Category: economics

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.

Look after unemployment and…

Budget long

Via Simon Wren-Lewis‘s blog. You see the flattish bit from 2002 to 2008? When people like Hopi Sen talk about “spending out of control”, that’s the bit they mean. This is some weird use of the word “control”, huh?

In fact, the only period on the chart where the budget wasn’t either busting or booming out of control was…the period of roughly stable close to full employment between 2002 and 2007-8. It’s like the man said: look after unemployment and the budget will look after itself.

Gavin Kelly is of course right. But I wonder if this is actually the mark of a deeper truth. If you want a tough fiscal rule, it might just be “full employment, dammit”.

Green Friedman

Econospeak has been having a debate about whether aggregate supply/aggregate demand models are actually any use in economics, which is important because pretty much everyone who does a macroeconomics class gets taught them, like me.

One of the things I remember being dissatisfied with was how to reconcile the long-run aggregate supply curve with the idea of economic growth. If growth is a thing, it means the production possibilities of the economy are increasing. Therefore, the long-run aggregate supply curve is shifting outwards, and further, it’s also dependent on economic growth in the past. If you think capital formation is important – i.e. you’re either a capitalist or a Marxist – I don’t think you can convincingly deny this.

If the LRAS is actually vertical, and therefore stimulating the economy just means inflation, how can the economy be growing? Now, you could argue that perhaps it’s not. Perhaps it’s a zero sum activity. But the people who are most aggressively capitalist are also the ones who deny the most vigorously that this is a problem.

Logically, if you think we’re permanently on the historic planetary production-possibility frontier, you ought to be a super-deep green who believes that economic growth is harmful.

The troika in one country

I don’t read Hopi Sen but apparently he reads me, as evidenced by this blog post regarding the idea of a “fiscal policy council” analogous to the monetary policy committee, but with a substantially wider remit and membership. I can remember when this was floated in the late 90s in a wave of cheer about the success of the MPC, but it strikes me as weird to fall in love with it just when independent central banks are very much in question.

Not only aren’t they as independent any more, with the exception of the ECB, but there is plenty of intelligent criticism of how well they worked in the first place. After all, we had a hella-big bubble and then a three-fisted crash and then a picayune pint-sized recovery and they were meant to avoid all three. About the only thing they did achieve was to stop real wages going up, and this is now a situation that has not necessarily developed to our advantage, as Emperor Hirohito so wisely said.

Anyway, Hopi’s version includes people from the IMF and OECD. Right now this would be fun, because the IMF wants stimulus and the OECD wants more austerity. Hey, democracy is discord, right? But this isn’t my point.

Angela Merkel has, according to Reuters, rowed-back on giving the EU more power to intervene in national fiscal policy. This is possibly because France recently started talking about its longstanding idea of an “economic government” for the eurozone, and if such a thing emerged from giving the EU (ECB? Council? Commission? Parliament?) more power it might not agree with her.

Another reason to row back, though, is that the EU has quite enough power to do so now all the member states but the UK have ratified a sort-of balanced budget amendment, and both the German government and the ECB have constituted themselves as a sort of international air force to back up Olli Rehn’s judgments. From the same Reuters piece:

Hollande had infuriated officials in Germany and Brussels by initially suggesting that the Commission had no right to “dictate” to Paris. The Germans believe that a strengthening of the EU’s Stability and Growth Pact has granted the Commission that right.

“The chancellor made very clear in Paris that Hollande had an obligation to follow the Commission’s recommendations,” a German official told Reuters on Sunday.

See those contrails? Right. Here’s my point. If you don’t think the UK’s economic policy process should be placed under permanent supervision by Olli Rehn, with the ECB close air support wheeling overhead, why would you think it should have a similar setup just with the OECD’s terrifyingly mad advice informed by the IMF’s notoriously worthless forecasts?

And in what way isn’t the left-eurosceptic critique that the EU is an outsourced agency for policies towards workers that you couldn’t get through a British general election actually borne out, if you’re trying to implement a structure equivalent to troika surveillance within the UK?

Larry Elliott’s alternate history of what would have happened if Alex Harrowell got his way in 2003 in today’s Grauniad is very much on point here, with the exception that I can well see alt-George Osborne explaining again and again why we must stay the course with the Euro to fight for competitiveness and stability and you get the fucking picture. Perhaps the Tory hard right would have all gone ‘kipper, and the “official” Tories would have borged the Lib Dems. Like a lot of other Eurozone political classes, ours would have taken full ownership of the project, and there’s probably a reason for that.

Railtrack in the sky, at war!

To expand on something I wrote as a comment, one of the things I hate about wizard privatisation schemes and especially “total outsourcing” or whatever is as follows. The FSTA deal for the RAF’s new jet tankers is especially awful and exemplary.

Here’s the idea. Rather than buy the aeroplanes and do the job, we’ll buy “what we need” – a guarantee of however-many flying hours and tonnes of offloaded fuel where required. This will be awesome, because the availability is guaranteed. At the same time, the PFI contractors get to (supposedly) charter out the planes when not needed, which makes them money. This pays some of the costs and therefore it’s meant to be cheaper.

Guarantee, you say? What guarantee? What are these planes that never ever break down? Why can’t the RAF just buy some of them? Well, of course, they will break down but there’s a contract that says Airtanker will give the MOD a refund if they miss a slot. What good the refund is if you crash in the sea is left as an exercise to the reader. Obviously, they won’t just accept it, they’ll argue bitterly and sue everyone, and if Airtanker can’t airtank, does anyone imagine that the Treasury solicitor will find any money there in receivership?

You’ve seen this story, you’ve lived it – it’s Railtrack. Everything was ponies because contracts. It didn’t work, it cost more to litigate the disputes than it cost to build actual trains, and when it fucked up, there was no money to pay out the compo. It’s the Treasury’s attachment to the myth of immaculate compensation that’s doing the work here. As Bob Dylan sang, they say everything can be replaced

And this thing is costing £14bn for 11 planes, that sell for vastly less to the airlines. Well, say the PFI panjandrums, that does include every sheet of toilet paper used by the ground engineers, and all the fuel. But this is precisely the problem. How confident are you that their cost accounting is honest? You can’t really control it. How do you audit the price of jet fuel 20 years hence? There’s a reason why the Americans have the phrase, to sell someone a bill of goods.

Closer to home, think of one of those guys in the Tottenham Court Road flogging computers. If you take the pricier option, of course, I’ll throw in a bag and some USB sticks and an airbomb and that neat little fart-robot. The margin is on that stuff. If you take it you’re a sucker. It’s a similar process to the one I described here. Ryanair works by disaggregating its price, Airtanker and friends by aggregating it, but the point is the same – moving economic activity from the domain of competition and of legibility into that of monopoly and of mystery.

Both have the effect of destroying information and therefore efficiency. This is why taking railway maintenance back in-house saved money at Network Rail.

Update: I forgot to include this. US healthcare is basically completely think-of-a-number, nothing has a single price.