Category: economics

The budget and the bogus hairdressers

Chris Dillow has a nice chart, plotting the government deficit out-turn against a forecast based on its historic relationship with unemployment, swinging off John Maynard Keynes’ remark that if you look after unemployment the budget will look after itself.


As he says, the interesting bit is what happens after January 2012. Unemployment dropped sharply, but the budget didn’t come in anywhere near as much as you might expect, although it did improve a bit. A gap has opened up. Chris thinks this is a story about productivity.

I half-agree; it’s also a story about the policy-driven shift from unemployment, mitigated by Jobseekers’ Allowance, to underemployment mitigated by Working Tax Credit, aka the bogus hairdresser phenomenon (see here, here, and here). There has been some improvement in the economy, but much of the reduction of unemployment is accounted for by people declaring self-employment with nugatory hours, plus various other fiddles on the Government’s side, like not counting Work Programme attendees or persons under sanction as unemployment. They aren’t earning-out of the tax credit regime, and they aren’t paying income tax, so the budget doesn’t improve.

It’s trivially true that if you aren’t getting any hours, your productivity is zero. Importantly, though, efforts to improve productivity as such won’t help this problem at all, because low productivity is an effect rather than a cause. It’s an effect of policy, but it’s also an effect of the weakness of the labour market, because if the bogus hairdressers were in work they wouldn’t have to find ways to get Iain Duncan Smith off their backs.

How tight the labour market really is may be the most important question in British politics at the moment. Hence Duncan Weldon:

Balls has decided not to offer any new capital investment funded by central government borrowing. In this view, GDP growth is up, and therefore growth should bring down the deficit, and there is no case for fiscal expansion. If there is going to be more public spending there should be more taxation. This shouldn’t be a reason to harrumph off in the corner, though. Resolution did this rather nice chart of the parties’ fiscal plans.


As you can see, before anything else, just going slower is a big, big improvement on Osborne’s plans. Pushing the deadline out to 2019 and finding another £10bn of revenue or savings would allow for a 2% real-terms annual increase for the departments, while the Tory plan requires a 7% annual cut for the departments even with an additional £12bn taken out of social security. And we’re not even discussing Cameron’s giveaway yet, which takes the total cuts in the pipeline to £33bn. Labour would be fools not to run on the Tories’ £33bn cuts bombshell and to repeat the number every five minutes; personally I’m going to bore everyone to tears with it from here to May.

The problem, though, is Chris’s chart; although GDP growth is up and measured unemployment is down, the budget still sucks. And, you know, one in ten young people despair, because they’ve been stuck in the queue since 2007. As the EEF economics blog says, it sucks on the revenue side because income tax revenues are poor, because incomes, i.e. wages are poor. That is, to say the least, not what you’d expect in a tightening labour market.

It might, however, be what you’d expect in a market that is still pretty close to a high-unemployment equilibrium, but one that expresses the insufficiency of effective demand via underemployment rather than unemployment. If we were, that would explain why it is so difficult to reduce the deficit and why wages are so poor, and also why productivity is so poor, via Verdoorn’s law, where productivity gains usually happen when industry is operating at capacity. This is the crucial issue, and I suspect it’s roughly what is happening in France. The risk is that we end up running to stand still, deficit reduction keeps failing because wages and productivity are too low, and the statistics get progressively worse as the low-trust society becomes entrenched.

The good news is that there are some options for Labour investment to go with the absence of more Tory cuts. The public bank plans have evolved, and now foresee National Savings & Investments as its main depositor, which could give it enough welly for quite a substantial capital programme, and you know where I think it should go.

In a parallel universe, I scored!

So the economists are now saying that even if you made testable predictions and they came true it doesn’t mean you’re right because of, you know, quantum and catallaxy and hey What the Bleep?! Do We Know. There’s an infinity of possible universes in which I might be right, and averaging over the Gaussian copula, therefore I’m considerably richer than yow:

Simon Wren-Lewis and Paul Krugman dispose of the intellectual rubbish, but there’s a better gut point here as follows.

All right, you’re committed to radical scepticism, are you? You’re unwilling to move without a solid evidence base of randomised-controlled trials? So where was this scepticism when everything from public housing to the interior design of buses became part of a war on the Keynesian legacy? Where was this scepticism in 2006? In 1978? In 1992?

Few people have ever been as sure of the truth of their ideas as economists have been. They didn’t just believe that they were logically consistent, or borne out by empirical evidence, or representative of a greater moral truth – they believed all three at the same time. It was economic rationalism. There was no alternative. It was built on microfoundations arising from sheer mathematics. It was literally equivalent to democracy itself. If you disagreed you were a Stalinist or you were trying to deny economic development to the poor.

Steve Levitt’s now celebrated attempt to give advice to the prime minister is a case in point. Noah Smith points out that Levitt didn’t have an alternative or even a sensible criticism to offer, but that didn’t detract for a moment from his superb certainty. But in fact it’s worse than that. What strikes me about the Levitt/Cameron story is Levitt’s utter incuriosity.

He trotted out his little parable but never paused to wonder if, in fact, the British actually do use infinite amounts of medicine. It is fairly well known that the US healthcare system is really expensive compared to any European country’s. This is the sort of thing any newspaper reader ought to be aware of, and if you reflect on the fact for a moment, it’s obvious that demand cannot therefore be roaring out of control due to the unpriced nature of the NHS. Despite all his talk about natural experiments and questioning everything, in practice, he completely ignored a huge natural experiment and questioned nothing. He evidently didn’t feel facts would inform his thinking in any way. The shocking thing is the incuriosity.

The whole thing reminds me, most of all, of the old German general staff. Nobody doubted, or doubts, that they were smart, deeply smart. They possessed a wealth of professional competence. They made a number of major methodological achievements that are still used today. They were as respectable as it was possible to be. But they got it wrong; repeatedly, desperately, disastrously wrong. And they blamed everyone else and proceeded to do it all over again. Interestingly, their institutional history is closely similar to the emergence of the classic executive career path.

It’s just not good enough to discover scepticism now. The whining now only highlights the swagger of the past. After all:

And (I think I’m making my own position clear here) I think this is why Friedmanism fails. Because actually, the buck does have to stop somewhere, and pretending that you can manage a complex system via a simple rule is basically impossible (it falls foul of Stafford Beer’s Principle Of Sufficient Variability). In practice, in a system based on a Taylor Rule, an Evans Rule or even an NGDP target, the buck stops with whoever it is that is responsible for maintaining the model which generates the forecasts of the control parameter. And this person is always going to deny that he’s making activist policy and claim that he’s a technocrat who simply goes where the data takes him. Friedmanism in economic policy, in the general sense I’m talking about here, is nothing more nor less than a distributed responsibility avoidance system.

But, y’know, pass the bong, we can’t, we…uhh…can’t really know anything…right…?

A short post

Schuller pointed out that, if the economic theories of Mises’ book Human Action really are derived by painstaking and valid deductive argument, then it should be possible to set the book out in a formal symbolic form in which all axioms, premisses, and deductions are shown formally and proven.

No Austrian has ever done this…

But if we could somehow persuade them to try, the Internet would be so much quieter!

A novel theory of the business cycle, with an old critique

Charles Murray, as far as I can make out, has dropped racism in favour of old-school reactionary elitism. It’s not that other races are inferior, any more, it’s that the race, in general, is inferior. I understand this to mean he’s realised that Gang A are no closer to the White House than they were in 2008, and a strategy that doesn’t require popularity is therefore career enhancing. And then there’s this.

Murray has, without knowing it, created a novel theory of the business cycle. Fluctuations in manliness drive boom and recession. We are thrown around by the Cockdratiev wave. Now this could actually give you a fairly sophisticated understanding of the macroeconomy.

The transition through Minsky’s stages, from hedge finance to speculation and eventually to Ponzi schemes, might be ascribed to manly competitiveness and status seeking. Austrians might see something similar at the root of malinvestment. Joseph Schumpeter might have pointed out that capitalism overinvests in the boom, but that’s the point – without the fundamentally irrational drive of entrepreneurship, we would miss out on all kinds of innovations. That said, if you identified this with testosterone, you’d be wrong.

But that’s not Murray’s point. It’s not a fundamentally masculine hunt for risk on the part of entrepreneurs that’s doing the work, but rather, that workers are all girly and out of work, or something.

The Keynesian critique would be that, if manhood is socially defined as Murray requires, then the opportunities to live up to it are defined by the market for labour. Demand determines income, and therefore it determines the opportunities young people have to live up to the expectations of society. After all, the era of the Great Compression, the Keynesian years, is also known as the baby boom.

The enduring radical punch of Keynes is simply that he accepted that causality might point the other way.

This one weird trick will improve your productivity and deliver social justice

Shorter me: economists should study business more, and in an ideal world, industrial sociology, before they try to do cognitive psychology

Peter Dorman at Econospeak takes issue with a Robert Frank piece about workplace safety, which has all the whoopee doo Econ-101 problems you’d expect. I think, though, that there is a really big issue Frank is wrong about that he shares with economists generally and that Dorman has missed. It is a problem of framing.

Frank (and economists generally) frame safety as something you buy (“safety devices”) not something you do (“a safe process of work”, as the UK Health & Safety at Work Act puts it). Safety is a product, not a process. The model in Frank’s head is that there’s a marginal cost of production curve, and you add an overhead cost of safety to it, shifting the curve up (aka an x-inefficiency).

In general, effective safety measures are usually something you do, and scattering costly “devices” around an unchanged process is a classic failure mode. Not least because they might instil a false sense of safety and lead people to take risks. Consider the Shower Jobby and his “cycle superhighways”, aka “some blue paint slapped on an urban motorway”. This video is a great visual illustration of the point. I had no idea it was so bad.

In this case, adding some “safety devices” to an unsafe process has not only failed to make it safer, it seems to have rendered it more dangerous because the participants – cyclists, drivers, and Transport for London – think it is safer.

Of course, economists do actually have a framework to analyse this point! And they’re usually very keen to expound it!

In the process view, though, it becomes clear that greater safety is not necessarily a cost.

Accidents cost money, in the same way that quality failures cost money. At the very least, in the most cynical 19th century Yorkshire mill-owner’s view, they cause downtime, quality problems, and damage to expensive equipment. In a less cynical and more general sense, accidents are just one of the sources of excessive variability in the production process, like late change requests, tools whose tolerances are too large, or a virus outbreak among the Windows boxen. If accidents are happening, this is a symptom of problems with the process.

Reworking production processes to eliminate the sources of variability is precisely what industrial managers are meant to do all day.

For some reason, if you do this to reduce rework or machining waste, that’s awesome, but if you do it to reduce accidents, that’s a cost imposed by stupidheads – even if you do it with only cynicism in your heart, in order to eliminate the downtime and expense of hosing the body parts out of the conveyor belt. You see the power of framing.

Correctly considered, accidents are another source of unwanted process variability and therefore anything that reduces them is an opportunity for improvement. The model in your head now should be one with two marginal cost curves of different gradients, one where accidents are happening and one where they aren’t.

This is actually a separate question from whether the cost of accidents is dumped on individuals or the state, or whether the perpetrator pays. However, if the perp pays, they are more likely to worry about them, which may mean that safety regulation or pressure from union representatives can lead to efficiency gains.

As I said earlier on, and as Peter Dorman says, the annoying thing here is that the behavioural economics stuff could actually be useful here. Depending on whether you frame safety as an add-on gadget, or as an aspect of a well-tuned production system-of-systems, you’ll either practice it or you won’t! Also, if you have to practice it because it’s the law, you might be nudged – I believe this is the term, Your Honour – into adopting a process view and benefiting from it. And if you do that, you’re probably more likely to actually achieve safety than if you see it as a bolt-on minimal concession to show the English, as they say in Brazil.

Dorman also points out that behavioural economics has a lot to say about both managers’ and workers’ perceptions of risk. People find a lot of ways to deny and minimise dangers. And this is especially the case if they don’t believe anything can be done about it, or if they identify safety issues with social groups they perceive as hostile or just different.

But thanks to the power of framing, Frank can’t say anything about this. I think what’s happening here is that the process view challenges the role of employers as all-powerful within the firm. What the last 667 words have been basically saying is that constraint can be a source of creativity. We recognise this in all sorts of ways. When The Economist says that such and such a union workforce is sleepy and whatever, they’re saying that they need to be constrained to the objectives of efficiency. But for some reason they rarely think this about management.

This is the sort of thing I was driving at with the call centre series. Management and workers, but especially management, have got to a local maximum that’s basically pathological. Because improvement is framed as either a cost, or else a selection from the too-hard basket, nobody does anything.

As Chris Dillow once said, cognitive biases have a lot in common with ideology.

A case study in cluster spillover from the financial services sector

Now this is really interesting. The Grauniad talks to some drug dealers about how they use bookies’ video roulette machines to launder their earnings. The main reason to do this is that they issue receipts, which permit you to explain to the police (and also the Revenue) why you’re carrying so much cash. It’s also useful to be able to transfer money into an online betting account and therefore reduce how much float you have to carry around at risk of robbery.

“James” is especially interesting because he seems to have an impressively precise grip on his business’s KPIs and his numbers add up. First, it’s said that the cost of the laundering – i.e. the losses due to the house edge – is about 5-10%. He sells £5,500 a week in cocaine, and his gross margin is 50%. He also says that he reckons that he spends about £15,000 a year in losses/laundering costs with the bookies. That’s £288 a week. 50% of £5,500 is £2,750, so that works out to 10.4%.

The actual loss rate is much higher, because he only wagers about 40% of the cash he pays in and evidently all the net losses come out of that. The figure of 40% is deliberate, because he suspects that there is a suspicious activity alert set at that level. Other interesting details are that his wholesaler supplies him on credit, although he still needs a substantial float because this might be called in unpredictably, perhaps due to conflict between suppliers, and that he travels everywhere by bus because the police are more likely to bother him in his car.

Hilariously, the surprisingly detailed accounting is because he worked in the back-office of an investment bank before quitting to pursue a more lucrative career, or conceivably to work his way back to respectability.

The missing millions, found hairdressing

So, back in March we were transitioning towards a low-trust society via the phenomenon of the bogus hairdresser. I identified a maximum at the chilly limit of 1.16 million people who might be kept off the official unemployment number via Work Programme wipe-your-own-arse classes, zero wage placements, or bogus hairdressing. I didn’t believe it was that many for reasons I set down in the post.

Anyway, here’s Markit chief economist Chris Williamson comparing a variety of survey-based metrics of employment. They note that the total employment growth according to the ONS since 2010 is 1.16 to 1.2m jobs. Other survey-based estimates put it far lower, between 174k and 308k. If this is the case, the fabled “productivity gap” is at least halved.

Reading into the piece, Williamson notes the existence of 300-odd thousand additional self-employees – the bogus hairdressers – and also a sudden increase in the number of companies registered for VAT and PAYE, an extra 86.7k overall with 31k turning up between 2011 and 2012 thanks to a database cleanup at HM Revenue. He estimates, on the basis that an average British firm employs 11.4 workers, that this on its own would account for 989k jobs.

We’ve got two effects here that point in the same direction, and I said as much in the March post – one is the bogus hairdresser one, a survival response that creates fake employment to stop abuse from IDS. The other is genuine employment being forced out of the black economy and being counted, whether responding to Work Programme badgering or to VAT audits.

The upshot, anyway, is that the unemployment numbers have a cushion of something well north of a million. Williamson doesn’t, as far as I understand, try to model the contribution of zero-wage Work Programme placements or of people who signed off to reset the clock, so it’s quite possibly more.

The macro implication is that the whole second dig at recession was even worse, but that the recovery could be better. The real surprise is that anyone who lived through the 80s or 90s could be at all surprised that they just rigged the dole numbers again.

Some economic links

This is quite impressive – a very short blog post that explains the Marxist idea of reification in neoclassical economic terms of equilibrium, game theory, and collective-action problems. I think I now know what it means.

A case for Help to Buy. Most of the work in it is either done by the notion that it’s not all that much money, or by the notion that the housing market is still in an abnormal low-liquidity condition and there is frozen supply that could come onto the market if only there were more trades.

If it’s possible for a smallish intervention to cause a lot more trading, though, it’s possible that this might mostly be on the demand side. Dan Davies would argue that it’s the presence of a price-insensitive actor that moves a market. The government in HTB is such an actor, on the buy side. If there were price-insensitive sellers still out there, they wouldn’t be waiting, by definition. Also, if there is frozen supply out there, that’s another way of saying there’s an overhang of sellers. Which way do they expect it to go?

Here’s a Robert Vienneau post even I understand – there are two versions of the firm in perfect competition. One, the classical version, just says that unusually large profits eventually get competed away. The other goes for the whole rational expectations fat bloke slog over midwicket.

In practice, no.1 is far more useful – back in 2009, when the general roaring growth of the smartphone market was selling tons of BlackBerries, it was a sensible and valid point to say “Well, one of the competitors might eventually just win and take over” or “Someone might launch a really professional mobile Linux and give it away, strapping a rocket to whoever can manufacture cheaply at acceptable quality”. Saying instead that “Everything is in the current price of $RIMM” was completely useless and indeed disastrously misleading.

Junk Charts likes this chart and so do I:


It points up two things for me – the underrated, huge impact of Android that was so unprofitable for its authors at Google, and the point that Apple didn’t just barge into the business in 2007, they kept hitting us again. The chart shows nicely that it was the 3GS that really hurt. Also, “other smartphones” peaking in 2006 – that’s us, that is.

League tables make you thick, even two years later. It does worry me in the light of the Ryanair fuel league.

Demand determines income. It does so through investment

Chris Dillow loves the idea that there is nothing in industrialised economies worth investing in, and there hasn’t been for years. As far as I can see, the evidence for this is a quote from Ben Bernanke in 2005 that might have been included in his speech by heaven knows what PR flack. But I have a more substantial point.

That point is that “a dearth of domestic investment opportunities” and “stagnant real wages for the 99%” are the same thing, both in the sense Chris means it – if there is nothing that looks interesting to invest in, there won’t be much investment, and therefore no growth and no wage growth – and in the opposite sense.

In an economy where the biggest component of national income is wages and the biggest component of national expenditure is consumption – to put it another way, where the biggest flow is from wages into consumption – how many investment opportunities can there possibly be if real wages are stagnating?

The only way your investment could pay off would be by grabbing market share from competitors, or by leading the way in grinding down margins. Alternatively, there’s the option of an investment that won’t pay off if you look at it in a normal fashion, i.e. moving ahead with the Minsky cycle towards Ponzi finance. I think it’s defensible that precisely these things happened in the 2000s. Free Google searches and very expensive houses.

(Distribution is also an issue – growing inequality might lead to a higher marginal propensity to save across the economy, which would suggest a third option, selling luxuries to the rich, and also that it wouldn’t be enough.)

The interesting point here is that the same principle is at work however you cut it, which is the basic Keynesian insight that demand determines income. Further, the mechanism is the same, and is just as Keynesian – demand determines income, and it does so through investment. The entrepreneur’s assessment of an investment necessarily involves an estimate of demand for whatever it produces. This is evidently influenced by the macro-environment. Nobody ever said “My customers have no money. Time to buy!” Only an economist could think otherwise.

But the way we look at this is an ideological question. You can stand at the slot marked “management” and you’ll see that wages seem too high. You can stand at the one marked “entrepreneur” and you’ll see there are no investment opportunities. You can stand at the one marked “labour” and you’ll see that wages are too low. All three are observing the same phenomenon.

You can also stand at the one marked “contrarian” and you’ll see that there is no solution except, perhaps, for listening to your good self.

Of course it’s possible that there is something wrong; we’ve finally arrived at the great Marxist crisis of the falling rate of profit, we mean it this time, or we’ve finally invented everything there is to invent and therefore it’s not my problem, or we’ve reached Peak Concrete and only ineluctable metaphysical decline that somehow teaches all my enemies a lesson remains. But you can’t reject the hypothesis that the problem is the bastards from this data – a hypothesis well discussed here.