Britain is trying to shrink its way to prosperity. It doesn’t work.

You may not realise it, but those empty shelves, the unfuelled car of Kirstie Allsopp, and thousands of pointlessly culled pigs all mark the “birth pangs of a new economic model.” Get over it, we are heading to prosperity, this is what it looks like.  

Prosperity, here we come!

The gist of the idea is simple, and much-rehearsed in various protectionist quarters. Britain has in the past “reached for the same old lever of uncontrolled immigration to keep wages low”.[1]  Instead we should control immigration, and as a result business will invest in people, skills and capital and so make native Britons richer and better paid.

It sounds simple. In its crudest form, it even sounds like it has some economics to it! “Basic supply and demand, duh” as some on Twitter claim: fewer people, more prosperity per person! All these years, we could have been fixing productivity simply by cutting the supply of workers! While we are at it, why not a French-style shorter working week, and insist that everyone retires at 60?

There are any number of ways of attacking this. Most don’t work politically, even if they are perfectly valid. Here are a few:

  • I thought you were free traders, but this is protectionism. This charge has been thrown at some on the right for a while (US Republicans, anyone?), and it never sticks.[2]  Free trade in goods and capital, fine. People, no, yuk. Politics gives few marks for ideological consistency
  • What is with the sudden urge to protect workers’ rights? I really get this. I spent a lot of time in Government (2010-14) fighting a Conservative attempt to water down rights, called the Beecroft Report; read my Spad’s Eye View here. But Conservatives reversed course on this as long ago as 2016, with support for the Taylor Report instead. And remember the point above about ideological consistency.
  • Since when did Conservatives fight for the Producer Interest over the Consumer? All these ministers so pleased with lorry drivers’ wages going up, and customers suffering the higher prices and worse service – it is quite the reverse of what Margaret Thatcher fought for.  It’s a version of favouring the more visible over invisible interests (see p19)

But the one that I really believe, which Danny Finkelstein alludes to here, is this:

  • You can’t make people prosperous when shrinking the pie. I remember the arguments as a schoolboy in the 1980s. Labour lefties just wanted to redistribute, give a bigger slice to the people they thought deserving (back then, union-members). Tories instead wanted to grow the whole pie, and see everyone get a larger slice.  

Let’s not argue about whether Thatcher succeeded, but simply marvel at the transformation wrought by 30 years. Thatcherites would applaud companies that sought markets and suppliers far and wide, and fought to provide them that right. Now, to search for the best person for a job is “taking the easy way out”.

To illustrate how wrong headed I think this may be, consider this caricature.  Two managers, Maynard and Mellon, are charged with raising the productivity of their respective company divisions. 

They take a very different approach. Maynard devises a strategy based upon growing production, using all and any inputs to get there.   He cuts prices to chase sales, introduces incentive schemes to encourage work, funds research into new products and sends staff onto red-eye flights to find new markets. It works, and soon the place is buzzing – demand pressing against supply. He also needs to hire a lot more – some locally, but a lot from all around – which frees up staff to work on growing sales. Pay rises.

Mellon takes a lazier and more negative tack. He looks around cuts, and soon orders a hiring freeze, cancels use of the outsourced caterer – people can make their own sandwiches! – and culls the list of approved suppliers, removing anyone further than 50 miles away. He also lets prices rise a bit.

In the short term, Mellon succeeds. Demand again bumps against the now-diminished supply. The staff that remain, disgruntled at the loss of perks, face less competition from outsiders and so feel they can demand more. But in the years afterwards, things go wrong. With less choice of suppliers, quality suffers, new markets are harder to find. Staff are also wasting time on work they used to pay someone else to do.  Soon, Mellon finds himself forced to choose between a pay freeze and redundancies.

You get the picture. The expansive Maynard is like a fast-growing Asian economy in their miracle growth years – find new markets, capture share with cost efficiency, expand, innovate, expand more! In this way Korea and Japan catapulted themselves from poverty to modernity in a few decades.  Mellon’s way is closer to the protectionist, special-interest-captured, import-substitution model, as followed by Argentina – which sagged from the richest country on earth to a continuous crisis soap opera.  It is also the sort of economy I picture when I hear that cutting overseas supply is the path to prosperity.  

Is it a fair analogy? Perhaps defenders of the government line would argue that I should portray Mellon as encouraging his staff to train up more and become more productive. Taking away the easy option of other sources of supply provides that incentive. Is that reasonable?

I don’t think so, because I still share the market-oriented outlook the Conservatives used to have. When pro-EC Tories like Nigel Lawson called for entry in the 1960s, they welcomed what Lawson called “the cold douche of competition”.  Protecting British companies and workers had not worked. Incentives needed to change. The best source comes from competition on all sides: the Five Forces of Michael Porter: new entrants, suppliers with bargaining power, industry competitors, substitute products, empowered customers.  It was a call for more – more markets, more competition, more variety.

More is better than less. I find myself having to repeat a view so basic it is hard to articulate. Supply is good! What the “shortages to prosperity” crew ignore is the basic value of what is being supplied.  Cut the supply of overseas nurses, and what you definitely experience is … less nursing! Forcibly remove choice from the market, and you end up with less supply. The set of possibilities when you are allowed options A to Z is simply greater than when you arbitrarily take out letters J to V. Your horizons contract.

All this is before you consider the other advantages provided by variety and choice: innovation-by-emulation, the exploitation of economies of scale, all of that.  Every time I go from a busy city (London) to one less busy (all of the rest), and whinge about the paucity of cafes, bars and shops, I am experiencing this.

The world has been suffering from a curtailment of supply on massive scale, everywhere and in all sorts of ways. The major vectors of it have been energy, semiconductors, shipping containers, and the right workers. No matter whether some special interests benefit, overall the effect is bad. It could end up posing the most difficult challenge for policymakers since Covid burst upon us. Not the least of this is the possibility of a major central bank mistake, tightening too soon or too late. (Either should scare the wits out of our Treasury, given the shortening effective maturity of our debt.) But even without monetary policy mistakes, supply shocks are the most fundamental economic problem there is. You Can’t Get The Stuff You Want. It is rationing, it is queues, it is making less and having less and everything being worse.

Britain is suffering this as badly as anyone, possibly worse. Brexit is not the sole impulse.  But it is the only major policy programme that apparently revels in curtailing supply! With goods markets bunged up, we in the UK face the risk of more import controls.  With industries everywhere hunting for the right staff, we are meant to welcome new barriers on free movement.  And now the government is justifying this by acting like there is a lump of economic prosperity, and the fewer people we let grab at it, the more prosperous each be. 

Meanwhile, subtle thinkers try to imagine ways in which curtailing supply just encourages an economy to find smarter and better ways to re-establish it.  Destroy all the coaches, and then people will invent cars!

I just don’t think that is how matters turn out. Maybe Tim Harford is right that sometimes great creative achievements come out of adversity, like Keith Jarrett producing marvels from a tinny keyboard. But it is a dodgy theory for entire economies. Cutting supply so that demand pushes up against it is not like running the economy hot. It means less of everything.   Poorly supplied places don’t become inventive and productive out of sheer necessity. Things become more inconvenient (see Julian Jessop in this clip). Businesses sometimes just go out of business. Rationing didn’t lead to an explosion in UK culinary quality post war[3]. Protecting our companies didn’t make them world leading and productive. English football didn’t soar in quality when banned from competing in the 1980s. Hermit kingdoms don’t create marvellous inventions.  Wakanda isn’t real. Korea absolutely destroyed Argentina, economically.

Britain doesn’t have a fixed lump of prosperity, a fat pie to share out to the deserving. Deliberately hobble its supply, and the markets it can serve overseas will shrink, and the services it can provide itself become less. It needs functioning markets and abundant, diverse supplies of labour and capital to keep growing.  Conservatives do really understand this. I know many who do. I can understand the political impulse to portray shortages as part of a clever plan. Their deeper instincts surely know better than to fall for it. Conservatives need to get behind the supply side once more.

[1] Quoting from the PM’s speech

[2] I even put this one to Vote Leave when they came to the FT: how do you campaign on protectionist slogans, but then do this Global Britain thing? Cameron’s problem, apparently.

[3] Elizabeth David bringing back ideas from Provence did that, I understand. 

Shortages are really not such a good thing

I am writing this because my liberal instincts appear to be in conflict.  But probably not. Let me explain.

First, I am a fan of running the economy hot, and think this can be good for productivity and helping the less well-off.  Second, I am pro-economics, and happen to think that means being in favour of actions that increase the supply capacity of the economy.  Third, I am pro-immigration, and see it as a subset of being pro-economics.  Immigration broadens the market, increases effective labour supply, and provides opportunities to all sides of the bargain.

The problem is that these can appear in conflict with each other. “Running the economy hot” is (in some eyes) synonymous with “operating above your short-term labour supply”. For some commentators, it follows that it is good to do this by interfering in the labour market to cut supply, such as putting limits on immigration. (It does not have to be immigration – rules that insist on absurd qualifications to operate in a particular profession, or social rules banning certain types from working, or default retirement rules – all would achieve the same hit to the supply side.)

I don’t think my fundamental views are in conflict, but first I thought it worth just expanding on them a little.  

  1. I like the idea that running the economy hot might lead to improvements in productivity. I pushed this somewhat coyly in my piece about sectors and productivity, published a month back.  It was hard not to see a suggestive link between higher levels of activity and productivity. On a year-by-year basis, the pattern is clear.  See the IT sector in the chart below.  Big up-years like 1999 saw massive increases in productivity. The top-line is clearly in the driving seat:

The pattern can also be seen sector-by-sector.  Higher GVA growth sectors are higher productivity growth sectors (see figure 13 in the report).

That hot demand growth might drive productivity is also a half-spoken premise of Biden’s economic programme. Read this by Claudia Sahm, an outspoken critic of the “but we’re overheating” school. Her side would argue that the big mistake after the Great Recession was to run the economy too cold – “a timid policy response in the face of the Great Recession led to immense damage in our productive capacity”.  Lowball your guess of the economy’s true potential and, tragically, your weak response may make your under-estimate come true. Janet Yellen in a 2016 speech laid out some of the mechanisms by which a high-pressure economy can unlock productivity-growing behaviour: “additional capital spending … a tight labor market might draw in potential workers who would otherwise sit on the sidelines … higher levels of research and development spending and increasing the incentives to start new, innovative businesses”.  In short: necessity is the mother of invention, and demand that runs far ahead of supply forces provides that necessity, so companies raise supply by investing, training and so on.

2. Economists should be wary of ideas that cut supply. If your policy goal is higher output, it is almost axiomatic that should be very wary with ideas that restrict supply. Sometimes, sectional interests blind us to this rather fundamental point.  A society with more corn is better off than one with less, even if a few domestic corn-producers would rather the supply coming from everyone else were restricted. I have always struggled to applaud Roosevelt’s decision to slaughter animals and plough up the cotton crop.  Surely there are other ways of supporting prices in a hungry society? The whole story of economic growth, told over the long term, is of increased supply.  More capital, more labour entering the workforce, better technology enabling it to combine for more output – that is what we are aiming for.

3. But I have been sympathetic to the idea that over-supplied/over-loose labour markets can bias us to low-productivity outcomes. A good statement of this case can be found in Martin Sandbu’s Free Lunch blog, and his book The Economics of Belonging.  Low-wage, high-employment economies generate less incentive to enhance the value of each worker. Martin uses the example of car washes, which in the US involve a few people on the minimum wage crawling over your motor, and in Norway just one worker and a very fancy machine.  I found good suggestive evidence in international comparisons of how different countries (with different labour rules) recovered from the Great Recession. The lightly-regulated, such as the UK, went the high-employment, low-output-per-head route, when compared to France, say.  In this line, I have been very influenced by Ryan Avent’s The Wealth of Humans, which (inter alia) documents the multiple effects of the explosion in aggregate labour supply seen in the 20 years up to writing.  Here is my review of it.

A glib way of expressing points 1 and 3 is on a simple supply-demand curve. If your object is higher wages, then generate higher demand for and lower supply or labour. This is the basic model underlying the argument made by Larry Elliott here – that Brexit is great for the low-paid in the casual labour economy: vote leave, tighten the labour market, get wage rises.   

So does the “supply is good” rule break down when what is being supplied is labour? Avent and Sandbu are not simplistic one-period supply and demand curve people. Their arguments are more dynamic, looking more at the incentives provided by tighter labour markets, and also the special role played by labour in the economy; as well as being a factor of production, labour is the means by which people lay claim to a portion of the value produced.  There are, after all, a huge number of factors of production. Buildings, land, energy, semi-conductor chips, spectrum, lorry driver capacity, cobalt – depending on what you are producing, any of these might be scarce and therefore a matter of concern for a production manager*.  But labour is the one that is most directly, most intimately connected to pay, to welfare outcomes.

I see the case. Flood the market with too much labour, and you end up with over-staffed, low-paid car washes, and a society biased towards lower productivity industries. I have read accounts of how Britain enjoyed an Industrial Revolution, and not China, because Britain suffered labour-scarcity, and China’s problem was land.  When it comes to immigration, I have even heard the argument raised around the Cabinet table (in committee): a Secretary of State cheerfully reported how the Arts sector was being forced to look domestically for its labour force in the wake of Brexit. The PM applauded.  

But if memory serves, neither Avent nor Sandbu are immigration hawks, and nor are economists such as Jonathan Portes who have produced brilliant work looking closely at its effect on native labour.  Read Jonathan’s co-authored piece (page 2) for an object lesson in how this is about so much more than pure supply and demand.  Immigrants affect labour market outcomes in multi-faceted ways. Don’t fall for batting-average fallacies**, for starters. Look at how new workers change the possibilities for the existing ones.  Look at spillovers, geographical effects, incentives, the knock-on effects of economic demand, and more.  The net result? Immigration does very little to lower native wage outcomes (see BOE report).

I also think one should distinguish different means by which labour supply might be curtailed.  A decent minimum wage is fine – there is monopsony power in the labour market, and it is quite acceptable for society to decree that employers should strive to create jobs that have a floor to their productivity. If some economists see this as an artificial curtailment of the supply of labour willing to work at <£5/hour rates, then that is a curtailment I am fine with.  Against this, rules telling people they are not allowed to work in different geographical locations, beyond a certain age, or an unduly limited number of hours are not.  The medieval guild system, which prevented out-of-towners from practicing their trade and presumably putting downward pressure on pay, was not altogether a good thing, even if it helped maintain some local wages.

This leads to another point. One-eyed analyses that seek to maximize outcomes for just one group – the incumbent worker, say – can come down in favour of damaging supply limits because they fail to include other relevant groups. My musings on this subject were triggered by the lorry driver shortages. A very narrow analysis might look at the upward pressure on HGV driver wages and, like Larry Elliott appears to, stop there. Higher wages good! Hooray for Brexit!  But the shortage of HGV drivers is clearly not a good thing, and any actions that are preventing new drivers entering this hot market are damaging. Consumers are suffering from higher prices and empty shelves. More broadly, to the degree that the economy is suffering from shortages because of artificial restrictions on the movement of labour, post Brexit, that is also damaging to the workers that might have come here, earned money and helped the economy.  Without them, the whole economy is less efficient.  The pie is being shrunk.

So, cutting to the chase in an already overlong post, I am comfortable with all my views, still. Run the economy hot but only by raising demand. Higher demand that raises the value of labour, and induces employers to find ways of getting more from each hour worked, is a good thing. Restrictions on labour supply that cut the potential of the economy and damage people’s opportunities are not.  Self-induced privations are not a good policy tool, even if they give you some incentive to innovate. After all, perhaps the best known example of lower labour supply raising wages was meant to be the Black Death (1346-8?), which I was taught was great news for the peasants that survived, as it boosted their bargaining power (although this work suggests wages didn’t start rising for 30 years.)  But, seriously – can anyone really sit back and say the Black Death was a Good Thing?

*this is one reason I find the sole interest in productivity as measured by “value produced per unit of labour” as a little maddening – there are many cases where it is some other factor that is the limiting one.  Semi-conductors for the car industry, say? Energy, for the world as a whole? Carbon

**This is what I would snappily call the All the Averages are Lower and Yet People are Better Off Paradox (that spoilsport Chris Dillow reminded me it is actually Simpson’s Paradox). When a talented immigrant who at home earns a higher-than-average income travels to a richer country, where his pay rises to a level below the prevailing richer-country-average, the average per-head incomes in each country falls, yet world income/capita rises.  Averages mislead: this is another lesson I learned writing about UK productivity and sectors

Sectoral boasts, or a few dumb ways of sizing up the economy

This morning’s perusal of the Guardian’s brought forth a small sigh, as there just below the A level story sat the headline “UK green economy four times larger than manufacturing sector, says report”.  

Now, I have been marinating myself in sectoral data for months to write this monster, and pretty much know every sector backwards by now.  Manufacturing in 2018 was a £182bn GVA sector – a number that is actually disappointing, as it is no larger in real terms than in 1998. In terms of sales – a nonsensical way of measuring it, for reasons to be set out below – it is £545bn, and it employs 2.5m people or thereabouts.  Anything four times that large is going to be … massive, basically employing half of your family. Certainly, a lot more than the 1.2m people apparently employed in the low-carbon industry, according to the same story.  

For me, the moral of the story is that people should apply some sort of sense check when confronted with sectoral boasts.   

Sectoral boasts are a constant feature of the government adviser’s life. A typical meeting request will begin with a polite email, attached to a sector description setting out quite how ginormous is the sector you are about to meet, in terms of jobs, taxes, exports, Levelling Up Power and so on. If you collect a sheaf of these over a parliamentary term, you will usually have enough sectoral GVA to create at least a dozen United Kingdoms.

Advisers learn to cock an eyebrow at this, and most journalists do as well. The sense check I would most recommend is this: production needs income. If a sector is producing £X of value, then someone is buying that much. So are they? I was struck by the figure in the report for Wind. If the wind industry is producing £33bn, as that report implies, then customers of wind – electricity customers– are paying that much.  A glance at Drax Electric Insights can tell you that Wind is around 25% of the electricity mix.  So does the whole lot come to £130bn? I don’t think so – £5000 per household is steep* … dividing through by households is also quite a good way of thinking through a number**. The report saws Low Carbon sales are £200bn. Does it feel like you spend £8000 of your budget on this (there are ~25m households)?

But what really bugs me is anu confusion of sales with GDP. A sale is not GDP.  If you buy a piano for £200, fix it up and sell it for £300, you have generated £100 of value add, not £300.  Some industries naturally have high sales-to-value-add ratios. Financial traders! Or the auto/aero industry, which has £117bn of sales, £28bn of value add. Without making this distinction, you can spin up an economy of almost infinite size. Imagine the full production chain of the piano, all the creation of wooden and metal parts, all the purchases and labour along the way. If each of those gross purchases were counted separately as final production, as well as the piano sale at the end, then you would end up with a lot more than £300.  But that is all you have at the end – a £300 piano.  

That’s one poor way of evaluating the economy – but I didn’t intend to write about that at length, it should be the job of the ONS in an explainer.  I am a fan of the green economy and don’t think it deserves a kicking for being exuberantly over-described.

Which brings me to the other topic: this foolish way of attacking green investment on the Gaia/Guido blog.  In short, it starts with how the government is providing a £95m grant to help upgrade ports for offshore wind production and delivery, rounds that up to £160m, the full size of the fund from which this £95m is drawn (because ‘secrecy’) then divides through by the jobs created (1,340 apparently), and runs away with it from there: £119,400 per job, what a ripoff, imagine how many years of income tax is needed for that, etc etc!

There is plenty of chicanery in this, but what really bugs me here is the method. The money the government is spending is for capital. It is a capital intensive business. What you get out of it in the end is capital – infrastructure, plant, machinery, that sort of thing.  Investment is not meant to be a job creation scheme.  If all you wanted to do was target investments in industries with a low capital-to-job ratio, then you would be subsidizing restaurants, advertising and leather goods, apparently (see table).  But then you would be coming up against the other idiocy, which I covered at more length in my report – the belief that the only good policy is one that automatically chooses the industries with high GVA per job – which are generally capital intensive.

Looking across all the industries, it appears that the sector in which you find electricity-supply has £128bn invested, and 145,000 employees, or £885,000 per job (see the table below).  In those terms, producing new jobs for a cost of £119,400 each is good value – but not if the comparator sector is manufacturing.  But I don’t really care.  Job creation is a dumb way of evaluating this.  The point is to encourage capital investment, and the point of the capital is not JUST to employ people, but also to produce whatever the capital produces – in this case, wind turbines, and eventually zero carbon electricity.  

I know these blogs are written cynically, but I think they reflect a trap that the promoters of green investment have set up for themselves.  Making out that your industry is really BIG is a mistake, when you remember that someone else pays for your big-ness. Jobs are a cost as well as a source of income for someone.  Greening the economy is going to be highly capital intensive, and if you portray it as being a way of boosting the size of the economy in terms of jobs, you will be hoist by your own petard.

*OK, OK, you can just google it, that offshore wind has £6bn of turnover according to the ONS

** yes, households are not the only electricity users. They are maybe half of it. But we do know not much more than half their £1300 utility bills are electricity …

Services matter, or more on productivity

I miss the speed and spontaneity of blogging, even if it comes at the expense of rigour and completeness.  More on those last two later.

A blog feels like the right medium for a quick postscript to the much slower report I published last week, on what sector analysis can tell us about the UK’s productivity problem.  The report was inspired in polemical fashion; someone on Twitter argued that the UK’s weak productivity performance reflected its poor industrial policy, and I thought, instantly, “This is surely (dis)provable with data”.  Put another way, if we had had a different industrial structure, could we have grown faster and better? Did we put too much into the lower-value, slower growing sectors?

It did not take long to realise the answer was, fundamentally, no.  Anyone with good instinctive maths can get this. It is about averaging. For the average of the whole to be altered by a shift into a fraction of it, either that fraction must be MUCH better than the rest, or the shift into it needs to be massive. Taking Manufacturing as the sector most people have in mind, its GDP per worker is only about 40% above that of the rest of the economy. Only 8% of workers are in manufacturing.  The productivity gap we are looking at since 2008 is around 17%.  There is no amount of shifting of workers out of manufacturing that can explain that much.*

So I set out to write a 2 hour blog, went looking for data, stumbled upon the massive OECD STAN structural database, and instead emerged 3 months later with a 12,000 word piece investigating pretty much everything I noodled on.  I realised in so doing that, as well as the trivial matter of proving the initial point (something already well covered by the Industrial Strategy Council and its multiple sources), this kind of data deluge provides a lot of the raw stuff needed to amplify a few other policy prejudices.  These ended up landing in the report, including:

  • That there is not a simple relationship between extra technology and innovation on one side, and jobs, growth and GDP on the other
  • That “low-value” sectors are important to the economy to a degree that is not captured by the simplistic averaging technique mentioned above
  • That breaking the economy into sectors spreads a misleading impression of how the economy works (we are not sitting there like a product manager, deciding whether to sell more computers, socks or ice cream) …
  • … and it neglects the important role of aggregate demand in explaining the emergence and persistence of the UK’s productivity disappointment.  

In the Twitter feedback, easily the most applauded thought was the last, and rightly so: if weak aggregate demand has helped to cause weak aggregate supply, the UK (and the world in general) has rejected the greatest free lunch of all (I say this as someone who thinks that nominal aggregate demand can always be raised, with sufficient determination).  I would like to return to that topic in a later blog, because it is too massive to be a mere sub-heading. 

And the first is the one that has most fascinated me, not least because we are persistently ruled by policy wonks obsessed with the idea that technology policy is the most important part of economic policy.  Even the smartest of them appear to translate the question of productivity into one of technology stagnation, and while the two topics are surely related, they are just not the same. Again, for another day.

But the middle two are what I want to discuss, thanks to some reading thrown my way since publication. In preparing my report I encountered a wide spectrum of views on the significance of low-value sectors. Sometimes people say that they cannot ever become more productive. Think of the piano lesson, which requires one piano teacher sitting with one kid. Fantasise all you like about this shifting online, you can see that the basic product of one-on-one piano-teaching is not infinitely improvable.  To which my response is: sure, but that is not typical of the EIGHTY PERCENT of the economy that is services.  More typical are the kinds of service Martin Sandbu talks about here – comparing how the UK and Norway carry out Covid tests very differently (the example he uses in his book, of car washes in the US vs Norway, is just as striking).  There are clearly large improvements possible, with different levels of trust and technology.  Don’t just think haircuts, think logistics.

Another odd view I heard was that non-tradeable services productivity doesn’t matter because it is not traded.  So what if your supermarket is more sluggish and ill-stocked, or your gyms run badly or electrical supply a bit intermittent – it isn’t competing on the international market and so it doesn’t lose the UK valuable ‘business’. This again feels straightforwardly wrong. Services are provided to the rest of the economy, and if they are provided badly then the rest of the economy gets a bad deal – essentially, the rest of the economy sees its income reduced, in real terms.  This might make the rest of the economy less competitive, if international competition is your obsession, but more fundamentally it is still a loss of real income and real productivity.  This touches on my third prejudice above – don’t (ever) look at a sector in isolation, but as part of the whole economy it serves, and indeed the wider society.

Which brings me to this interesting paper by Julie Froud, Colin Haslam and Sukhdev Johal, sent to me after I published mine, and which if I had more rigour and completeness I would have spotted earlier. Titled “(How) does productivity matter in the foundational economy?”, it in many ways rows in the same direction as mine, and draws attention to other works that argue against the “fetish of the frontier” (to quote from a Nesta paper).  As its title suggests, it questions whether productivity as measured by GDP per head is even the point when it comes to ‘foundational’ sectors, those needed for the functioning of the rest.  It is also eloquent in highlighting the heterogeneity of services sectors (which spread from capital-intensive utilities to labour-intensive personal services) and, consequently, the difficulty of producing generalised policy answers. I was struck by their warnings about the perverse consequences of a blind pursuit of “GDP/L”:

in mature retail businesses, output per worker hour can be improved by working on the numerator and/or denominator to improve the efficiency ratio, while also leaving unserved or mis-sold customers and dissatisfied workers providing worse service with no regard for social needs. Sales revenue can be boosted by confusion marketing which makes price comparisons difficult, as in supermarket special offers or multiple tariffs in utilities; or mis-selling and cross-selling of mortgages, pensions and personal protection insurance in high street banking, with closure of retail branches or the pruning of product lines to save costs

And perhaps the key point of all: higher productivity does not necessarily lead to (proportionally) higher wages.  You can all imagine your own examples of technology-transformed industries that have also transformed the power of its worker-producers to command a decent economic rent.  I was a kind of journalist once, you know.

The major criticism I am waiting to confront is: “so what do we do?” It is easy to establish that lower-value sectors matter, aggregate demand is important, and technology is no magic bullet. What is the policy answer? I won’t pretend there is an easy one, but on such a topic, it at least helps not starting in the wrong place.

*I also question those who think the way the economy works is “shift workers into that sector, watch the sector’s output rise in proportion”.

Is all GDP created equal?

Scott Corfe of the Social Market Foundation* has with his team produced an eye-catching report about gambling regulation**. The major headline: while gambling supports thousands of jobs in the economy, clamping down on it is nothing to worry about, because the spending currently diverted to gambling would go elsewhere. In fact, it would probably go to places that have a better overall economic effect.  This is because other industries on the whole have a larger ‘footprint’ and higher economic multipliers, so when the spending is diverted back to, say, retail, the knock on to the rest of the economy is greater.

This brought back to mind a 2018 argument I had in the Policy Unit with a colleague who was railing against a cut in the maximum stake on Fixed Odds Betting Terminals (FOBTs); I remember gently arguing that you cannot take the full jobs number from the industry at face value. Yes, a lot of people work servicing these terminals, but the money spent on them would be spent elsewhere, generating different jobs.  I even prepared a thought experiment: suppose every town had roadblocks, which you had to pay £5 to pass, and which needed manning. The Town Roadblock Industry would protest against the removal of the roadblocks and use the job losses of road-block-workers as part of their argument. But it is basically mafia economics: keep our protection racket, because the racket hires people.  It is pure economic rent.

Glad I didn’t send that email.

The report also brought to mind a passage I saw in Thomas Phillipon’s recent book The Great Reversal about competition and productivity, which also talks about ‘footprint’. It is making a different point to Scott, however.  When asking which companies really matter to productivity of the whole US, Phillipon writes

“The notion that the biggest tech firms are somehow the pillars of the US economy is false on its face.  The defining feature of the new stars is not how much money they make or how high their stock market values are.  If we exclude amazing, the defining feature of the new stars is how few people they employ and how little they buy from other firms …. Because their footprint is small, whatever happens to the GAFAMs does not matter a lot for the overall productivity of the US economy.  If GM’s productivity had doubled in 1960, people would have noticed the difference.   Cars would have become cheaper, safer and more fuel efficient, and the entire supply chain of GM consequently would have become more productive”. 

He goes on to say, naming a modern tech company, that if its productivity had doubled you would not really notice much, since it isn’t spending that much in the US economy. If you are interested in his whole argument, he and a co-author set it out more in this NBER working paper. The major point I see Phillipon making, however, is this: don’t equate “building a company or industry with a high equity value”  with “boosting the overall productivity of the economy”– a point I have laboured in posts like this for the IFG and the article “Companies can thrive without creating tech billionaires”.

What about Scott’s argument? On the face of it, it conflicts with basic economic sense (see the tweet of Renkitt). The view that we should choose policies that divert spending into industries with a bigger ‘footprint’ sounds awfully like urging the economy to move down the productivity curve. Borrowing off a message from a critical friend, it would be like arguing that it is better to eat heavily processed food (because of the employment) than just pluck an apple off the tree. Or, taking the Simpsons as one should, it would be like looking at their imagined bowling-pin system and applauding it.  

There is force to this argument. We should not (as a car lobbyist once tried on me) resist the growth of the electric car industry, because its internal combustion predecessor employs more people.  Absent a serious demand problem, shifting demand to industries that use fewer factors of production (i.e. are more productive) is a good thing, because any labour freed up is assumed to have a good use elsewhere.

But. Is it possible to stretch this thinking too far? I am particularly interested in thinking about it when the industry in question has a really high, owner-kept mark-up (a bit like the industries Phillipon is so preoccupied with in his book).  Allow me another thought experiment.

Imagine an economy where the main leisure activity is watching people dance.  There are a lot of dancers – say, 10% of the population – and the rest of the economy gladly hands over, say, 11% of their income to watch dances.

Then a new technology comes along – a single superb dancer, videos, very cheap distribution.  As a result, the population no longer paid 11% of their incomes, but only 5%, and this time to the single provider of all the dances. That single provider is now a billionaire and takes the money to spend himself: on having lots of houses, building a giant island complex in the sea, owning the politicians, all sorts. The people who were hitherto dancing for a decent salary are now stuck in service-level jobs that pay less well, because that is what the structure of the economy allows.

In such a scenario, would a regulation aimed at reversing some of this be a ‘good thing’? In economic terms, perhaps not; it would shift spending from the very high productivity activity (watching the genius dancer) to the lower, more artisanal past. In terms of actual prosperity, it may well work though. It messes with the distribution of economic rent in the economy, in a way that is broadly positive (given diminishing marginal utility curves and the way the billionaire wasted money on vanities).

Back to reality. Is the dancer-economy fairy tale remotely applicable? Some industries could claim that the parable captures what they have gone through in the last 30 years – lower employment, lower revenues, vastly more consumer surplus, a radically different distribution of economic rent.  Ask any grizzled journalist from the era of long lunches and six week Sunday Magazine assignments, or recording stars from a few decades ago.

In the case of the gambling analysis, a pure examination of the cost structure of gambling compared to retail in providing the service is probably not enough alone. I would want to know where the economic rent goes too, and think more about dynamic effects like what each industry invests in.  Gambling produces more revenue per worker than retail, and at less cost.  Once I would have assumed that this makes a shift from retail to gambling a straightforwardly good thing.  Now I wonder if we need to look at more than just that.  Read the report.

*disclosure: I sit on their Advisory Board, although I had no input in the production of this report

**second disclosure: I sort-of worked in this business from 1996-2006, though in truth our sector was more about financial derivatives than gambling as currently understood.  Insert your own snarky comment on what’s the difference.

There are far worse crimes than being smug

I try to avoid the Sunday press. From its echoes on Twitter, it appears to be a troll-fest through which innocents like me are unpleasantly reminded of the existence of columnists we’d thought had gone to pasture years ago.  And even the thoughtful ones, like Matthew Syed, feel an extra urge to be provocative on Sundays; perhaps it is that sense of a readership already wound up by the Marr show and eager for more.

It was in this hardened spirit that I read Syed’s “there’s no rabid Right without a smug Left”, which attacked the idea of “liberal good, conservative bad”.  If I dare simplify shamelessly, the author concedes with the peerless David Aaronovitch that conservatives have been on the wrong side of many, many battles this last few decades, and always ooze past, with little pause for remorse or reflection.* DA is worth an excerpt:

It has been like this my whole life. A month before I was born the Bletchley Park codebreaker Alan Turing killed himself; homosexual acts were illegal and gay men went to prison. When I was a year old Ruth Ellis was hanged in a prison two miles from where we lived. Until I was 11 it was perfectly legal to operate a workplace “colour bar” against black people. Pupils at my school were caned. Until I was 21 it was legal to discriminate against women in the workplace. Trains were full of cigarette smoke right up to the 1980s. In every case the same thing happened. Reformers — liberals, nanny staters, environmentalists, human rights campaigners — would point to a problem and campaign for change. And conservatives (Tory or otherwise) would oppose.

There are two counters, as I see it, in Syed’s response. The first, that the liberal left has been guilty of just as much wrongthinkery, is the one less worth engaging with. In a feast of false-equivalence and whataboutery, we see listed the love for Stalin, the abolition of national borders, militant trade unionism, and even cutting the age of consent to 12 as liberal smoking guns, just as bad as the structural anti-reform bias of the conservative right.  But these postures were never the agenda of the social democratic, liberal left – the part that actually got a crack in power, and which did just as much to keep the lid on raving Corbynism as anyone else. 

As for the crimes of the liberal left in power, the list includes the invasion of Iraq – fundamentally a project of American neo-cons – and the financial crisis, brought about in part by manic deregulation initiated under conservative governments. It is hard to come away convinced that the world would have been better with IDS in power.  

The second is the part that interests me: that by being right and sure of it, the liberal left is smug, unwisely contemptuous and hence responsible for the grotesque rise of Trump, the self-harming act of no Deal Brexit, and the other populist horrors of the past decade.  Apparently, the reason conservatives have adopted such extreme positions is “the militancy of liberals”, forcing them in turn to ever greater extremes.  “You didn’t want refugees bombarded in the Channel? Well MAYBE YOU SHOULD NOT HAVE MENTIONED TRANSGENDER RIGHTS, HUH?”

You can tell I’m disappointed here.  In particular, something I admire some conservative thinkers for is their rejection of soggy relativism, the idea that my-right-isn’t-your-right-and-that’s-fine.  Sometimes there IS right and wrong, and saying so unflinchingly is the correct thing to do. Cringing before people you know are badly informed or horribly motivated is both cowardly and patronising.  If someone today held forth like the Daily Mail columnists described in Aaronovitch’s piece – about “the criminal proclivities of various races. Jews equalled fraud and blacks equalled knives, apparently” – then it isn’t liberal or openminded to nod sympathetically and say, well, everyone gets a point of view.  Nor are there two sides to the question of whether sundering all arrangements with the EU is a smart idea (it isn’t), or being asked to wear a mask in a shop is a horrible infringement on liberty (no, again).

And, relatedly, it is just patronising to suggest that ultra conservatives do bad things because horror of liberal extremes forced them to. They are meant to be grownups, and if they are indulging atavistic urges in a sulky fit at the mockery of the liberal left, well the only answer is still more mockery. Tell them they are wrong, remind them they were wrong when they opposed the decriminalisation of homosexuality or supported bars on interracial marriage, too. It may inspire them to pause and think – certainly more than pandering to them has.

It is heroically unlikely that the conservative and liberal side have had the equal winnings from the intellectual arguments of the past couple of centuries. Just reflect on how much the world has changed. Look up when a child was last hung for stealing bread.  There has been a direction of travel, and reminding people of that is no bad thing.  So what if it is smug?  There needs to be a psychic punishment for being wrong, a reason to fear it. The smugness of the other side in the face of their eventual recognition of their wrongness is key part of this.

There are worse crimes than being smug about being right.  Being wrong, in power, and unashamed of it is definitely worse.



*I don’t deny that the liberal left was wrong about a few things. State ownership of industry, for example, although like the peerless and lamented Samuel Brittan I would regard that as a far from liberal postures

What you need to think if you are calling for a NGDP target

Don’t worry. I am not going to write another post arguing that the world’s problems would all go away if its central banks adopted a NGDP level target (it has been over 10 years now, give it a rest!). There are plenty out there already: this one by Sam Dumitriu is a good place to start, this by David Beckworth, or if you are really dedicated, go back to when Tyler Cowen introduced Scott Sumner to the world in 2009 and read on from there.

And if you want a sober, understanding rejection of the idea, this speech by Charlie Bean from 2013 is the place to go.

But recent weeks have seen a series of Conservatives step up to call for a NGDP target*, and I would like to think aloud on what this means about their view of the economy. Here is Bim Afolami with the SMF (where I am on the advisory board); Gerard Lyons et al at Policy Exchange, and now Sajid Javid at the CPS. Ultimately, if people near the room where it happens are calling for this, it is interesting to reflect on how the arguments must be proceeding in the Tory soul.

So what do you need to think if you are calling for a NGDP target?

  • You think there is a problem with aggregate demand You have to – that is what monetary policy operates upon. The internet is full of central bankers’ speeches complaining that it is not their fault if the supply side is failing. Go and talk to the Treasury about skills, innovation investment and all that stuff
  • That means worrying about insufficient demand Right now, that’s not hard – spending in the economy fell some 20%-plus in April – but longer-standing fans of the idea probably suspect that the economy would have been much healthier this last 10 years if spending had not done this:

That is a £100bn/quarter gap on its pre-2009 trend. Even if you think just a tenth of that was unnecessary, that is a giant amount to leave on the table. A Brexit-sized amount, if you like. Not everyone has always felt this – Charlie Bean clearly didn’t. But this also means…

you need to think that extra NGDP would mean some extra RGDP Which is not always the case. For much of the postwar period, we were up against the UK economy’s limits. Giving people more to spend – which the combined Bank-Government authorities somehow managed to do – normally just meant prices being higher, and wages too, with the deleterious effects that such inflation brings. Another way of putting this: you feel in some way that simply giving people extra spending might unlock extra real resources – despite all this stuff put out there about a productivity problem. I have always liked the way a man called Howard Bogod put it in a letter to the FT:

My brothers and I run a relatively small family business with a turnover of below £20m. We could easily cope with a 20 per cent increase in business with no extra staff, and even a 50 per cent increase might require only a 10 per cent increase in staff. This would mean a huge growth in productivity, and I strongly the suspect the same is true for most smaller and even many larger businesses across the UK.

So you probably need to agree with Howard. And in a largely services-based economy, it is easier to. An estate agency serving 20 transactions a month doesn’t need twice the shiny-suited employees to serve 40. And in the short run we have seen this in the corona-crisis – employment is far less elastic than production on the downside, so why not on the up?

  • You have to believe that monetary policy is not entirely ineffective This is where things get more heated. Opponents of a higher AD policy on the right tend to be those who think you are wrong to want it – it is inflationary, or bound to lead us into some other sinful pathway like credit bubbles. On the left, in my experience they are more likely to deride monetary policy as some kind of evasion from the duties of fiscal policy to keep aggregate demand up instead. It seems to let off the wicked Austerians of 2009-16. There are a dozen reasons to dislike the pace and nature of Osborne’s fiscal approach, but if you want the entire bingo-card, you need a macro one too – “killed the recovery”
  • But “effective” does not just mean “capable of boosting the economy when rates are zero”. If you think too tight a Bank of England target might constrain the demand-boost that came from fiscal policy, then you should still worry about the inflation target. Both monetary and fiscal stimulus just contribute towards aggregate demand growth. If one does more, when we were already on target, the other might just do less. That central banks know and take into account fiscal policy has been called The Sumner Critique and a NGDP targeter probably believes in it. This is conventional wisdom for 1993-2007, by the way: the government’s fiscal balance swung around considerably, the Bank kept NGDP growing just steadily (see chart).
  •  You probably also care about how expectations guide the economy Sajid Javid (and authors) touch on this towards the end of their bit on the Policy

… over time, so long as the Bank’s commitment to keep nominal GDP on a stable growth path was seen as credible and binding, market expectations for inflation and total spending would start to rise, pushing up nominal interest rates. In turn, this would allow the Bank to raise the base rate away from the zero lower bound and reduce its reliance on quantitative easing

Here the maddening circularity of the policy rears its head. An economy convinced of the credibility of the Bank’s commitment to NGDP targeting doesn’t need the Bank to do much to hit that target: expectations cluster around that pathway, and it becomes self-fulfilling. Ultimately this is where the more purist advocates end up – suggesting a target can be so credible that the Bank does not have to do much to meet it. Rather like the way Mervyn King saw the Bank of England in 2005, as a sort of Maradona.

  • And you think current members of the MPC are only human. It is uncontroversial that a strict inflation target can cause all sorts of misfiring when negative supply side shocks hit – Bim Afolami hints at this. Inflation rises, some hawk calls for tighter policy (weaker demand) – so a supply shock has a demand shock added to it. Charlie Bean thinks the “flexible” in Flexible Inflation Targeting handles this:

inflation targeting as practised, here and elsewhere, allows for an accommodating response to cost shocks, so long as it is consistent with inflation being stabilised in the medium term. Such flexible inflation targeting can thus look quite similar to targeting nominal income growth.

Maybe. But some MPC members were far from this in the summer of 2008 and the spring of 2011, and market-probabilities of rates rising soon shot up. Because NGDP targeters place great store by expectations and market reactions, they think these mistakes matter. Just because those nutters on the MPC never actually raised rates in those depressed days of 2011, doesn’t mean the small chance they might have didn’t damage economic sentiment.

Could such mistakes be made again? You need to believe they could. We face in the corona-crisis a very confusing mixture of demand and supply damage, and plenty of voices warning about medium term inflation risks. Suppose we recover three quarters of the loss and then the scarred economy starts to send bleeping red signals about inflation … do you think the MPC will tough it out?

There you have it. These people calling for a new NGDP target for the Bank have to believe that there is a significant demand problem with the economy that won’t be resolved within inflation targets, that dealing with it will produce more real growth, and and that you need a different target because otherwise monetary policy might constrain the recovery through an unnecessarily tight stance, no matter what you think of using fiscal policy.

As for whether the Johnson administration is tempted, I just don’t know. They like focus groups. And this sort of thing really struggles in a focus group …

*The last time there was such a kerfuffle was 2012 – read Duncan Weldon’s Touchstone Blog – which was triggered by a few events: the shift in the US monetary approach which inspired talk of Scott Sumner Day, also the UK’s stubborn refusal to grow through austerity, and the advent of Mark Carney at the Bank, he having sort-of called for NGDP targets when back in Canada

Keynes on how to pay for the War, and what to worry about most

It is marvellously calming to pick up a hitherto unread piece by Keynes at a time like this. For some reason, a number of the epoch-making economists of the past were also wonderful writers – I am thinking Smith, Keynes, Friedman and Hayek, whether you agree with them or not – and it is nice to be subject to the prose of the best of them. (Not Ricardo though, I don’t think I have ever got anywhere with him).

Keynes’ “How to pay for the War” (nice Prospect article here) is think-tank pamphlet in length, based upon a few long articles for the Times, and clad in the sort of stiff brown cardboard that suggests the first answer to his title is “begin by economising on book coverings”.

What is calming is the beautiful writing and clear thought, rather than the ready provision of applicable answers to our current situation; in fact, the situation Keynes analyses with such brisk clarity is almost diametrically different to today, and to what he spent the middle years of his career fixing.  In early 1940, Keynes had no doubt that the British economy could and would produce far more. GDP was growing explosively.  He was confident to the point of blitheness on this point, writing casually “we shall, I assume, raise our output to the highest figure which our resources and our organisation permit” – the problem the whole world of economists grappled with unsuccessfully for much of the 1930s.

Instead, he identifies the problem as how to restrict consumer spending – the less of which there is, the more there is for war production.  And with GDP and therefore national income soaring, you cannot just let people’s earnings turn into their consumption – again in his words, “we cannot allow the amount of mere money in the pockets of the public to have a significant influence … on the amount which is released to civilians”. How to break the link between the higher incomes the civilians are all earning by working more and harder, with the amount of stuff they get to enjoy?

What follows is for me an object lesson in clear exposition, as Keynes walks us through the various methods possible and proposed for this – forced saving, voluntary saving, price inflation, taxation and so on – all of the time keeping the reader’s mind on the essential underlying logic of the thing: that people are “paying” for the war by consuming far less than they are producing.  He glides smoothly into the justice of the matter, even attempts some IFS-esque analysis of which classes (by income) ought to suffer which restrictions, and cleverly muses on how his proposed answer (basically, forced savings*) might contain a ready-made answer to the post-war problem of a sudden spike in unemployment.  Force everyone to save now, get them to release it later when we are going to need a lot of work for the demobilised, it all fits beautifully.  And in the meantime distort markets and preferences as little as you can – try to avoid rationing or dictating who exactly should consume what. It is true what they say – Keynes was never trying to replace capitalism, but to save it.

It is not hard to see the diametric differences to today. Here, we have plummeting GDP, and consumption much lower than we would want it.  We want those retail-facing industries working again – if they can do so safely.  If national accounting identities hold then incomes are plummeting too, and the most lauded of the government’s interventions are those like the Coronavirus Job Retention Scheme that try to keep said incomes high.  With the exception of healthcare and some other businesses like delivery, no sector of the economy is running hot.

There are some similarities, such as soaring government borrowing, and its mirror image, higher private saving, I assume (I carried out a brief analysis of my household and found collapsing spending on restaurants, coffee, entertainment and transport, and slightly more on groceries and household goods) – in particular for those with incomes intact. But only the most optimistic V-shape-er can now think that all those pent-up savings are about to release a symmetric recovery in spending when the healthcare rules allow (but for a monetarist view on this, worth reading Simon Ward).

Keynes makes it look easy, and I am sure it was anything but. It is probably a function of his genius that he makes the most extreme financial challenge the British state would ever face look soluble in 70 or so pages.

But I’ll say it: the problem he addressed feels analytically more straightforward than the one we face now.  Do we want higher demand now, or later? How serious is the supply problem? Is it even useful to think in terms of supply or demand (the same restaurant may be suffering a supply problem – same space, fewer tables allowed – and demand problem – smaller clientele willing to risk their health)?  The country is almost certainly facing a structural adjustment, affecting urban economics, the future of the office, the size and role of the state, even how we think about social insurance – but when is the right time to start work on that? Are market forces working? Landed property values are almost certainly much lower now – surely one of the key values of land is that it where you physically meet, and that now comes with a steep negative externality – but is the system robust enough to cope with a sudden adjustment to the trillions of pounds tied up in land? And what about corporate equity – thousands of balance sheets have taken a heavy hit in last three months (my god, it has been only three months) and surely an ideal government policy would somehow address this– but how on earth can you do that in a way that is fair?**

Oh, and I understand that the question of how to relax the lockdown itself may throw up a dilemma or two, and even some ugly politics. Then, after that (or perhaps during it all …) we have the fiscal dilemmas, and the financial risks to the state.  In a sense, the whole problem is a cousin to the one Keynes was musing about: there is damage to be taken, and so who should take it? But back in 1940 it was an actual war, and actual wars are conducted by governments, who seize all the levers, and force all the payment. That is no longer possible now.

I have the sort of worrying mind that wakes each day convinced nothing is soluble. It is only by the end of a fast run and a stiff coffee that I feel remotely up to the task of thinking about difficult things.  For this one, I struggle even to know what to worry about first. So I do hope this era turns out its own Keynes.

*In his words “a proportion of each man’s earnings which must be deferred – withdrawn, that is to say, from immediate consumption and only made available as a right to consumer after the war is over”.  That is forced savings in my book though he adds a nice progressive twist (p10-11)

**Jim O’Neill has co-authored an article calling for this, but in my view does not really tell us how


Some of the bailout reading I compiled

OK, so my technique when asked to write a big piece (like my newly published report on Bailout Policy for the Coronavirus Crisis) is to engage in a constant, mind-wearying conversation with myself over email and sometimes with Twitter on the back of all the stuff I read that may have some tangential relationship with the topic.

Here are some of the links I set aside when writing about bailouts and coronavirus-crisis.  They start with news pieces that pertain to the thing, and then a sample of the many blogposts etc that I bookmark on Feedly when doing this work.

Here I am going to post them as an aide memoire, but hey you might find something useful in there too.  And also it helps me to reflect on how much I have needed to absorb to develop even half an opinion on this impossible topic.


Rana Faroohar: we’re subsidizing the US corporations responsible for the hire-and-fire culture we don’t need

Big hedge funds are raising money: there is private sector cash if you look for it (late March)

Equity stakes serve two purposes: they are affordable for the debt-laden, and they give the public a seat at the table

The IPPR “Beyond Bailouts”: a bailout plan where ” The government is likely to generate very high
returns on its equity investments – as much as three times its investment, over
a decade, if not a lot more”

Nick Rowe thinks aloud about having to redistribute between affected and less-affected sectors

The State as Insurer of last resort, and many other ideas

Bailouts get abused: evidence from the FT “UK language trainer to use job scheme for already planned redundancies”-

Not going as fast as people want: “Frustration despite UK coronavirus bailout loans reaching £450m”-

Supply chains are a specific problem and need some love during the coronavirus pandemic – 

Serious evidence on Labour Market Scarring from VOX – it is about “matching capital”

The Economist “Unicorn Reality Check” – no, not every hyped up company needs “saving”

Brilliant starting thoughts on Vox on Trying Equity

You cannot bail out Investment bank profits which may be under pressure later –

A small example of a supply-important sector that may need help  – Ferries

News on the financial and other restructuring that companies are doing anyway – THE MYTH OF THE ECONOMY IN DEEP FREEZE

Mohamed El-Erian warning that you cannot rule out a depression

Cash-rich Gulf funds hunt for bargains as asset prices plunge – 16th April.  THERE IS MONEY OUT THERE

Even big cinema operators can raise money at some price via @FT

And HMT has a right to be not impressed by Virgin

Jonathan Ford points out the laid back approach to financial risk that went before this

Bloggy things

Sumner on Yellen and Bernanke on monetary policy options

The Resolution Foundation welcomes the JRS et al

Simon Wren Lewis on the economic effects of it

An early assessment of what the stockmarkets were telling us

A smart guy called Zachary Booker thinks about how bridge loans can’t work

Tyler Cowen says minimum wage hikes are a very poor idea right now 

and also that wages have become flexible again

“This column argues that in light of already elevated debt burdens, provisions for future debt restructuring should be made as soon as possible.”

Tyler Cowen discusses the idea behind bridge loans

this is a good bit: “you might actually want those resources to be reallocated to good transport, biomedical testing, and so on.  If the wartime analogy is apt, you don’t want to freeze the previous capital structure into place, unless of course you get lucky and win the war early”

how the crisis is different from 2008

Iza Kaminska’s idea for a Prudential Authority for the real economy

The economics of wage compensation and corona loans: Why and how the state should bear most of the economic cost of the COVID lockdown

Greg Mankiw’s future-income contingent idea for social insurance

The “Fix NGDP and the rest follows” view and Lars’ crazy-level optimism

James Bullard’s key early points about the US during the pandemic

John Cochrane thinks moral hazard is still a thing in a pandemic.  He also wonders why the landlords need to get off lightly

We didn’t buy pandemic insurance and can’t forever pretend that we did

Several aeons have passed since I began thinking about covid-19 bailouts (IFG pamphlet out shortly, watch this space), and still I struggle to get my thoughts straight.  During that time, the blogosphere and in particular VoxEU have drenched us in high-speed, quality thought, even as the facts on the ground have shifted at speed.  Just a month or so ago, it was possible for the superlative Richard Baldwin to write the clause “given the transient nature of the underlying medical shock”.  This presumed transience has helped to condition the policy advice in turn, which I will shamefully attempt to summarise:

  • Non culpability: The shock is an unforeseeable one-off that hits the economy irrespective of prior behaviour (unlike, say, a tidal wave that affects everyone who chose to live near the coast)
  • Preservation: the economy that went into this crisis is the one you want coming out of it. So try to “freeze financial time”: stop the accumulating bills from burying the hibernating economy when it re-emerges into the Covid-free sunlight
  • Fiscal superpowers: whatever the bill, it can be afforded.
  • Treasury man is dead The Man from the Treasury is the nagging voice on one shoulder* making awkward points like:
    • “Doesn’t this just discourage the company seeking private sector help?”
    • “Won’t this distort competition – what about all the companies well-run enough not to need our help?”
    • “Don’t believe these sob-stories about lost jobs – new jobs are always being created – aid just postpones necessary change”

So there sprung into life many proposals that were best captured in this piece by Gollier and Straub as “the state as insurer of last resort”:

The containment strategy is a necessary collective sacrifice for the common good. This effort must be shared fairly from an economic and financial point of view …. Ex-post solidarity is ex-ante insurance. Only the state can set up such an insurance mechanism as a last resort.

We didn’t all buy pandemic insurance, but now the infinite-pocketed state needs to act like we did, and pay out, in proportion to the losses brought about by the enforced hibernation.  For, as James Bullard of the US FOMC put it, the coronavirus shutdown is “not a recession but an investment in survival”.  Bullard says it very simply: match any lost wages. Match any lost business. No questions asked.

And that is what Chancellor Rishi Sunak’s Treasury implicitly set out to do with his “whatever it takes”, through a rolling landslide of welfare payments, furlough schemes, sickness pay, tax holidays, grants, low-condition guaranteed loans, Bank of England purchased loans, and so on. It was easy analytically but an impressive achievement administratively, given how hard it is to identify all those pockets of lost income in our complicated economy full of varied employment models.

But at least we did not have to worry about those dumb, forward-looking Treasury questions.  No one when claiming insurance has to explain what the money is for. They just need to show they are entitled to it. In fact, that is how much of the to-and-fro commentary between Treasury,  business and its representatives went in the following weeks – it was about entitlement. “Firms/people that are entitled to money are not getting it – go back and find another scheme”. And so they did.   The preservation assumption is a great fairness rule – it avoids awkward decisions about desert.  None of you caused coronavirus, so you should be helped (never mind that, as Grumpy Economist observes, individual companies are seldom “culpable” for a recession).

Which is all right – for so long as we are in that world of V-shaped, temporary passing recession expected those aeons ago.  But what about if or when we are not?

In some regards, the Bullard assumptions were never going to be aimed for, let alone met.  No one believes in making investors whole, for example: the point of corporate aid is to help the underlying people, social and organisational capital, not give the fund manager a retrospective put.

And are all companies really blameless for current financial distress? What about one that financed itself such that the smallest downturn was always going to blow it away – should it be rescued by covid?  Or what about a start-up taking a long-odds bet on space travel – is it the state’s job to keep that particular dream alive?

But the grand ex post social insurance idea has been steadily crumbling for a while.  At some point in April it became horribly obvious that the preservation assumption was not going to be fit for purpose. The economy due to exist in May 2021 was not going to be the same as May 2019.

We can’t be disingenuous about the shape of the future economy. Oil has collapsed from $50 to $20.  Some of the lost income pre-to-post Covid was premised on higher oil.  It doesn’t make sense for the government to keep hosing money towards companies as if oil was still $50 because, hey, coronavirus was not their fault and we would love November 2019 back. Oil is only the most visible financial market emblem of a new world.  What are your assumptions about: hotel bookings, flights, restaurant visits, commercial property transactions, sales conferences organised, and so on? Imagine how many pre-covid business propositions are riddled with assumptions about economic inputs like those, and now need rewriting.

At some point, the Treasury has to work towards the economy of Christmas Future, not Christmas Past.  If it sticks with “no questions asked”, the money keeps inflated a corporate structure built for the wrong time, and the chances of a robust return to growth are undermined.  And this is incredibly important, because while I believe the Fiscal Superpowers assumption, this is very much premised on a one-off, 1%-cost investment now yielding great returns in terms of the future pathway.   Pull up a spreadsheet and work out how much it costs to finance £300bn of extra borrowing, repaid over 20 years – it is not all much, arguably not as expensive as, say, committing to raising the income tax threshold all the darned time.

But lower the future growth pathway by 0.5% and suddenly we are in deep trouble.

To be precise, the point is not what the Treasury thinks about any particular business (many of those guys struggle to get served in bar, let alone evaluate a business case 😉), but what the market does.  That is why commercial tyre-kicking has value, and dropping it for ideas like a 100% loan guarantee is dangerous. More to the point, the sifting of business opportunities into sheep and goats is a phenomenal job of work, one that only a million private sector interactions can pull off.  If, for example, there will need to be 20% fewer restaurants in post Covid Britain, that can only be done through countless nagging and unpleasant conversations between lenders, investors and managers.

Business organisations will continue to clamour for maximum, conditions-free money; they are doing their job.  Whatever your assumption about the political economy of business lobbies, their payoff matrix is not “the average level of productivity of the business class”. It is much more related to survival, and you should not expect hymns to creative destruction.  Turn on the TV, listen to the stories of any entrepreneur and I would challenge you to feel or act otherwise.

But the Treasury has to look out for the health of the whole economy, and handle what I think may be the most difficult pivot ever in economic policy-making: the one from “every business insolvency is bad news, everyone is entitled to help” to “the market is working again, and we need it to”.

*you decide which