Stumbling and Mumbling

Profits & top incomes

Tim  greets the news of a 55% rise in chief executives’ pay by asking:

Profits are up, share prices are up. What do you think should happen to the wages of people hired to increase profits and share prices?

This raises the question: what is the link between top incomes and profits?
My chart sheds light here. I‘m taking the share of the top 0.5% of incomes in total incomes from Emmanuel Saez‘s data, and profits from national accounts data. 
This shows that, over the long-run, there is a rough correlation: both shares have a U-shaped pattern, troughing in the mid-70s.
However, since the late 80s, the correlation is less obvious. The share of profits in GDP was lower in 2005 (the latest year for Saez’s data) than in the late 80s. But the share of the top 0.5% in total incomes doubled during this time.
In recent years, then, moves in aggregate profits cannot explain moves in top incomes. The power of capital to exploit labour hasn’t changed much, but the power of top earners to seize incomes has increased.
I suspect there are two big reasons for this.
One lies in efficiency wage theory. Top bosses and bankers must increasingly be bribed not to seize corporate assets for themselves - partly because these assets consist more of portable things like goodwill or financial products and less of hard physical capital. At the same time, the need to bribe ordinary workers to behave well has declined as IT allows more direct monitoring of them.
Another lies in managerialist ideology. Firms believe that success requires them to hire super-talented managers, and so there’s a bidding war for talent.
In large part, there’s a fallacy of composition here. In aggregate, profits depend upon macroeconomic and institutional factors, not the skill of managers in total.
But what if there’s a germ (or more!) of truth in this ideology? Could it be that success for individual businesses today really does depend more upon the skill of managers and less upon corporate-specific assets, such as monopoly power or product quality?
If this is the case, then the rise of top incomes is, in a sense, a symptom of the fragility of capitalism - because a firm that’s dependent upon the talent of individuals is one that is highly vulnerable to failure.

For a state bank

In the FT, Gerry Holtham - one of Wales’ most celebrated economists - is arguing for a National Investment Bank. I’m inclined to side with him and Duncan on this, and against the idea that it is a clinching argument against such a bank that it will lead to politically-directed lending. I say so for six reasons:
1. It’s quite possible to organize such a bank to be at least a little autonomous of government. The Bank of England and BBC aren’t politicians’ playthings, so why must a National Investment Bank be?
2. In our current pickle, any lending at all would be a help in macroeconomic terms.
3. Yes, many of the lending decisions of state bureaucrats are likely to be poor ones. But this is an inevitable consequence of the fact that the future is inherently unknowable. The relevant benchmark against which to judge a state bank is not some mythical counterfactual of perfect decisions but rather the real world of banking in which lending is also systematically misdirected. Would over-lending to “green” companies really be worse than booms in property lending, which is what the private sector gives us, when it gives generous loans at all?
4. Many of the costs of misdirected lending are second-order (the diversion of resources towards bad companies) whereas the costs of insufficient lending are first-order (lower GDP). It takes a lot of Harberger triangles to fill an Okun gap.
5. Yes, many western countries have gotten rich through free market institutions. But these are get rich slow schemes. We are rich because we’ve had 200 years of 1-2% growth. Societies that have enjoyed a few decades of 6-7% growth, such as the more successful Asian tigers, have done so with state involvement. See the work of Ha-Joon Chang, such as this paper.
6. Yes, it is easier for nations to grow fast if they are behind the technological frontier than if they are near it. But it‘s not clear that being near the frontier argues against state banking. We don’t know how the technological frontier will move - technical progress is by definition unpredictable. So, surely one reasonable strategy is to throw money at lots of different ventures and see what works. In a climate in which the private sector is unwilling or unable to lend to new firms, this provides a potential role for the state.

Miliband: Hotelling vs Overton

Many on the left have been disappointed by the Labour leadership’s insufficiently hostile response to Osborne’s cuts. However, I think there’s a good economic argument for this apparent lack of backbone.
This doesn’t lie in the macroeconomics. I’m thinking instead of Hotelling’s law. This says that it is often rational for firms/political parties to make products very similar.
To see how this works in our case, imagine the likely responses of the economy to the cuts as lying along a spectrum. At one end, the cuts could unleash booms in exports and capital spending. At the other end, they could plunge us into recession. The ConDems are positioned on the “it’ll be OK” point on this spectrum. Where should Labour be?
If they put themselves on the “recession” point, they’ll look very clever if we get a recession. If, however, we get merely weakish growth, their position will be as discredited as the ConDems’. Instead, the best position is just slightly away from the ConDems’. This way, they’ll benefit from a recession - as this’ll discredit the ConDems more than them - as well as from the numerous weak growth possibilities.
Hotelling’s principle, then, argues for Labour positioning themselves quite close to the ConDems.
Where I share the Left’s disquiet is that there are two big dangers in doing this.
First, there’s the danger that if you repeat anything often enough, you’ll come to believe it. Labour will therefore fail to distinguish between the truth and the marketing position, and become overly sympathetic to the principle of shrinking the welfare state.
A form of this was the big failing of New Labour. It’s common on the left to decry Blair as a liar. But for me, what’s most unpleasant about the man was his honesty; he actually believed the marketing story about equality and efficiency being reconcilable within hierarchical capitalism.
Secondly, such a strategy shifts the Overton window. Because no mainstream party will espouse modern monetary theory, or some variant thereof, entirely reasonable economic positions are denied the respectability they deserve.
In this sense, there is a trade-off between rational political positioning on the one hand, and rational, open debate on the other.

Worthless banks

Are UK banks worth anything at all? I’m prompted to ask by Mervyn King’s recent speech, in which he says “of the many ways of organizing banking, the worst is the one we have today.”
One remedy he discusses is a levy on banks’ profits. He likens this to a Pigou tax, which is intended to internalize the externalities generated by banking - the main externality being the risk of a crisis.
Yes, Osborne has introduced something like this, but only in watered-down form. King says:

It is not difficult to see that a crisis that reduces output by between 5% and 10% for a number of years, and occurs once every fifty years, amounts to an annual cost several multiples of the revenue that will be generated by the UK bank levy

Let’s do the sums.
Let’s assume that a financial crisis reduces GDP by an average of 5% per year for five years. This is a loss of around £360bn in today’s money. If in the average year there is a one-in-fifty chance of such a crisis, it follows that the bank levy should be 0.2 x 360 = £7.2bn per year. This is three times as big as that planned by Osborne.
But what is the net present value of this?
Clearly, this levy should grow in line with GDP over time, because the larger is GDP, the larger is the absolute cost of a 5% fall in it. So let’s assume a 5% pa growth rate in the levy.
We must then apply a discount rate to this. Let’s call it 8%, which is a reasonableish estimate for the likely annual return on equities.
Applying Gordon’s growth model therefore gives us a present value for the levy of 7.2/(0.08 - 0.05) = £240bn. Granted, one-third of this - the likely size of Osborne's proposed levy - should already be priced into bank shares (but is it?). But this leaves £160bn not priced in.
But the market capitalization of the big five banks in the FTSE 100 is now only £266bn.
If other words, a proper Pigovian tax on banks could easily wipe out over half of their equity value.
You can quibble with these numbers in all sorts of ways. One reason why King is not enthusiastic about the levy is that it is so hard to truly estimate what it should be.  (Another issue he doesn't mention is that the incidence of the levy might not fall upon banks at all). But the fact remains. A large part of the private value of the banking sector arises solely from the fact that the costs of its activities - the risk of a crisis - are externalized. In an efficient market economy - one where private costs equal social costs - banks might not have much, if any, equity value at all.
Perhaps nationalization isn’t a wholly bad idea.

Tories vs the OBR

Fraser Nelson has chided the media for not giving enough attention to the OBR’s forecast that the private sector will create 1.5 million jobs in the next five years. If I were he, I wouldn’t crow about this.
My chart, taken from my day job, shows why.  It shows annual labour productivity growth - defined as GDP divided by employment - over five year periods, along with the growth implied by the OBR forecasts for GDP (pdf) and employment (pdf).
It’s clear from this that the OBR’s forecast for lots of job creation implies low productivity growth.
Stunningly low, in fact.
The OBR expects productivity on this measure to grow by just 1.8% a year over the next five years. This is less than it grew in the eight years to March 1979 (2.1% pa).
In other words, a massive switch in employment from the “inefficient” public sector to the “dynamic” private sector will be associated with lower productivity growth than we saw at a time when trades unions were, allegedly, holding the country to ransom.
If the OBR is correct - and of course it probably won't be - then Tories’ basic views about the economy are plain wrong. Shrinking the state and weakening trades unions do not increase productivity growth.
As I say, Fraser shouldn’t draw too much attention to the OBR forecast.
Now, you might object here that my measure of productivity is biased. My employment measure - actually, the OBR’s - conflates full- and part-time jobs. This means that if the share of part-time employment rises, productivity will fall on my measure.
This, though, is little help to Fraser - unless he wants to draw attention to the fact that many of the private sector jobs that‘ll be created will only be part-time ones.
(The OBR, AFAIK, does not give separate forecasts for full and part-time employment).

Self-deception & the undeserving rich

A few days ago, the great Paul Sagar noted an asymmetry in the Tory attitude to "fairness" - that whereas they are keen to point to the "undeserving poor", they are silent about the undeserving rich.
I was reminded of this by listening to Nick Clegg on Desert Island Discs.This provoked the question: why do the undeserving rich not recognise their undeservingness?
Clegg said (I'm writing from memory here, so the quote might not be exactly right) that "I was very lucky to go to a great school." This is a mix of self-awareness and self-deception. Self-awareness in that "very lucky" remark. And self-deception in failing to see that the distinguishing feature of Westminster School is that it is great but that it is expensive: £29,406 is more than most workers earn in a year (pdf).
What's going on here? One thing, I suspect is normalization. Most people (I think I'm unusual in this respect) are surrounded most of their lives by people like themselves so they fail to see that they are unusual. Clegg can no more see his privilege than fish can see that water is wet.
Another thing is that many of those born into privilege have forms of self-deception that prevent them seeing that they don't deserve their fortune.
The general phenomenon here is simply illusory superiority. Everyone likes to think they are better than average, and it is always easy to believe in things it is comfortable to believe. Self-interest breeds self-deception.
Among the likes of Clegg, though, I suspect there are two specific forms this takes.
One is a belief that one can offset one's privilege by doing good works; noblesse oblige. This is not wholly unreasonable; the Tory lady doing charitable work is not entirely a mythical figure. In Clegg, however, it takes a warped form. He says he was "propelled forward [into politics] by idealism". He fails to see how convenient it is that his particular form of idealism brings with it power and money.
Secondly, there's the perception that one has merit.Toby Young writes:

The aura of privilege that surrounds the Prime Minister and Deputy Prime Minister shouldn’t be mistaken for aristocratic hauteur. Their sense of entitlement doesn’t stem from good breeding, but from their conviction that they’re meritocrats. And in a sense they are. After all, admission to Britain’s top public schools, as well as Oxford and Cambridge, is at least partly based on merit.

This is, of course, laughable. But that's the point. Self-deception is hugely powerful.

The Dorries paradox

Is George Osborne doing a great job? From one perspective, it is logically impossible that he is.
What I mean is that Nadine Dorries says he’s doing a great job. But she also says her blog is “70% fiction.” Which raises the question: what is the probability that Osborne is doing a great job, conditional upon our MPilf saying he is?
Enter Bayes’ theorem.

Let P(A) = the probability that Osborne is doing a great job. Let P(B) = Dorries saying he is doing a great job. So P(A¦B) is the probability of him doing a great job, conditional upon Dorries saying so, and P(B¦A) is the probability of Dorries saying he’s doing a great job, conditional on him doing so.
Let’s suppose you are well disposed to Osborne, so the value of P(A) is high, at 0.8. We know from her “70% fiction, 30% fact” remark that P(B¦A) is 0.3. And let’s call P(B) 0.9; you might think it should be one, given that you’d expect Tories to support Osborne, but Dorries might have remained silent instead.
It follows that P(A¦B) is: (0.3 x 0.8)/0.9 = 0.266.
In other words, even if your prior belief was that Osborne was doing a great job, the fact that Dorries says he is means that you must attach only a low probability to him doing so.
The simple maths tells us Osborne is probably not great.
How can we avoid this  conclusion?
One possibility is that Dorries’ mis-spoke; she claims that she intended to say “30% fiction”: women and numbers, eh? If P(B¦A) is 0.7, then P(A¦B) rises to 0.62.
However, this does not greatly help the Tory cause. If you’re undecided about Osborne’s competence - P(A) = 0.5 - then P(A¦B) is only 0.39. A floating voter reading Dorries’ amended statement would therefore infer that Osborne was probably not great.
Another possibility is that Dorries does not intend her “70% fiction” remark to apply to this statement. She might say: “My statement ‘Osborne is doing a great job’ is true.” However, this statement must itself be subject to her “70% fiction” statement. We have, then, a variant of Epimenides’ paradox. This cannot overturn my reasoning.
Another possibility is simply that her “70% fiction” remark was wrong. We can rule out the possibility that it was a lie; an “honourable member” would not lie to a parliamentary commissioner. So we’re left with the possibility that it simply has no truth-value at all.
Here, though, we must draw a sharp distinction between statements that might have truth-value, and ones that are pure nonsense. The principle of insufficient reason suggests that when Dorries says “Osborne did a great job“, we should attach a 50% probability to him doing so. But if P(B¦A) is 0.5, then P(A¦B) is only 0.44. Again, we must infer that - even from a high prior support for Osborne - that he is doing a bad job.
We can only avoid this conclusion by reading “Osborne did a great job” as “whshfn  ghe n dkp henlg” - mere meaningless nonsense.
My conclusion here is simple. If you want to support Osborne you must regard Dorries as a nonsensical figure, who’s utterances have as much meaning as the barking of a mad dog.

The regressive red herring

Is the CSR regressive or not? I’m not sure this is a useful debate.
To see my problem, start with this (really good) report(pdf) from the TUC. It estimates that the poor receive huge benefits in kind from state spending. Heath and education spending on the bottom two deciles, it reckons, are equivalent to over 40% of their incomes.
Starting from this perspective, it is trivial that spending cuts will hit the poor harder even if they are merely even across the board:

For a given cash value of services lost, the impact will be larger relative to household income for poorer household for richer households…low-income households would be proportionately worse off if services were withdrawn and households had to replace them with services (at the same cost) paid for out of their own income.

However, this analysis is based upon how money is spent, rather than how it is valued by recipients.
Take, for example, spending on the police. Does this benefit the poor because they live in crime-prone areas and so gain from police protection? Or does it harm the poor because they are more likely to be victims of police harassment and brutality, whilst the police do not take sufficiently seriously the crimes they suffer from?
Or take schools. Are these a route out of poverty? Or are they places where poor kids will be bullied, demeaned and have their ambitions crushed, and where the ideological basis of inequality will be reinforced?
Technocratic analysis of the data is little help here. What matters is the actual experience of the worse off. And for some (many?) of these, the state doesn’t do much. Just ask the family of Ian Tomlinson.
From this perspective, the question of how the cuts will hurt the poor depend upon how, precisely, they are implemented. It’s possible that the pupil premium will actually benefit them, whilst kids from better-off families suffer. Or not. What matters is the detail of organizational change, not number-crunching.
I have a further problem - about incidence. Take housing benefit. Will cuts in this hurt only the poor? Or will they instead lead to a reduction in rents, in which case the upper deciles of the income distribution will suffer? What is true of housing benefit is true of all benefits. When the disabled get Employment and Support Allowance, the money isn’t eaten by the Evil Scrounging Goblin. The disabled spend it. And  this spending raises the incomes of the better off. Restrictions in ESA, then, don’t solely bear upon the worse off.
Of course, I don’t say this to defend Osborne. Instead, I do so to suggest that top-down statistical analysis about the overall “fairness” of the package is something of a dead end.
Instead, perhaps the left should highlight the petty-minded cruelty of some of Osborne’s measures, and remember that perhaps the main way in which the worse off will suffer is that the CSR will almost certainly lead to worse job prospects for workers than would otherwise have been the case.

Does university pay?

Will higher tuition fees deter men from going to university? This is the question posed by a new paper by Ian Walker and Yu Zhu on the returns to having a degree.
They estimate that, if tuition fees rise to £7000, degrees in the arts, humanities and non-economics social sciences will be bad investments for men. The cost of getting them will exceed the uplift in future earnings.
What’s more, at a higher discount rate on future earnings, or in the bottom 25% of graduate earnings, even degrees in science, technology and engineering will have negative pay-offs for men.
For most women - except those with lower seconds or worse in the bottom quartile of the wage distribution - degrees will continue to pay.
However, the problem here is not the fees themselves; these make only a small difference to the calculations. Instead, it is the underlying wage pay-off to getting a degree. This is larger for women than for men. Women graduates earn an average of 31% an hour more than those with A levels, whilst for men the return is only 19.6%. For men with degrees in the arts, other social sciences and humanities, the wage premium is only 5%.
For men, then, humanities degrees should be regarded as a consumption good, not an investment. And with the price of that good about to double, poorer students might be priced out. In this sense, those who fear that universities will become rich boys’ playgrounds - except for the geeks studying economics, law and sciences - might have a point*.
Here, though, is a quirk. The reason why degrees are better investments for women is that women without them earn much less than men. This suggests that if universities wish to attract female business - and let’s not kid ourselves they have any higher purpose - they should oppose any attempts to close the gender pay gap.
* How far this would change the character of universities is, however, a moot point.

How big a squeeze?

By how much will public spending fall in real terms? The Treasury puts the fall in departmental and administration budgets at 8.3% in real terms between 2010-11 and 2014-15: see table A5 here (pdf). This could be too optimistic.
It implies that prices rise by 9% in the next four years - 2.2% a year.
However, in their Budget forecast, the OBR predicted the GDP deflator rising by 9.8% cumulatively; table C5 here (pdf).
What’s more, there’s a long-run tendency for general government prices to rise faster than inflation generally - that’s the Baumol effect. In the last 20 years, the general government consumption deflator has risen 1.5 percentage points a year faster than the CPI - by 3.9% against 2.4%*.
If this continues, and if the Bank of England hits its inflation target, then the government deflator will rise by 14.8 per cent over the next four years, implying a fall in real departmental budgets of just over 14% - almost 6 percentage points more than the Treasury expects.
The real squeeze on spending could be tighter than Osborne claims.
* I’m dividing code identifier NMRP by NMRY from table A2 here.