Stumbling and Mumbling

Post hoc ergo propter hoc

Here are four claims from across the political spectrum:
1. George Osborne says that inequality has increased under Labour, without pointing out that had it not been for Labour’s efforts to redistribute income, inequality might have increased even more than it did.
2. Richard Murphy says yesterday’s GDP figures show that increased public spending and the car scrappage scheme lifted us out of recession - missing the point that a large chunk of the scrappage scheme leaked into imports, and that there might therefore have been more efficient ways of supporting the economy.
3.  A caller to Radio5live says the NHS saved the life of his wife, without wondering whether alternative institutions for delivering healthcare might also have done so.
4.  In rejecting Philip Blond’s claim that the welfare state undermined working class habits of autonomous organization, a commenter at Bad Conscience points out that workers are vastly better off now. But he does not consider whether they might be even more so, had the welfare state taken a different form.
There’s a common theme here. All four are examples of the post hoc ergo propter hoc fallacy - the “after this, therefore because of this” error. So, for example, George Osborne sees inequality rise after the election of a Labour government, and espies causality. Ditto, Richard Murphy sees recovery after the introduction of the car scrappage scheme. And so on.
What’s missing in all four of these cases is an analysis of mechanisms. What precisely are the routes through which Labour has increased inequality, or the scrappage scheme boosted GDP, or the NHS saved lives, or the welfare state enriched workers? What’s also missing are counterfactuals. What would have happened to inequality  without Labour policies? What GDP figures would we have had we had alternative fiscal policies? What sort of healthcare would we have under  alternatives to the NHS? How well off would the poor be under different forms of welfare provision?
Filling in these blanks is of course very tricky. But that is the nuts and bolts of social science. Without mechanisms and counterfactuals, all we have is what Hopi rightly caricatures as “1. Underpants, 2.?, 3. Profit!!”
I mention all this because the election campaign will, I fear, be dominated by post hoc ergo propter hoc arguments on both sides: “Things are better than in 1997 so Labour‘s succeeded“; “No they‘re not, so Labour's failed.” Which is just unscientific gibber.
But here’s a wrinkle. Although post hoc ergo propter hoc is always fallacious, it isn’t always empirically wrong - because effects often follow causes*; it's quite possible that some of the claims made above are actually true. So, could it be that the costs of such faulty reasoning turn out to be small - perhaps because post hoc ergo propter hoc draws attention to a legitimate causal mechanism, or perhaps because some wisdom of crowds effect cause the logical fallacies to cancel out?**
* Not always. Sometimes effects precede cause, as when Christmas causes people to send Christmas cards. 
** Eg “Inequality has increased under Labour, so Labour increases inequality.” “Yeah, but the Tories increased inequality too.” “Well, maybe neither party will do much to achieve equality.”

Corporate surplus hits record

The big story in today’s GDP numbers is that companies’ inability or unwillingness to invest has hit a record level. Non-financial firms’ financial balance - the gap between retained profits and investment - reached £26bn, or 7.4% of GDP, in Q4. This was by far the largest since current records began in 1987.
This is not simply because their spending has fallen - though fixed investment did fall 19.9% in the year to Q4. It’s also because their savings have risen. Retained profits hit a record (since 1987) 15.3% of GDP in Q4, thanks to higher profits, higher rent incomes and dividend cuts.
The counterpart to the corporate sector’s massive surplus is, of course, that the public sector is running a record deficit: across all sectors of the economy (which includes foreigners), the surpluses must sum to zero. Since 1987, the correlation between these two balances has been minus 0.55. If we add in households - which ran a huge surplus last year after years of deficit - and financial companies, the correlation approaches one.
There’s an optimistic and a pessimistic reading here.
The optimistic reading is that the corporate surplus will eventually fall. As banks become more willing to lend, firms will be able to invest. And those firms that are sitting on huge cash piles will eventually spend them. As the corporate surplus declines, so public borrowing will fall.
The pessimistic reading is that the corporate sector’s reluctance to invest is not merely a temporary cyclical artefact but rather a sign of a structural dearth of investment opportunities; even in the boom of 2007, firms had a large surplus. If this is the case, then a permanent large corporate surplus means permanent large government borrowing.
I’m not at all sure which of these is right. But I know two things. One is that people are under-estimating the significance of the latter possibility. The other is that government borrowing is - to a large extent - out of the government’s hands. This is the elephant in the room that last night’s Chancellors’ debate failed to mention.

Generational determinism

I was thinking the other day of doing something for the day job on whether 2010 will be like 1994. The point being that in 1994 the Fed started to raise interest rates, having kept them very low after a financial crisis, and although the hikes were widely expected, shares and bonds sold off. But then the thought occurred to me; there are reasonably experienced people in the City who were still at school then. 1994 means as much to them as the mid-70s does to me.
Then I heard 66-year-old Richard Stilgoe mourn (51 min) the imminent demise of Dennis Hopper as marking the end of the Easy Rider and Rebel Without a Cause generation. But this means nothing to me. I associate Mr Hopper with the villain in Speed and 24. I’m of the Half Man Half Biscuit generation:

James Dean was just a careless driver
And Marilyn Monroe was just a slag

All of which is a way of saying that our beliefs are shaped not just by class but by age. There’s firm research on this. This paper finds that individuals whose formative years (18-25) were spent in recession:

tend to believe that success in life depends more on luck than on effort, support more government redistribution, but are less confident in public institutions.

This one (pdf) found that people who saw poor stock market returns in their youth invest less in shares even decades later. This one shows that people who grew up in communist East Germany favour big government more than those who didn’t. And this pdf estimates that the political views of a 60-year-old are shaped more by events in their 20s than in their 50s.
All of this rings true for me, as I’m very much a child of the 80s. I mean this in three different ways:
1. The memory of mass unemployment made me very aware that capitalism is dysfunctional. I suspect it also contributed to my risk aversion; I’ve no taste for gambling.
2.  The miners’ strike impressed upon me that Tories are class warriors, so strongly so that I’m unmoved by Cameron’s efforts to “decontaminate the brand”, and that coppers are the bootboys of the ruling class - and racist ones too; this classic sketch spoke for the times.
3. Within a few weeks of starting work, the stock market crashed.  I therefore became very aware that extreme events do happen. So my response to Nassim Nicholas Taleb’s talk about non-Gaussian distributions was: “no shit Sherlock.”
The contrary is also true. More recent events leave me cold. I can’t get worked up by climate change; I regard 9/11 as an extremely criminal act rather than a politically significant one; and “culture wars” about religion seem unimportant.
Of course, I’m not saying that all mid-40-somethings are Marxist copper-hating nervous ninnies.  What I am saying is that whilst economic determinism is not to be dismissed, we should perhaps give more weight to generational determinism.
And on this score, remember that many first-time voters weren’t even born when Thatcher resigned as Prime Minister. Whilst she is, for me, a strong influence upon my views, first-time voters might see her as I regarded Harold Macmillan - as just a doddery old relic.

"The overspend"

The Spectator is trying to start a stupid and nasty habit. Fraser Nelson says:

Cameron should ban the word "deficit" and simply say "overspend" instead.

This week’s dead tree version of the mag contained two examples of this. And it has begun to leach out into other media.
Of course, calling the deficit an overspend makes as much sense as calling it an undertax - which is to say, no sense at all.
Equally obvious is the ideological intent behind this legerdemain - to make it seem clearer than it is that spending must be cut. I’m reminded (via John) of Daniel Davies' maxim:

Good ideas do not need lots of lies told about them in order to gain public acceptance.

Herein, however, lies a problem. We must distinguish three separate arguments for cutting public spending:
1. The macroeconomic one - cuts will somehow crowd in private spending.
2. The micro one - big government causes lots of allocation inefficiencies.
3. The philosophical one, that big government is an enemy of freedom.
I have much more sympathy for 2 and 3 than for 1. However - and this point is insufficiently appreciated across all political persuasions - there might be an acute trade-off between them. If, as I fear, the corporate sector’s long-standing unwillingness to spend has generated a tendency towards stagnation, then government spending, by default, becomes the engine of macroeconomic growth. We’re in the world of James O’Connor’s Fiscal Crisis of the State.
In this case, the aim of shrinking the state might be laudable on microeconomic or philosophical grounds but is dangerous on macroeconomic ones; cutting waste reduces aggregate demand too. As James Tobin said, it takes a lot of Harberger triangles to fill an Okun gap.

The management con

What do bosses do? This old question gains force from two sets of figures released about the NHS yesterday.
First, the number of managers in the NHS has risen by 83.9% over the last 10 years; that compares to a rise of 48.4% in the number of doctors and 26.6% in the number of nurses.
Second, the ONS estimates that health service productivity fell by 2.3% between 1999 and 2008.
Hence my question. A naïve person might think that the purpose of managers is to improve efficiency. He would therefore expect productivity to have risen as the numbers of managers rose. So why hasn’t it?
It could be that the ONS has mismeasured productivity and on some other measure management has improved efficiency. Or it could be that some of the growth reflects title inflation rather than substantial change. Or perhaps there are lags between increased management numbers and efficiency gains. Or maybe the link between managers and productivity is non-linear, and more managers would increase productivity; note that even now, only one in 32 NHS staff is a manager.
There is, though, another hypothesis that fits the evidence. It’s that management is a con-trick, promising - but never actually delivering - increased efficiency. Stephen Marglin's famous answer to my question was right.

Welcome back the Macmillan gap

Yesterday’s Budget revived an issue which I thought had died years ago - the relationship between finance and industry. Many of Darling’s measures - such as the University Enterprise Capital Fund, the green investment bank and targets for nationalized banks’ lending - are, in effect, saying that the job of financing investment cannot be left to the free market, because the financial system, on its own, will not adequately support innovative businesses.
This echoes ancient complaints about the UK banking system which go back at least as far as the Macmillan committee which complained in the 1930s that banks were not financing small business well enough - a view which persisted into the 1990s, when Will Hutton wrote in The State We’re In:

Disengaged, uncommitted and preoccupied with liquidity, the financial system has been uniquely bad at supporting investment and innovation.

This view, however, died out soon after Will wrote those words, perhaps because the world became flooded by cheap and easy money, some of which found its way into real businesses.
The distinctive feature of the Budget is that it has resurrected the idea. This is despite the fact that the world is still awash with cheap money; the IMF reckons the global economy will generate over £9 trillion of new savings this year - which is why index-linked gilt yields are still under 1%.
If I were Darling, I’d have made more of this. He could have said explicitly:

The legacy of the crisis is that bank lending criteria will be tighter in the next few years. And the lesson of the crisis is that banks are terrible judges of good and bad investments, so there’s no reason to suppose that lending will flow to genuinely profitable opportunities. Our financial system is so dysfunctional that it is unable to convert massive global savings into genuine productive investment.

So, should we welcome Darling’s return to mid-20th century orthodoxy, as Hopi does? I’m not sure. My concern is that, generally speaking - there are of course exceptions - our lack of capital spending might reflect not a lack of finance, but rather a “dearth of investment opportunities.”
Could it be, then, that Darling is repeating an old error of social democrats - he’s assuming that capitalism's troubles can be solved by technocratic fixes?

Government spending and happiness

Is government spending too low? It sounds like a silly question, but it’s the one raised by this new paper by Zohal Hessami. He estimates - based on 12 EU nations in the 1990s - that there’s an n-shaped relationship between the size of government and subjective well-being.
But here’s the thing - the peak in well-being comes when government spends around 70% of GDP. This suggests that, from the point of view of maximizing well-being, all governments spend too  little. This chimes in with Sunder’s point - that the general public are in no mood for spending cuts.
Which raises the question: how can one argue against this?
We can quibble with the econometrics (we can always quibble with the econometrics); the fact that such huge spending is out of our sample means it’s dangerous to infer that it really would increase well-being. And the in-sample data shows that increases in government spending from high levels have only a small positive effect upon well-being.
But these are mere quibbles. A stronger argument is needed.
Many of you would say that this estimate holds GDP per capita constant but in practice, bigger government would depress GDP growth, and folk would become less happy on this account.
This, though, is an awkward argument. In developed economies, GDP has only a small effect on well-being, so it would require large falls to offset the benefit of higher public spending.
Instead, I’d suggest two other arguments.
First, this estimate holds corruption constant. In fact, though, as Mr Hessami shows, increased corruption causes a negative relationship between government spending and well-being. This matters, as it’s likely that once government exceeds a certain size, corruption increases. Stephen Byers could not have offered his “influence”* for sale had government been so small that it didn’t affect business much.
Secondly, there’s the question: why should well-being have priority over liberty? This philosophical question gains practical force from the fact that many of the public’s anti-liberal demands rest upon irrationality and cognitive biases.
And there might be such a bias at work here - the representativeness heuristic. Maybe support for higher government spending rests upon the belief that inputs (money) are representative of outputs (better health and education, more support for the worst off). But this belief might be mistaken; it is at least possible that these outputs could be achieved with lower spending. If so, support for higher spending might rest upon an error.
Whatever you think about the merits of these arguments, there is one strong implication here. There’s a flat contradiction between libertarianism on the one hand and utilitarianism and democracy on the other.
* Dsquared has the final word on this.

"Not well off"

Here’s a horrible example of the middle England error from David Aaronovitch:

For eight years [Stephen Byers] remained on the backbenches, periodically suggesting an engagement in forming policy ideas for Labour’s future, but then announced his retirement at the next election. He was isolated and possibly rather bitter.
And almost certainly not well off.

Almost certainly not well off? Consider this.
1. As MP, Byers is paid £64,766 a year, or £1245 a week. This is more than three times the median weekly wage. And it puts him well into the top 10% of male full-time earners; it’s 15% more than the 90th percentile male earner gets.
2. Having been an MP for 18 years, Byers should be eligible for a pension (pdf) of almost £30,000 a year. This is more than 75% of his North Tyneside constituents earn. And this ignores his income from chairmanships and consultancy work, which might add another £10,000 a year.
3. In his four years as a minister, he earned (pdf) around £400,000. It would take 22 years for the median earner in his constituency - who gets £348 a week - to earn that much.
4. When he was sacked as a minister, he was entitled to a severance pay-off of over £17,000 - equivalent at the time to a year’s wages for his median constituent.
Not bad going for a graduate of Liverpool Poly who is practically innumerate.

"Natural limits" of social democracy

In his review of Tony Judt’s Ill Fares the Land, Oliver Kamm says that “social democracy appeared to have reached natural limits“ in the 1970s:

The quadrupling of the oil price in 1973 by the Opec cartel and wage claims by powerful unions caused accelerating inflation…[Keynes] had little to say about inflation resulting from upward pressure on wages and earnings in an economy close to full employment.

This, I fear, is only part of the story. Inflation was accelerating before the oil price rose; between 1967Q3 and 1972Q3 it rose from 1.7% to 6.5%. And this didn’t happen because the economy was “close to full employment”. It was actually moving further away from full employment. During this period, employment dropped by 2.1% and unemployment rose from 535,400 (three people for every Job Centre vacancy) to 798,100 (over five for every vacancy).*
What happened, then, wasn’t so much a move along the Phillips curve as a sharp move of the Phillips curve; the unemployment-inflation trade-off worsened.
You can blame this upon powerful trades unions. But this only raises the question: why did trades unions exercise their militancy in the later 60s rather than in the 1950s, when unemployment was lower**?
One possibility is that, in the 50s, people had a vivid memory of the 1930s and so were scared of unemployment, and this restrained wage militancy. By the early 70s, though, workers who remembered the 30s had retired, to be replaced by those who had only known full employment and so expected it to continue.
What we saw in the late 60s, then, wasn’t a mere cyclical inflation, but rather the fact that workers became accustomed to near-full employment. Social democracy had indeed “reached its natural limits.“ This is consistent with what Michal Kalecki wrote in 1943:

Under a regime of permanent full employment, the sack would cease to play its role as a disciplinary measure. The social position of the boss would be undermined and the self assurance and class consciousness of the working class would grow. Strikes for wage increases and improvements in conditions of work would create political tension.

Kalecki inferred from this that capitalism, whether tempered by social democracy or not, could not create lasting full employment.
I think events of the 1970s - and indeed of today - prove him correct. But then, I’m a Marxist. What’s Oliver’s excuse?
* Table 3.4 of this big pdf.
** Thanks in no small part to the de facto exclusion of women from the workforce.

Gilts & creditworthiness

In the dead tree Spectator James Forsyth has discovered gilt yields, and is greatly vexed by these new-fangled gizmos:

The amount of interest the government must pay on government debt - the so-called gilt yields - is greater even than Italy’s. This means that a country that has had 61 governments since 1945 is now considered more creditworthy than this country.

Granted, UK five-year yields are slightly higher than Italy’s: 2.81% vs. 2.72% for benchmark bonds. But this is not a pure measure of creditworthiness. Bond yields also depend upon inflation and currency risk. One reason why gilts yield more than their Italian counterparts is that the latter is perceived as greater for the UK than for Italy; the market thinks there’s more chance of sterling falling against the euro than of Italy leaving the euro.
Indeed, CDS prices tell us - if they tell us anything - that the UK government is more creditworthy than the Italian.
I don’t mention this merely to point to the village idiot. I do so for two other reasons.
First, this is, I fear, an indication of how debased the debate about government debt might be during the election campaign. 
Secondly, the fact that government bond yields depend upon more than creditworthiness suggests that improved creditworthiness might not reduce the cost of borrowing.
One obvious way in which this would happen would be if we could engineer a massive inflation. This would make it easier to repay (devalued) debt, but would raise gilt yields. This is no mere possibility. It’s just what happened in the late 1960s and early 70s. .
Alternatively, a severe fiscal tightening might set markets worrying that sterling would fall because of the weakness of the economy. Such fears could in principle raise gilt yields by more than the lower (planned) deficit would tend to reduce it.
I’ve said it before - but since no-one was listening I’ll say it again: gilt yields depend upon more than creditworthiness.