, she reminds us of the importance of luck in politics (and in the latter case, structural economic relationships), relative to that of intentions.

6. Reducing snobbery. When Thatcher became Tory leader, she faced both gender and class snobbery; she was seen as a shrill lower middle-class housewife. Her success reduced class and gender prejudice amongst the rich. I suspect that my job prospects (as someone with an accent similar to her natural one) improved because of her. I fear, though, that this increased equality of opportunity was only temporary.

I don't say all this to sing her praises. I suspect her legacy is mostly a malign one and that she was more of a class warrior than a genuine libertarian. I do so merely to suggest that she was not wholly the devil the left pretends.

* Table 2.33 of the OBR's supplementary fiscal tables.

"Paying more in"

Over the last five years, I've paid almost £2000 in home insurance and got nothing back. This is unfair. It should change.

Now, anyone with an IQ higher than their hat size will spot a problem with this. Paying in more than you get back is not a fault of insurance but a feature. The point of insurance is to pool risk, so that the lucky - those who don't get burgled - pay in whilst the unlucky take out.

This shouldn't need saying. But it seems it does, because Liam Byrne writes:

we must do more to strengthen the old principle of contribution: there are lots of people right now who feel they pay an awful lot more in than they ever get back. That should change.

This is just confused. Even the best institutions for pooling economic risks - whatever your conception of them might be - will have some people pay an awful lot more in than they ever get back. This is simply because some people will be lucky and not suffer economic risks. This will be true however strong the principle of contribution is.

The only way you can avoid having some people not pay in more than they get out is to have no welfare state at all (and no private insurance for economic risks either). In this world, people would protect themselves against risk by saving and borrowing, in effect self-insuring.

So, what is Byrne doing here? One possibility is that he's just being stupid: he has form. The other possibility is that he's not. He's trying to pander to a prejudiced public who are ignorant of the facts of the welfare state by invoking a silly notion of a distinction between the deserving and undeserving poor. I hope none of you were daft enough to think "divide and rule" was only a Tory strategy.

Benefits' biases

Alex Massie is, of course, correct to say that it is a mistake to draw any inferences from something as freakishly unusual as the Philpott case. Why, then, has the mistake been so common? I suspect there are two biases at work.

One is the confirmation bias. If you think the welfare state incentivizes bad behaviour such as laziness or fecklessness, you'll see Philpott as an extreme confirmation of your prior.

We should, here, note an asymmetry. Those who see Philpott as confirmation of the "bad incentive" hypothesis don't regard HBOS's bad lending as evidence that low top taxes have perverse incentives, or Stephen Seddon's murder of his parents as evidence that low inheritance taxes have bad incentives. This asymmetry cannot be explained by sound statistical reasoning, unless your prior is that the welfare state has stronger bad incentives than the tax system.

The second bias is a form of the halo effect.Hostility towards benefit claimants is founded upon a moral instinct - the norm of reciprocity. People fear that claimants are getting something for nothing, that "hard-working tax-payers" are being ripped off. The halo effect - the tendency to believe that all bad things are connected - lead people to think that such scrounging is also a macroeconomic problem. Which it isn't. This bias is exacerbated by our natural tendency to exaggerate harms done to us.

Herein, though, lies a problem. I fear this reciprocity norm is an atavistic instinct with an evolutionary basis which is no longer relevant to post-industrial society.

In hunter-gatherer societies struggling for subsistence the man who does no work and expects others to provide for him is a threat to the very existence of the tribe. It's natural, therefore, for a norm of reciprocity to emerge so that shirkers are stigmatized and shunned.

But we no longer live in that world. We have the opposite problem. There's not enough work to go round. In this world, the shirker does not threaten our existence. If anything, he's a help, as his not looking for work increases the chances of others getting it. And, remember, on average the unemployed are significantly unhappier than others.

My point here is a depressing one. The tendency to stigmatize benefit claimants, and so to regard Philpott as sufficiently representative of them to justify inferences (or dog-whistle "questions") is not the sort of error that can be corrected by evidence. It arises from biases and beliefs which are hardwired into us.