Stumbling and Mumbling

Costs of austerity

It’s not just public sector workers and benefit recipients who are suffering from fiscal austerity. So too now are bank shareholders.

The FT reports that the sharp fall in banking stocks so far this year is due in part to fears of more negative interest rates.  This is because negative rates are in effect a tax on banks: banks have to pay the ECB and BoJ to deposit with it. JP Koning might be right to say that banks will eventually find a way of passing this tax onto others – say, by charging customers for deposits – but stock markets don’t agree with him (yet?).

The link between this and austerity should be obvious. Negative rates are a response to weak economic growth. But growth is weak because fiscal policy isn’t loose enough. A looser fiscal policy would prevent the need for negative rates, thus removing the potential pressure on banks’ profits.

In this sense, the costs of fiscal austerity are widespread. Not only do they fall upon public sector workers and benefit recipients, but they are also being suffered by savers who face nugatory interest rates and bank shareholders (and bankers themselves!) who are hit by fears of a de facto tax.

This poses the question: why isn’t this more widely realized? Why is anti-austerity seen as a minority left-wing position when it would in fact have wider benefits?

One reason, as I’ve said, is that people are lousy at making connections: they just don’t join the dots between fiscal austerity and low interest rates. And our illiterate media don’t help them.

A second reason is that anti-austerity comes as part of a package. A fiscal expansion might be good for bankers. But in many countries, this would come with policies they don’t fancy so much, such as higher taxes and more regulation. For some reason, right-wing anti-austerity isn't on the table. 

A third possibility is Kalecki’s famous one:

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.  But once the government learns the trick of increasing employment by its own purchases, this powerful controlling device loses its effectiveness.  Hence budget deficits necessary to carry out government intervention must be regarded as perilous.  The social function of the doctrine of 'sound finance' is to make the level of employment dependent on the state of confidence.

I confess to being unsure about this: do capitalists really prefer control over policy to economic stability?  However, if you discount this possibility, we are left with an awkward question: why do so many people not favour policies which would seem to be in their own interests?

Are recessions predictable?

Amidst all the talk of a recession, this chart presents something of a puzzle. It shows that there’s a decent correlation (0.57) between annual changes in the All-share index and in UK industrial production*.

The puzzle is that this correlation is contemporaneous. If stock markets anticipated recessions and booms, we’d expect to see the blue line move in advance of the red one. But this isn’t really the case**. Sure, the strongest correlation (of 0.68) comes if we lag industrial production four months. But such a short lag might exist simply because the stock market is a “jump” variable whereas output isn’t. Shares can respond immediately to bad news (such as the collapse of Lehmans in 2008), but because output takes time and must be planned in advance, it can be slower to respond.

For longer lags, the correlation is weak – for example, it’s only 0.23 between price changes and output changes 12 months later.

This lack of a significant lead between share prices and output is especially surprising simply because you’d expect one simply because changes in share prices can cause changes in output – via cost of capital or wealth effects, or because share prices should send signals about future economic conditions.

So, what explains it?

I don’t think the story here is about equities: my second chart shows a very similar relationship between output and sterling’s trade-weighted index.

Instead, all this is consistent with a simple possibility – that stock markets just don’t see recessions coming (or at least don’t anticipate the things that trigger recessions). We know that economists have consistently failed to foresee recessions. Perhaps this isn’t (just) because of their own inadequacies. Maybe it’s because economic fluctuations are inherently unpredictable.

This could be because recessions are the product of complex emergent processes. But there might be a more mundane reason. If some recessions were predictable, policy-makers would loosen policy in advance, thus preventing them***. The only recessions we ever saw would then be the unpredictable ones.  

The message I take from this is that we should be humble about our ability to foresee recessions coming, especially when others aren’t expecting them.

* Given that UK equities are correlated with overseas ones, and UK industrial production with global output, I suspect a similar pattern is true generally.

** The chart is also inconsistent with Samuelson’s quip that the stock market has predicted nine of the last five recessions. If this were the case, we’d expect to see some falls in share prices which aren’t followed by falls in output. However, except in 2003 (and maybe now!) we haven’t.

*** They would then be criticized with hindsight for loosening policy unnecessarily!

Are football tickets under-priced?

Saturday’s protest by Liverpool fans at the proposed rise in ticket prices poses a puzzle - that from the point of view of elementary economic theory, football tickets are too cheap.

What I mean is simple. Fans are addicts; many would pay much more to see their team. Demand is therefore price-inelastic. And despite playing indifferent football, Anfield – like most Premier League stadia – has been full this season. Both these facts suggest that Liverpool’s owners could increase profits by charging fans more. Econ 101, therefore, tells us that tickets are under-priced.

This is not just true for Liverpool. A survey (pdf) by Anthony Krautmann and David Berri has found that most fans in many popular sports pay less for their tickets than conventional economic theory would predict.

Which poses the question: are team owners therefore irrational?

Not necessarily. There are (at least?) four justifications for such apparent under-pricing.

First, say Krautmann and Berri, owners can recoup the revenues they lose from under-pricing tickets by making more in other ways: selling programmes, merchandise and over-priced food and drink in the stadium.

Secondly, Shane Sanders points out that it can be rational to under-price tickets to ensure that stadia are full. A full ground and vibrant atmosphere, he says, increase a team’s chance of winning and thus increases future revenues. One way in which this happens is that referees are biased towards home teams with big crowds: we all know there is such a thing as a “Stretford End penalty” (aka a fair tackle).

Thirdly, higher ticket prices can have adverse compositional effects: they might price out younger and poorer fans but replace them with tourists – the sort who buy those half-and-half scarves and should, therefore be shot on sight. This increases uncertainty about longer-term revenues: a potentially life-long loyal young supporter is lost and a more fickle one is gained. It also diminishes home advantage: refs are more likely to give dodgy decisions in front of thousands of screaming Scousers than in front quiet Japanese tourists.

Fourthly, high ticket prices can make life harder for owners. They raise fans’ expectations: if you’re spending £50 to see a game you’ll expect better football than if you spend just £10: I suspect that a big reason why Arsene Wenger has been criticised so much in recent years is not so much that Arsenal’s performances have been poor but because high prices have raised expectations.  

This imposes several costs on owners. Impatient demands to sack managers force them into difficult decisions. Fans’ protests can be bad for the owners’ “brand”. And even the thickest-skinned owner doesn’t like having tens of thousands of people shouting abuse at him: even Mike Ashley has felt compelled to spend money at Newcastle United this season.

In these ways, apparently irrational behaviour – the under-pricing of tickets – might not, in fact, be so irrational after all.

Sometimes, what looks like irrational behaviour turns out to make sense if we consider agents’ motives and incentives more carefully.

The point, I suspect, broadens. To take just one example, the great performance of momentum and defensive stocks makes it appear that fund managers’ have, stupidly, left money on the table. However, when we consider that such stocks expose them to benchmark risk – the danger of under-performing their peers and so getting sacked – their behaviour becomes more understandable.

Apparent departures from rational behaviour should not lead us to immediately decry stupidity. They should instead be cues to investigate further why people are behaving as they are. This, of course, is true for life as well as economics. 

On recommended reading

Diane Coyle’s question – what should the well-read student read? – has prompted some good answers, not least her own. But for me it raises a question: are there some classic books which are age-specific – which youngsters might love but older folk not, and vice versa?

Here are two examples from my sixth-form years. For my English A level, I had to read Middlemarch. It inspired me – to drop my plans to study English at university. God it was turgid. But it’s quite possible that its themes of disappointment and mediocrity would chime better with the middle-aged – though I’ve yet to summon the appetite to find out.

Then my history teacher, seeing that I was a gobby socialist (what – you’re surprised?) urged me to read Hayek’s Constitution of Liberty. His motives were entirely correct: one must read to challenge one’s prejudices, not confirm them. But I couldn’t get to grips with it. Maybe Hayek’s key insight – that our knowledge is tightly bounded – can only be learned properly at the School of Hard Knocks and formalized by reading after that bitter experience. Perhaps some things can’t be understood by cocksure youngsters, and nor should they be.

I suspect that two other writers I admire – Michael Oakeshott and P.G. Wodehouse – would have left me cold had I tried them when I was young.

The converse is also true. Some books are more suitable for youngsters. To a certain type of 16-year-old, Thus Spake Zarathrusta is a fantastic read. The older reader, however, thinks that someone should have had a quiet word with Mr Nietzsche. I suspect the same goes for Ayn Rand.

And I remember reading Crime and Punishment in almost one sitting as a teenager. But I was disappointed when I re-read it in older age (The Brothers Karamazov, on the other hand, remains my favourite novel.)

This thinking leads me to two principles that should inform our suggestions for what bright young people should read.

One is that readability matters. Books, at that age, should be fun to read. For me, this makes Diane’s suggestion of Hume’s Enquiry Concerning Human Understanding a brave one: it might work brilliantly, but might not. I’d also quibble with her recommendation of Kahneman’s Thinking Fast and Slow. Much as I admire his work, and think behavioural economics and cognitive biases very important, I found the first few chapters of that rather dull. I’d prefer to recommend Dan Ariely’s Predictably Irrational, which is a livelier read.

For the same reason, if I had to recommend a work of political philosophy, I’d plump for Nozick’s Anarchy State and Utopia on the grounds of readability. Most of you – and me – would find Rawls or Sen’s ideas more congenial. But let’s face it, they’re not exciting reads.

Young people will discover soon enough that most people – not least those who claim to be intellectuals – are tedious bores*. There’s no reason why they should learn this earlier than is necessary.

Secondly, books should alert youngsters to the breadth of ideas out there without necessarily flatly contradicting them. In my youth, Sabine’s History of Political Theory and Russell’s History of Western Philosophy did this. I like to think that Alasdair MacIntyre’s After Virtue might have a similar effect, with a twist, today.

You might object here that the books we should advise youngsters to read are those we agree with. I disagree. The point of education is not to turn out a generation of mini-mes. If your ideas are worth having, intelligent and curious young people will eventually discover them for themselves.

I must, however, caveat all this massively. I have little experience of young people: for obvious reasons, few people would me anywhere near them. My question to those who do have such experience is: how wrong am I?

* In their defence, this might (in a few cases at least) be because, as Isaiah Berlin said, there’s no reason to suppose that the truth, if it is ever discovered, will necessarily prove interesting. I worry that a lot of the advice I give readers in my day job is boring and repetitive.  

Immigration, crime & jobs

Since the Cologne sex attacks, there has been even more of a backlash against immigration in Europe. Whilst the details of those attacks are unclear, I wonder: might increased crime be the price we must pay for doing our moral duty?

I ask because of a new paper from the CEPR (ungated earlier version here (pdf)) from Switzerland. It estimates – based on migration to Switzerland –that:

Cohorts exposed to civil conflicts/mass killings during childhood are on average 40 percent more prone to violent crimes than their co-nationals born after the conflict.

This rings true. We know that people are scarred by experiences in their formative years and that there is an intergenerational transmission of violence. As Glen Bramley points out, British adults who are chronic offenders “had very high instances of adverse childhood experiences”. It is surely, therefore, plausible that people who suffer the trauma of civil war and mass killings in their early years will themselves be disproportionately predisposed to violence.

But these are precisely the people we have a duty to help. The principle of luck egalitarianism tells us that it is unjust for people to suffer through no fault of their own – and it is not one’s fault if one suffers mass violence in one’s childhood. To condemn people to suffer because of a misfortune of birth is to revert to feudalism.

From this perspective, the claim that migrants are prone to violence – far from being a reason to exclude them – is in fact a reason for letting them in. It is those who have been most traumatized in their youth that we have a duty to help – but equally, it is these people who are prone to violence. If our immigration policy is at all humane, it will increase the domestic crime rate.

You might reply that our duty to help the world’s most traumatized people is trumped by a duty to reduce the threat of crime to “our own people.” Nations, however, are imagined communities. It is not self-evident that our duties to our co-nationals outweigh our duties to the very worst-off: the claim that they do requires cool-headed philosophical argument, not hysterical populist shrieking.

In this sense, we have a fundamental trade-off - between a duty to rescue people from civil wars and mass violence on the one hand, against curbing crime on the other.

But this trade-off can be mitigated. The very fact that violent crime has fallen in many western nations since the 1990s tells us that cycles of violence can be broken. The way to do so is to give work to asylum-seekers: common sense tells us that men are less likely to commit crime if they have something to lose (such as a job) by doing so. In fact, that Swiss research finds that:

getting labor market policies right can wipe out any crime-fuelling impact of past exposure to conflict.

Wouldn’t this (slightly) bid down the wages of native workers? It wouldn’t, if it were accompanied by serious full employment policies. Perhaps, then, proper macroeconomic policies have even bigger pay-offs than people think, as they would also help reduce anti-immigration feelings.

"Unelectable"

There’s one increasingly common meme I find very irritating: the dismissal of politicians as “unelectable”. Corbyn has long been tagged such, as are most US presidential candidates.

I’ve two beefs with the word.

One is that it presumes that elections are predictable. But they are sometimes not. Remember the old adage, “oppositions don’t win elections; governments lose them”? What if we were to have another recession? Or if the Tories were to split themselves over Europe? Corbyn wouldn’t look so “unelectable” then. As Anne Perkins and Jacques Peretti have pointed out, Thatcher was regarded as “unelectable” in the 70s, by both Tory wets and the Labour party. Look how that turned out. Public tastes are unpredictable – especially given today’s anti-establishment attitudes. As Adam Kotsko says, “electability is a “purely speculative property.”

What I especially hate here is the pretence to knowledge, even in the face of contrary evidence. People who never foresaw a Tory majority or the rise of Corbyn continue to pretend that they have the foresight to declare Corbyn “unelectable”: I don’t know whether Tim Bale’s self-awareness of his “arrogance” in doing this is admirable or not. What such people are ignoring is the wise warning of thehistorian:

Anyone who doesn't… admit to doubt, imprecision, contingency - is a fraud. No-one knows exactly what has just happened, let alone what is going to happen. Nothing is as clear as politicians, newspaper columnists, banks, betting markets, even commercial economists want you to think it is. Everything is uncertain.

My second problem with talk of “unelectability” is that it betokens a sense of entitlement. It is usually outsiders who are “unelectable” – Thatcher, Corbyn, Sanders, whoever – and only rarely Establishment figures. There’s a presumption here that elections can only be won by particular types: youngish good-lookers who went to the right schools and universities and who don’t unsettle the Very Serious People. “Unelectable” can be used to close off debate, to shift discussion away from policy and towards pseudo-technocratic psephology. Too often, it is used by the Labour right to cover up their intellectual vacuum. As Peter Ryley says, all they’re offering is “grisly managerialism.”

Now, I don’t say this to defend Corbyn at all. By all means attack his policies or association with the “regressive left”: at least we can then have a debate. Just drop the word “unelectable” – unless, that is, you want to be seen as an over-entitled arrogant charlatan.

Costs of the living wage

The living wage could put some people out of work even if it has only small effects upon aggregate employment.

I say so because of a new paper by Jan Kabatek which studies the effect of the Dutch minimum wage, which increases with age for workers up to the age of 23. Mr Kabatek shows that workers are more likely to lose their jobs around the time of their birthdays*. This is consistent with employers getting rid of workers as they become more expensive, and replacing them with cheaper younger ones.

This might have implications for the living wage. It will apply only to over-25s. Mr Kabatek’s work suggests that it might reduce employment among those slightly over 25 at the expense of younger workers.

Supporters of minimum wages sometimes claim that the price-elasticity of demand for labour is low because employers cannot easily substitute between capital and labour. That’s true. But they can more easily substitute between 25-year-olds and 24-year-olds. Granted, such substitution might be small – as it is in Mr Kabatek's study – but the more the living wage rises relative to under-25s wages the bigger this effect might be.

Does this matter? Maybe not. On the one hand, youngsters suffer disadvantages in the labour market: the unemployment rate for 18-24 year-olds is 12.3% compared to just 4.9% for 25-34 year-olds. Anything that tilts the balance in their favour is therefore a good thing.

But on the other hand, over-25s are more likely to have families so their joblessness might add to child poverty. And whereas youngsters’ low wages might be due merely to inexperience, over-25s low wages might be due to more fundamental reasons for low employability such as low skills or poor health. This means they could find it especially hard to get back into work.

For me, there are two points here. One is that the effects of minimum wages aren’t all obvious from macro data: substitution from 25-year-olds to 24-year olds won’t show up in the headline monthly labour market data. There’s danger therefore that (wilfully) incurious journalists and politicians will under-estimate the consequences of the living wage.

Secondly, all this corroborates my priors – that the living wage is a poor way to help the low-paid. Better options would include stronger trades unions, increased aggregate demand and hence a tighter labour market, and a job guarantee. All these policies would increase their bargaining power.

But let’s face it, Osborne did not announce the living wage because it is the best way to help the low-paid. He did it to embarrass the Labour party and to try to reduce in-work benefits.  Such motives are no way to improve the life-chances of the worst-off.

* The word “around” does some work here. Some workers are sacked just before their birthdays, in anticipation of their higher cost. Mr Kabatek says that research which ignores this possibility – such as this paper – understates the cost of minimum wage laws.