Stumbling and Mumbling

How I would defend inequality

Defenders of inequality are doing a desperately poor job.

For example, Tim Worstall's claim that the tax and benefit system already does a lot of redistribution fails to engage with the argument that pre-tax inequality might be a bad thing.

And Greg Mankiw's claim that the rich deserve their fortune barely counts as an effort. Even if we concede - heroically - that high salaries are due to high marginal productivity, questions remain such as: what about Rawls' claim that talents are arbitrary from a moral point of view? Do people really deserve to have been born at a time when their marginal productivity is high: if Wayne Rooney had been born 80 years ago he'd have earned £20 per week, not £300,000? And even if people do deserve credit for cultivating their own ability, they hardly deserve credit for the fact that others' inability to do so renders their ability scarce. Problems such as these mean that the more intelligent rightists, such as Hayek or Nozick, have acknowledged that the link between merit and income is weak.

So, is it possible to defend inequality better?

The issue here is not one of free markets: it's perfectly possible for a free marketeer to worry about inequality precisely because so much of it arises from market imperfections or state interventions such as bank subsidies, QE, crony capitalism or copyright laws.

Subject to that caveat, here's how I would try to defend inequality:

1. Bosses and bankers have epic levels of narcissism and high pay is the least bad way of gratifying this. If they were paid less, they would seek other ways of satisfying their self-regard such as pursuing non-pecuniary status symbols such as corporate jets or by plundering the firms' assets. There's a reason why the word "efficiency" appears in the phrase "efficiency wage models". It's because it might be efficient to bribe workers not to exploit their power.

Income inequality was low in the 1970s, but industrial relations then were poisonous, productivity low and management poor. There might be a link here.

2. Some policies to curb high salaries would merely shift incomes between the rich. Limiting footballers' pay, for example, would make John Terry worse off but Roman Abramovich better off; ticket prices would stay high because demand outstrips supply. Much the same is true of CEOs were paid less; shareholders would benefit, not customers or workers.

3. One of the best ways to increase equality would be to create countervailing power to the rich - either by strengthening trades unions or by encouraging worker control. But there is no demand for such policies.     

4. Even if we accept Wilkinson and Pickett's evidence that inequality has several social costs, it doesn't automatically follow that there's a case for reducing the incomes of the top 1%. They measure inequality by the ratio of the top 20% to bottom 20% of incomes. And it's plausible that it is middling inequalities that hurt us: it's our neighbour's new car or our colleague's pay rise that upsets us from day to day, not footballers' million-pound salaries.  

5. The question of whether inequality is bad for growth (pdf) or a cause of economic crises (pdf) is a tricky (pdf) one; much depends upon what causes inequality, and the form that redistribution takes. One big fact, however, warns us not to expect a growth bonanza from ergalitarian policies. It's that long-term economic growth doesn't vary much across countries or time. This suggests that variations in inequality might not have big effects upon growth.

FWIW, I'm not sure about these arguments; I've listed them in rough order of what I think is their plausibility. But I suspect they are better than wibble about desert. 

Fiscal idiotarianism

Politically, if not intellectually, the austerians have won. As Aditya says, both main parties are commited to "fiscal impossibilism". The IPPR's Condition of Britain report, for example, takes ongoing austerity for granted.

This raises a puzzle. The Bank of England has consistently said that the decision on when or whether to tighten monetary policy will be "data driven". Although some MPs have trouble grasping this simple concept, it is surely sensible; policy must be set according to the facts. Why then, should this not also be true of fiscal policy?

Let me deepen the question. There is a risk that the euro area could fall into a Japan-style lost decade of stagnation. This would gravely weaken the case for tighter fiscal policy. If a market which accounts for two-fifths of our exports stagnates, then tax revenues will falter and attempts to swiftly reduce the deficit would further depress the economy and might prove counter-productive.

To put this another way, think about financial balances. One aspect of euro stagnation would be that the region will continue to run a big current account surplus (pdf); this would be the counterpart of tight fiscal policy in the region, plus weak capital spending. If our biggest trading partner runs a current account surplus, we will probably have to continue to run a current account deficit. The counterpart to this is that some domestic sector must also run a deficit. But who? The OBR foresees companies continuing to run a surplus. This means that the government can return to balance if and only if households become huge net borrowers. But what if this doesn't happen - say because tighter macroprudential regulation prevents it or because households prefer to reduce debt? In this case, the government will have to run a deficit, possibly a big one. Attempts to bring even the current budget into balance would run into the paradox of thrift and simply depress demand.

Granted, all this is only a risk not a certainty. But sensible policy must be set according to risks and not merely according to a central case forecast.

Why then, don't politicians do what Carney does, and say that policy will be data-driven?

It's not good enough to argue that counter-cyclical policy should be done by monetary policy alone. This might be tricky if we are at or near the zero bound - or at least, if MPs think large-scale quantitative easing is the best counter-cyclical policy they should say so, and explain why.

You might think the answer lies in the word "credibility". It does - but not in credibility with financial markets; the fact that long-term real yields are negative tells us that, for practical purposes, this exists. Instead, the two parties are competing for "credibility" with a media and public that has fallen for idiotarian talk that the public finances are the nation's credit card. And we get the governments we deserve. 

When ignorance is power

In a tweet last night Stella Creasy, referring to Adrian Beecroft's claim that he didn't know about Wonga's fraud until recently, said:

Surprised to hear Beecroft claim as major shareholder in Wonga didn't know about fraud issues. Not great advert for his expertise is it?

Au contraire. It's a great advert for his expertise.

For one thing, bosses, let alone shareholders, simply cannot know everything. However much expertise you have, you cannot know what thousands of people are doing from hour-to-hour. Knowledge is bounded.

And even if such knowledge were attainable, it's not clear it would be desirable to obtain it, as doing so would entail massive micromanagement which would demotivate employees and stifle their initiative. If - say, hypothetically - a newspaper editor were to persistently ask staff how they got their stories she would soon find them walking out the door to papers where they were allowed to get on with their work.

But there's something else. It's that for bosses, ignorance can be an asset. John Gapper writes that "no public company can knowingly permit lawbreaking and journalistic recklessness." That word "knowingly" is doing some work. It's quite possible that, for some (many) businesses, law-breaking has a positive expected value: the expected benefits of fraud or phone-hacking exceed the expected costs. A profit-maximizing company should therefore undertake them. One way for it to do so is for managers to turn a blind eye so they can maintain plausible deniability, and ensure that if the wrongdoing is exposed that there's no smoking gun to connect them to the crime.

What's more, as Thomas Schelling pointed out back in 1956, ignorance can be power in bargaining situations. The boss who can maintain plausible ignorance about crime in his company is less likely to be blackmailed, for example. Linsey McGoey has claimed that ignorance was a source of power for bankers, because it both permitted them to make profits from taking on tail risk in mortgage derivatives and then gave them power to extract state hand-outs: "if you don't bail us out, who knows - the whole financial system might collapse."

In this sense, the old saying "knowledge is power" is wrong. Sometimes, it is ignorance that is power.

In saying all this I don't mean to criticize Ms Creasy personally, as she is generally a good thing. Instead, I fear that what we have here is an example of a casual comment betraying a wider mindset. In presuming that managerial knowledge is unbounded, and in ignoring the use of ignorance as means to cling onto power and wealth, she is revealing a classical weakness in social democrat ideology generally - a naivete about the nature of managerial power.

Liam Plunkett & the tragedy of social science

England's narrow defeat in the second test raises two important issues in the social sciences.

I'm thinking of the use of Liam Plunkett as a nightwatchman in the second innings - a role he played to the letter by virtue of getting out to the last ball of the day.

This poses the old question of whether nightwatchmen work.Charles Davis has argued that they don't on the grounds that tailenders used as nightwatchmen average as much as they do when they go in as tailenders.

But is this the best counterfactual? The nightwatchman's scores as a tailender might not be the right one because there's a selection bias here: nightwatchmen are usually used when batting conditions are tough - when bowlers are on top and the light is fading. To maintain one's average in such circumstances is creditable. And in England's case this week, had Moeen Ali had to go in on Monday night he might have gotten out and not played what was very nearly a match-saving innings. Using other counterfactuals. Anantha Narayanan says the use of a nightwatchman has been a "great success".   

This problem of counterfactuals is common in the social sciences, especially macroeconomics. It's sometimes said that we can't know for sure whether particular policies would have worked because we don't know what the counterfactual was. Others, though, say that one virtue of economic models is that they can generate plausible counterfactuals against which to judge policy.

But there's a second issue raised by the use of nightwatchmen. To see it, ask: what mechanism might cause them to work?

One plausible one here is the Pygmalion effect. If you make tail-end charlies believe they can bat by pushing them up the order, they will bat better, just as if you label kids as smart they'll do better at school. John Lambie, manager of Partick Thistle had this in mind when, on being told a player of his was so badly concussed that he didn't know who he was replied: "Tell him he's Pele and get him back on."

But there's an alternative mechanism - overconfidence. If you tell people they're good when they're not they'll be emboldened to over-exted themselves and so fail - as Plunkett did when he thought he could off-drive Herath.

This, though, proves a point Jon Elster made - that in the social sciences, "the opposite of a profound truth is another profound truth" precisely because there are countervailing mechanisms.
This point, of course, applies to very many political issues. Take just three:

 - Taxes. If you raise taxes on the rich, they might emigrate or evade the taxes or just stop working. Or they might have to work harder or longer to make up for the loss of post-tax income. Higher taxes might or might not deter effort.

 - Hospitals. Should we have more smaller hospitals, as Simon Stevens suggests? Maybe, because there are diseconomies of scale in bigger hospitals. Or maybe not, becuase there are economies of scale so smaller hospitals are inefficient.

 - Syria. If young British Muslims go to fight in Syria, will they return as radicalized terrorists? Or will they instead be killed there, or simply get their aggression out of their system and return as decent citizens?

In all these cases, anyone could make a case either way, and newspapers pay blowhards good money to do so. To be confident of such opinions, though, is to be guilty of what Jordan Ellenberg calls "false linearity" - a failure to see that offsetting mechanisms create hump-shaped curves.

What matters, though, is empirical evidence. But because of that problem of counterfactuals, this will sometimes be elusive. Many of those blowhards should remember Wittgenstein: "Whereof one cannot speak, thereof one must be silent."

Austerity in the mainstream

Economics and Westminster politics have parted company. That's the message of this claim by James Bloodworth:

There is no longer a mainstream anti-austerity narrative. The Tories and the Lib Dems are making cuts, Labour are going to make cuts and no one who isn’t is going to get anywhere near power anytime soon.

There might not be an anti-austerity narrative in the narrow Overton window of Westminster politics, but there sure as hell is in mainstream economics. There's now widespread ageement, even at the IMF, that austerity did hurt the economy: Oxford professors and the Director of the NIESR might be marginalized by politics and the media, but they are mainstream in economics.

You might reply that this is mere history. Although we know that austerity has depressed output, isn't there a case for cuts now the economy is growing? Maybe, but not necessarily. There are three issues here:

1. Why should policy tighten, rather than merely allow the standard automatic stabilizers - the cyclicality of tax revenues - to work?

The Westminster answer is that some of the deficit is "structural" and won't be eliminated by growth; the OBR claims there was a cyclically-adjusted deficit of 4.3% of GDP last year.

However, this estimate is far from certain; it relies upon an attempt to quantify the extent to which GDP is below potential and such quantification is grossly unreliable. The Bank of England says there's "considerable uncertainty" about the size of the output gap, which must mean there's also considerable uncertainty about the size of the structural deficit.

2. If policy must tighten as the economy grows, why should fiscal policy do so more than monetary policy?

One could argue that monetary policy should adjust first for two reasons. One is that getting us away from the zero bound means that we'll be able to use monetary policy to cushion us when the next recession comes - which will relieve fiscal policy of the job. The other is that sustained low interest rates run the risk of igniting bubbles in asset prices, and it's an open question whether these are remediable by macro-prudential policies such as curbs on bank lending.

3. Can we be sure that the economy will continue to grow? It's quite possible that there'll be a recession at some time in the next parliament. It is therefore imprudent for a government to plan on tightening without considering this possibility.   

I'll concede that I have maverick opinions on many things. But I suspect that, on these questions, I'm close to the mainstream. Granted, there might be a case for austerity, but it is far from as clear-cut as the Westminster village pretends.

The issue here, though, isn't merely about fiscal policy. It's about the extent to which politics should be informed by orthodox economic expertise. If anti-austerity arguments fall outside mainstream politics then it is not just the left that has been defeated, but rationality too.  

In praise of betting

Tim Harford says "the world needs more wagers between pundits." But he omits to say that, in fact, we see trillions of pounds of such wagers every day. I'm referring to financial markets. Many trades (apart from those undertaken for hedging or liquidity reasons) are bets on an economic theory - that there's predictability in a particular exchange rate, that a share is under-priced, and so on.

Now, most of those bets are gambles with other people's money - there are good reasons why so many traders work for big banks rather than on their own account - and traders can be selected for bumptious overconfidence.

Nevertheless, I'm tempted to agree with Tim that this form of betting can be a good thing in terms of its cultural effects.

The point here isn't simply that a bet is a tax on bullshit. It's that bets (or trades or investments - they amount to the same thing) teach us an important lesson. Everyone who has made a decent number of them learns that however good is your research, theory and evidence, you'll often go wrong. In this sense, trading teaches us that we have "severely limited knowledge of the opaque, complex, social world."

This is especially necessary because most of us go through life over-exposed to like-minded people; our friends tend to think like we do and we read websites which echo our own beliefs. There's an element of the smackhead in most people; we go through life surrounded by a comfortable cushion which numbs us against reality. Betting is a way of exposing us to that reality.

If more politicians had been traders, we might less less daft certainty about economic policy.

Of course, one could learn this lesson from reading the literature on bounded rationality and knowledge. But the best lessons - those that really change us - are learnt by practice not reading; I'm always surprised by the fact that so many Austrian economists who are supposed to have read Hayek often seem so damned certain about their opinions.

It's in this context that my readers at the Investors Chronicle are so different from others. If a Telegraph or Guardian reader has silly ideas about the economy, he hurts nobody other than those stupid enough to read the comments below columns. If an FT reader has a daft idea, he hurts hurt other people - employees, colleagues or tax-payers. But if an IC reader has a stupid idea, he hurts himself. This, plus his experience of the occasional misfortune, gives him a sense of humility and an awareness that thinking about economics is tricky.

What I'm saying here is a variation on a theme of Deirdre McCloskey. Markets - proper markets, not rigged ones - create a culture amenable to some virtues, those in this case being humility and scepticism.

Is it possible to create political institutions which foster such virtues?

Yes. One argument for demand-revealing referenda is that a system in which people have to vote a sum of money to back their favoured policy would drive out blowhards and favour evidence-based arguments. But despite the right's enthusiasm for introducing markets into so many other areas of life, such referenda have never been popular. I really can't think why.

Yes, there is a confidence fairy

Giles Wilkes does a good job of dismissing the idea that the "confidence fairy" is responsible for our economic recovery. I half agree.

I agree that "confidence" is a non-explanation for fluctuations in consumer spending. Such fluctuations can, for the most part, be explained by observable economic variables such as incomes, unemployment and credit availability, as John Muellbauer, for example, has shown. Insofar as spending is forward-looking, it's not because of confidence, but because consumers - in aggregate - have genuine foresight; this is why consumption-wealth ratios help predict equity returns.

So far, I'm with Giles. My chart show why I part with him. It shows that there's a close correlation between investment fluctuations and business confidence, as measured by the European Commission.

Of course, correlation isn't causality. It could be that both change for the same reasons - such as changes in interest rates and profits - or it could be that falling investment causes weaker sentiment.
But this is unlikely to be the whole story. There's a decent body of research which shows that sentiment, or animal spirits, affects investment. Central bankers agree with this. Here is Frederic Mishkin (pdf):

There is strong theoretical support for the management of expectations to stimulate spending when the policy rate hits the zero lower bound.

And here are Bank of England economists (pdf) on QE:

Asset purchases may have broader confidence effects beyond any effects generated through the effect of higher asset prices.

For example, QE might have worked - insofar as it did - by signalling that central banks were willing to do everything possible to ease the crisis, thus preventing an even more catastrophic collapse in in confidence. And the point of forward guidance is to give companies confidence that policy wouldn't tighten. As Mark Carney said in February:

Forward guidance is working. Expected interest rates have remained low even as the economy has recovered strongly. Uncertainty about interest rates has fallen. Most importantly, UK businesses have understood the message. Surveys [show that] virtually all businesses understand guidance, and almost three-quarters of them say it has boosted their confidence in UK economic prospects.

My point here is that one popular idea about the economy is 100% wrong. The media sometimes give the impression that consumers are like PR girlies, swayed by sentiment and "confidence" whereas business "leaders" are hard-headed experts. In fact, the opposite is the case. It is consumers, in aggregate, who are reasonable and bosses who are skittish and sentimental.

However, what we have here is an example of irrationality paying. Business confidence acts like a vengeful and capricious god does to primitive tribespeople; it must be appeased by regular sacrifices. As Michal Kalecki wrote:

Under a laissez-faire system the level of employment depends to a great extent on the so-called state of confidence...This gives the capitalists a powerful indirect control over government policy: everything which may shake the state of confidence must be carefully avoided because it would cause an economic crisis.

School utopianism

I've heard two examples of right-wing managerialist utopianism recently. First, on the PM programme (29 mins in) Martin Stephen said that the way to abolish private education, as Alan Bennett wants, is to "make the state system so good that nobody wants to go to independent schools." Then today Sir Michael Wilshaw, in calling for state schools to improve their sporting education, says that the "most important thing" in achieving this is "the commitment and leadership of the head teacher."

I say this is managerialist utopianism because it underplays the importance of resources and overplays the role of management.

Sir Michael says that "high school fees and large playing fields are not a pre-requisite to success". Maybe not. But they surely help. I live a few yards from Oakham School's sports ground, and I can tell you that it's far better than state schools' facilities. This surely must matter insofar as it helps foster a culture in which pupils feel that sport matters and that they can excel at it; just look at the number of top sportsman the school has produced. I'll grant that a few exceptional teachers at state schools might be able to compensate for this huge advantage. But not everyone can be exceptional, and to suggest otherwise is utopian.

Mr Stephen is equally utopian in calling for state schools to improve so much as to match private ones. What this misses is that state schools have far fewer resources. Spending per pupil in state secondaries is £5353 per year. That's only one-third of the day fees (that is, excluding accommodation) charged by top private schools. Of course, three times the spending doesn't mean three times the quality - there are diminishing returns - but it is surely naive utopianism to think that spending doesn't matter at all. If it didn't, how come no private school is offering Eton-style results for fees of £5353 per year?

Maybe I'm doing Mr Stephen a dis-service and perhaps he wants more spending on state schools. But he didn't say so. And I've not heard of anyone calling for the £28bn per year rise in spending on secondary schools that would be necessary to take per-pupil spending up to the level at Oakham.

My point is that state schools are destined to be inferior to at least the best private ones*, and so inequality of opportunity cannot be eradicated whilst such schools remain.

You can react to this in three different ways. One would be to call for the abolition of private schools. Another would be to say that the system should persist, because the benefits we get from having a minority of expensively-educated people - some good sportsmen and a cadre of business and political leaders - outweigh the costs.

For me, both are inadequate. The former is illiberal, the latter just bollocks. But there is a third way. It's to accept the inequality of opportunity but to equalize the unearned good luck of going to a good school and the unearned bad luck of going to an inferior one by having a redistributive tax and benefit system**.  

* Owen Jones' reply to Mr Stephen - that state schools are in fact the equal of private ones - seems to me odd. If it were true, it would imply that thousands of intelligent people are each wasting tens of thousands of pounds which is implausible. Insofar as I can tell, his claim is based on this OECD research (pdf), whose definition of private schools includes not just fee-paying ones but church-run ones. And it is inconsistent with other research which shows the pay-off to private schools is high and rising.

** Optimal tax theory suggests there might be a case for taxing ex-public school pupils directly. But nobody's interested in optimality.

Miliband's managerialism

Ed Miliband really is the heir to Blair. That's my reaction to his idea that young people without the equivalent of an A level will have to be in training if they are to get welfare benefits.

I say this is Blairism not just because it echoes Blair's belief that "education is the best economic policy there is", but because it represents a continuation of Blairite managerialist ideology.

Ewart Keep has pointed out that, for years, training policy has rested upon numerous dubious ideological premises. I'd highlight four such premises:

1. The assumption that everyone is trainable - that the crooked timber of humanity can be shaped into productive, trained workers. Maybe this is true if you invest in people in their early years. But is it really true of people who have left school? What if some people just lack the cognitive or non-cognitive skills to get a decent training? What about those with special needs?

2. The belief that one can foresee future demands for workers, and that this future will be one in which skills are in demand. But it ain't necessarily so. One feature of today's economy, as Frances says in this book, is "a hollowing–out of the middle as routine medium–skilled jobs are automated." We're seeing a process of job polarization, in which demand for middling skills is falling. This is consistent with what Brynjolfsson and McAfee describe. Jobs that could be done by algorithms, they say, will be done by robots. This could hurt those with office skills more than it hurts unskilled building labourers, men with vans or window-cleaners. In such a world, having middling skills might merely equip one to compete better for low-wage work rather than to get a good job.

3. The belief that skills will get people into good jobs. This deflects the blame for unemployment onto the jobless themselves. It invites us to regard unemployment and low wages as individual failings rather as a result of macroeconomic factors such as a lack of aggregate demand or a shift in the balance of class power which enables bosses to pay low wages.

4. The presumption that one function of government should be to act as a human resources department, ensuring that capitalism gets a supply of willing workers. Miliband wants to "give business the productive workforce they need." He doesn't ask: if business wants something, why doesn't it do what the rest of us have to do when we want something, and pay for it? Again, this is New Labourism. As Stuart Hall said (pdf), Blair thought government should be in the business of "vigorously adapting society to the global economy's needs, tutoring its citizens to be self-sufficient and self-reliant in order to compete more successfully in the global marketplace."

Now, I don't say this to wholly decry the policy; I'm not sure it's as mean-spirited as some reports have made it out to be, and it's possible that some youngsters could get a helpful chivvying into a good training scheme. Let's just remember that it rests upon some very questionable ideological assumptions - ones which serve to underpin the power of capital.

The poor white problem

Why do poor whites do so badly at school? For example, only 32.3% of white British eligible for free school meals get five or more "good" GSCEs, whereas 52.% of Asians eligible for them do so and 48.2% of blacks do (Excel table here, via Sam).

Here's a theory.It rests on two premises:

 - ability to pass exams and earn a living is highly correlated between parents and children, as Greg Clark suggests. For our purposes, it doesn't matter whether the transmission is via genes or culture.

 - ethnic minorites are more likely than white British to be underpaid relative to their abilities. This might be because they suffer labour market discrimination (pdf), or because immigrants are more likely to be over-educated for their jobs than natives.

These two premises alone would generate a pattern in which poor white British do worse at school than ethnic minorities. This is because many poor minority children will come from good-ability parents who happen to be poor, whereas the white British will be more likely to come from lower-ability parents. And insofar as ability is inherited, minorities will then tend do better at school.   

Now, neither left nor right will like this. The left will object to the assumption of a high inter-generational transmission of ability, and the right to my highlighting of racial discimination in labour markets. And managerialists will object to the apparent fatalism.

But it doesn't matter what you like. What matters is what's true. Is this theory?

Perhaps the strongest evidence against it pointed out by the Education Select Committee (par 44 of this pdf) - that there are massive regional variations in poor whites' attainment. For example, in Peterborough only 12.6% of whites eligible for free school meals get five good GSCEs, whereas in Lambeth almost half do. This huge discrepancy, says Adam Bienkov, suggests that where poor whites do badly it is because of poor schools rather than a lack of inherited ability.

Undoubtedly, this is part of the story. But I'm not sure it's all.

For one thing, in most (not all but most) of those local authorities where poor whites do well at school, poorer ethnic minorities do even better. For example, in Lambeth 49.6% of poor whites get five good GSCEs, but 57.7% of poor minorities do. (Annex 2 here). And even in Lambeth, poor whites do worse than the average poor Asians across the whole country.

And for another thing, it might not be fully possible for the rest of the country to emulate London's success. Insofar as better teachers would rather work in London than in Peterborough, poor whites in the latter are at a disadvantage. And as the JRF has complained, many schemes aiming to improve poor kids' achievements have been "a proliferation of ‘hopeful’ interventions with unknown effectiveness".

However, I don't mean this as a counsel of despair. I do so instead to repeat what I've said before - that if we want to improve the life-chances of the worst-off, the answer lies not just in investing in education, but in more income redistribution.