Chris Dillow's Blog, page 185

Long-term effects of youth unemployment

Today's figures show that there are 1.04 million 18-24 year-olds who are unemployed - more than one-in-five of those in the workforce. Even if we leave aside the waste and unhappiness this is causing - and we damned well shouldn't - this has long-term effects.

One of these is that an early spell of joblessness has long-lasting effects upon one's future earnings and employability. One survey says:

Unemployment while young, especially of long duration, causes permanent scars rather than temporary blemishes. For the young a spell of unemployment does not end with that spell; it raises the probability of being unemployed in later years and has a wage penalty.

For example, one study (pdf) found that men who had been unemployed for more than six months before the age of 23 earned an average of 7% less than others even at the age of 42; this controls for educational qualifications.

But there's something else. Experiences in our formative years shape our attitudes to risk. Ulrike Malmendier says (pdf):

Economic events experienced over the course of one's life have a more significant impact on individuals' risk taking than historical facts learned from summary information in books and other sources.

So, for example, people who had seen bad equity returns in their youth own fewer equities than others even decades later.

This rings true for me personally; I am very risk-averse, I suspect in part because my early adult years were times of mass and rising unemployment.  Among my (limited) circle, people of my age are less likely to gamble than those older or younger than me.

If this is right, today's youth unemployment could reduce risk-taking for years. It means we'll have fewer shareholders and entrepreneurs than we otherwise would even in many years' time.

If that sounds bad, there might be a silver lining here.

It could that one pleasant legacy of the 1930s depression was a favourable unemployment-inflation trade-off in the 1950s and early 60s. This was because workers who remembered the depression were scared of unemployment and so did not press for large wage gains even though they were in a strong labour market. The upshot was that inflation stayed low. However, as workers who remembered the 30s retired and were replaced by workers who had known only full employment, risk aversion and the fear of unemployment receded and so wage militancy rose.

It might be, therefore, that in 20 or so years time, we'll enjoy low inflation if we get an economic boom because today's joblessness might permanently reduce wage militancy (or an inclination to get into debt).

This, I suspect, is the best that can be said in favour of present economic policy.

Capitalism against freedom

This marvellous piece by Nick Cohen should provide a culture shock for those of us whose political sensibilities were formed in the 1970s. He says:

The managers of private and public bureaucracies justify their elevated status and salaries not only by attempting to run efficient organisations (a task that is often beyond the poor dears) but by monitoring and intimidating those beneath them.

And You Can't Read This Book attacks "the power of the wealthy to silence their critics."

His point is capitalists are often the enemies of freedom. We see this in the bovine corporate rules that led to the imprisoning and sacking of Paul Chambers; the use of libel law (or the threat thereof) to silence critics of Russian oligarchs; the suppression of whistle-blowers such as Paul Moore; or the demand for draconian anti-piracy laws.

And this is where the culture shock comes in. During the Cold War, opponents of communism routinely, and not entirely wrongly, claimed to be champions of liberty. Freedom for capitalists and freedom of speech and thought go together, it was claimed. "Freedom is indivisible" wrote Bruce Winton Knight in 1952. "Economic freedom is…an indispensable means toward the achievement of political freedom" wrote Milton Friedman in Capitalism and Freedom. And back in 1944 Friedrich Hayek complained that "We have progressively abandoned that freedom in economic affairs without which personal and political freedom has never existed in the past."

Today, though, this seems wrong. Many threats to freedom come from capitalists. The story is no longer capitalism and freedom, but capitalism against freedom. Two of the world's largest economies - China and Russia - show that capitalism can exist quite happily without political freedom.

We see this tension in the coalition. Although it has a capitalist mindset when it thinks of how the NHS should be run, or how fiscal policy should be run according to the whims of an incompetent cartel, it has little appetite for freedom. Of the 3000+ new criminal offences created by New Labour, how many have been repealed? Thatcher would often speak of freedom - even if it is questionable if she actually expanded it - but Cameron rarely does.

Speaking as one who values freedom, all this raises an important issue. In politics, interests and power often matter more than values. The question then is: given that capitalists are often opposed to freedom, where is the powerful interest group that might act as a force for freedom?

Talking among ourselves

There's a common theme in my last two posts, on the misunderstanding of QE and on the left's attitude to morality in politics. In both cases, I'm objecting to the tendency for the left to simply talk amongst itself rather than try to persuade others.

To see what I mean, start from Norm's valid objections - that efficiency is also a moral concept, and that "Marxism embodies a clear ethical standpoint".

In both cases, though, the morality here is what Michael Walzer calls a "thin" morality - the sort of conceptions which have universal appeal. When Marxists claim that capitalism is unjust because it is based on exploitation, they are appealing to the "thin" idea that exploitation, being a form of theft, is wrong. Their opponents do not generally reply with the moral claim that exploitation is OK, but rather with the empirical(ish) claim that the capital-labour relationship is not exploitative.

Efficiency - in the sense I used it - is also thin. Most people agree that it is better that firms be run well than badly; yes, it's healthy for firms to go bust - but because of competition and changes in tastes and technology, not because of bad management.

However, the moral talk I was most strongly objecting too is what Walzer calls "thick" - more detailed and particularistic conceptions which do not have such universal appeal.

And here's the difference. Appeals to a "thin" morality stand a chance of persuading others because they too share such moral intuitions, but appeals to "thick" morality are likely to win cheers from one's own side, but leave others cold.

For example, the claim that big bonuses are unfair invites the retort that they are in fact a fair reward for scarce talent. But my claim that they have adverse effects and are instead the result of theft has, I think, more chance of winning over neutrals.  Yes, at root it is a moral claim - but a thin one, not a thick one.

To take another example, Wilkinson and Pickett's claim in The Spirit Level that inequality is wrong because it hurts us all is also an appeal to a thin morality. Their critics don't argue the morality (which is thin)  but the empirics.

What's at issue here are two conceptions of politics. One is that politics should be (of course it isn't) a realm of ideal speech, in which we use standards of communicative rationality to try and reach intersubjective agreement, or at least understanding and tolerance. Given our lack of ability to make "thick" moral arguments, this requires an appeal to thin morality where possible.

The other conception of politics sees the public realm as an arena in which character is revealed; we make moral claims which are cheered by our own side and jeered by the opposition.

And this is where QE comes in. When what matters is getting a cheer from our own side rather than persuading others, standards of factual accuracy decline.  The left's misunderstanding of QE is a form of Nadine Dorries' "[choosing] the 'fact' I wish to believe." (Of course, the right talks amongst itself as much as the left).

For me - and OK, this might be a "thick" moral claim - this debasement of politics, form what was never a high level to start with, is to be regretted.

QE and banks

There's a common idea - for example here, here and to a lesser extent here - that quantitative easing involves the Bank of England giving money to banks.

This is not quite right. QE does not hand cash only to banks but rather to anyone who wants to sell gilts to the Bank.

In fact, banks have not greatly participated in QE. With considerable cussing, I've got the data out of the Bank*. These show that during the first round of QE, from March 2009 to January 2010, the Bank bought £198.3bn of gilts. This more than offset of £177.4bn by the government.  There was, therefore, a net £20.9bn money injection - underfunding, to use the 1980s term.

But it was not banks who got this cash, at least not directly. They actually bought £6.5bn of gilts. It was the non-bank private sector - institutional investors mainly - who sold gilts and got the Bank's money. They sold £33.8bn of gilts. (I'm ignoring foreigners here, so the numbers don't add up).

For the latest phase of QE, we have data for the fourth quarter. These show that the Bank bought £51bn of gilts, and that banks sold £10.5bn whilst the non-bank private sector sold £29.4bn - almost three times as much.

These numbers show that QE does not mainly work (insofar as it does) through banks. Instead it bypasses them. The Bank hopes that institutional investors will use some of their cash to buy corporate bonds and equities, which in turn will reduce their yields and so encourage firms to borrow in capital markets. Bank lending  has little to do with it.

This policy did have some success. Non-financial firms' capital issues did pick up in 2009, partly thanks to those lower borrowing costs.

This is not to say that QE will be very powerful. It won't be. Nor is it to deny that QE is a welfare state for bankers. It is. Insofar as it raises price of corporate bonds, it increases the value of some banks' assets. And insofar as it encourages more issuance, it improves investment banks'  corporate finance business. 

My point is simply that we should not judge the efficacy of QE by what happens to bank lending.

* It's in tables A3.2, B1.4 and D2.3.1 of Bankstats. Code identifiers are: B4CA for bank purchases (VQIF and TBMH for bank and building society buying respectively before 2010) and VTMB for the other domestic private sector.

Morality & the left

Emma Burnell says that politics has to be about morality. I'm not sure, for at least four reasons.

1. Morality is weak against power. If there is any moral truth at all, it is that the mass murder of innocent civilians is wrong. But when it happens, the "international community" does nothing to stop it. Stalin's famous sneer - "The Pope! How many divisions has he got?" is true.

On a more prosaic level, a similar thing is true of bosses' pay. A periodical fit of morality might stop one or two individuals from taking their bonuses. But a serious and systemic reduction in bosses' pay requires a shift in the balance of class power.

2. Policies are often a mix of morals. Take for example the welfare cap. Is this moral, because it stops feckless scroungers fleecing the tax-payer? Or is it immoral because it threatens to make children homeless? Morality alone does not adjudicate. The issue is about the facts of the policy or about how the issue is framed.

3. Morality can distract us from structural explanations, and hence serve a conservative function. Take for example someone who doesn't want to work. He might look like one of the undeserving poor. But is he? It could be that his "laziness" is an endogenous preference. Surrounded by mass unemployment - and perhaps brought up amidst it - he believes there's no chance of work and so he adapts his wants to his circumstances. Is he undeserving or not? Again, morality does not adjudicate.

4. "Morality" just poses unresolved questions. Take high pay. Is this unfair because it betokens inequality, or is it fair because it represents (in the unsubsidized economy) a free and voluntary exchange between individuals? Adjudication is a matter of moral debate; those leftists who think it isn't miss the point.

But as Alasdair MacIntyre pointed out, we have lost the faculty for such debate with the result that our moral judgments are little more than emotivist spasms. 

There is, though, an alternative here. The left should appeal more to efficiency. For example, the problem with bosses' pay and bonuses is not that they are unfair, but that they are economically inefficient and the product of power, not merit. And, I'd add, the structure of capitalism - at its current juncture - is inefficient, not (just) unfair.

In this sense, Emma is missing something. She's right to want an alternative to a managerialism which tries, feebly and ineffectively, to work within the confines of capitalism. But the alternative is not a moralism which threatens to keep the left within a ghetto of impotent self-righteousness. There is a third possibility - Marxism.

The power of management

My scepticism about the effectiveness of management has been challenged by Luis Enrique, who directs me to research by Nick Bloom and colleagues. But his work does not undermine my scepticism.

Take, for example, this study of medium-sized manufacturers, which says:

Better managerial practices are significantly associated with higher productivity and other indicators of firm performance.

So, management matters. Or does it?

The practices it identifies are largely about whether there are good feedback mechanisms in place. Is the production process sufficiently well monitored that errors can be eliminated and efficiencies identified? Is there good performance appraisal of employees? Are goals clear and sensible? And so on.

What we have here, then, is not a story about CEO's "strategic vision", or about the power of great individuals, but about day-to-day administrative structures. Common sense says these must matter, and must be basic good practice for any firm.

However, Bloom and colleagues find that less than one fifth of the variance in total factor productivity can be explained by these management practices. I'm surprised by how low this is.

What's more, they found that "a large number of firms are extremely badly managed with ineffective monitoring, targets and incentives." Vast numbers of bosses, then, can't even put in place basic good practice. Many managers, then, are poor even by quite undemanding standards. Why?

There is much evidence that management practices are hard to change and are deeply embedded in the culture of an organisation.

For example, older firms, and family-owned firms, tend to be worse managed, as are firms in less competitive industries.  Competition, says (pdf) Bloom, has a "critical influence" in improving management.

But this is just what I've said - that management is weak when set against more powerful forces such as path dependency and the complexity of social structures.

Pro-business, or pro-market?

Rob Marchant thinks Labour should become more pro-business. I'm not sure.

We should make two big distinctions here.

One is between business and entrepreneurship. The bosses of many big businesses are not entrepreneurs who risk their own money to set up companies, but are bureaucrats and salarymen.  Tesco's Philip Clarke, RBS's Stephen Hester and Sainsbury's Justin King, to name just three prominent figures off the top of my head, joined large companies straight from university. They are no more entrepreneurs than the Labour member working in the public sector.

You might object here that Labour should be the party of small business and entrepreneurs. Maybe. But there's a danger that, if it becomes pro-business it will listen more to the bureaucrat businessmen with their lobbying power and wealth than to the smaller, powerless entrepreneur.

Secondly, there's a distinction between being business and markets. Business is about concentrating power at the top of a hierarchy. Markets are about dispersing power. Business thinks high profits are a good thing, but supporters of markets worry that they are instead a sign of a market imperfection or monopoly power.

This distinction means that, in some respects, pro-business policies are very different from pro-market ones:

- A pro-business government gives tax breaks and subsidies for favoured activities. A pro-market government wants a wide tax base with low tax rates.

- A pro-business government favours copyright and  patent laws which protect incumbent firms. A pro-market government wants weaker IP laws to encourage new firms.

- A pro-business government will be relaxed about red tape that strangles small firms and thus entrenches incumbents' position. A pro-market government will not be.

- A pro-business government is happy with planning laws that protect incumbents from new entrants. A pro-market government is not.

- A pro-business government will look to give boondoggles and favours to "good" business (such as manufacturers). A pro-market government prefers a level playing field.

- A pro-business government might encourage or at least tolerate mergers. A pro-market government would worry more about the accumulation of monopoly power.

- A pro-business government will be relaxed about wasteful spending on procurement and infrastructure. A pro-market government will want less spending.

In these senses, to be pro-business is to be anti-market.

And - I'd add - it is to be wrong. New Labour's (misguided) pro-business stance gave us the managerialism which alienated public sector workers, wasteful PFI projects, IT and military procurement policies which were mere corporate welfare, and targets which often distorted the provision of health and education. In doing all this, Labour failed to see that what makes business efficient - insofar as it is at all - is the discipline of market forces, not the skill of "business leaders."

I would much prefer that Labour were pro-market - albeit in a more intelligent, evidence-based way than is associated with right libertarians. Sadly, this is even less likely to happen than it becoming pro-business.

On QE

The Bank of England is likely to announce more quantitative easing on Thursday. Six quick points:

1. Richard Murphy is basically right to say that this means that government debt is lower than official figures show, if we consider the government and Bank of England as a single entity. What's happening is that government borrowing is being financed not by debt sales to the private sector but by an increase in base money. This is entirely consistent with the government budget constraint (pdf). Warren Buffett was quite correct to say that you cannot have a debt crisis if the authorities can print their own money.

2. Complaints that "printing money" is inflationary miss the point. It is meant to be so. As Sir Mervyn King said (p14 of this pdf):

we were concerned that, had we not made those asset purchases, the chances were that inflation might fall below the target.

3. The claim that QE will lead to very much higher inflation requires two assumptions:

- That QE gives a big stimulus to aggregate demand. This is questionable. There are several channels through which QE boosts demand - most obviously by raising asset prices (shares and corporate bonds as well as gilts) thus boost corporate demand for credit - but these are not strong.  Bank of England economists estimate that the first £200bn of QE only raised real GDP by around 1.5% and inflation by up to 1.25%. This implies a rise in money GDP of less than £50bn - a quarter of the monetary injection.

- That the aggregate supply curve is vertical-ish, so higher nominal aggregate demand will lead to price rises rather than output increases. Whilst I agree that the recession has reduced capacity, and that there's a mismatch between unemployed workers and job vacancies, the belief in a near-vertical curve seems rather strong.

4. It's possible that QE will be reversed in coming years. As Sir Mervyn said, such a policy would be "exactly equivalent to the overfunding in the 1980s" - when the government issued more gilts than was necessary to finance the budget deficit with the intention of reducing monetary growth. Richard thinks this would be impossible, as it would - when combined with big budget deficits - swamp the market with gilts. However, there's no reason why a reversal of QE couldn't wait until deficits were smaller.

I suspect a bigger factor preventing negative QE is that - in contrast to the 1980s - bank lending will not be a force for great monetary growth, in which case negative QE would shrink the money stock, which would be a risky policy.

5. If "negative QE" has merely the opposite effect of QE, each £100bn of it would raise gilt yields by half a percentage point. Reversing all the QE we're likely to get by the end of this year would thus add less than two percentage points to yields. This would take 10 year yields to around 4% - their summer 2008 levels. On top of this, yields are likely to rise because the circumstances in which the Bank reverses QE - a stronger economy - are circumstances in which investors will be switching away from safe haven assets (which gilts are perceived to be) into riskier ones such as equities.

6. Low gilt yields are NOT desirable in themselves. Insofar as they signify a weak economy, they are a bad thing. And insofar as they rise because of expectations of recovery, we should welcome this.

The Left & the state

If you ignore the mindless tittle-tattle, David Miliband's New Statesman article raises a genuine issue: what should be the left's attitude to the state? He writes:

The weaknesses of the "big society" should not blind us to the policy and political dead end of the "Big State". The public won't vote for the prescription that central government is the cure for all ills for the good reason that it isn't.

Although this is seen as "Blairite" it is also consistent with a more radical leftist tradition of scepticism about big government is a longstanding tradition on the left such as guild socialism, anarchism, market socialism or Marxism; the SWPer who asked his public choice lecturer "when did you become a Marxist?" was making a serious point.

And such scepticism is valid. In some respects (not all - I just highlight the flaws), the state does not promote leftist ideals:

- It is not very redistributive. The difference between the Gini coefficient for post-tax income (that is, income including benefits after direct and indirect tax) and original income is only seven percentage points: 38% vs. 45%. The tax rate for the middle quintile, at 27%, is not far short of the 32.6% on the top quintile. To a large extent, therefore, the state redistributes income within the working class. And this has an unpleasant effect. It leads to a "divide and rule" the working class, with some public workers and benefit "scroungers" being stigmatized. 

- It is insufficient to protect the interests of the vulnerable. The state can be - and often is - captured by people hostile to the worst-off with the result that benefits are cut.

- The state serves the interests of the rich whilst attacking the poor.  A man who, in his mental distress, tries to kill himself is imprisoned for damaging property. A man who, with a more respectable mental disorder, wrecks the economy merely loses a knighthood; those who say Fred Goodwin broke no law miss the point - that there are no laws against capitalist vandalism.

- The state serves as a lightning conductor, which deflects criticism away from capitalism - for example, when the crisis is blamed upon Labour's deficit or weak banking regulation rather than the flaws of capitalism itself. 

- The state is run according to the same dysfunctional ideology than runs business - hierarchical managerialism. However, in the private sector its flaws are mitigated by the forces of competition whereas they are much less so in government. The upshot is that the state offers indifferent value for money.

It is in light of these flaws that we should read Sunny's claim that spending cuts won't make the government unpopular. Very many working people are not opposed to cuts because they do not regard the big state as their friend. And this is for a good reason.

Granted, David's analysis and solutions here would be rather different from mine. But he is posing a good question. The tragedy is that, in our anti-political political culture, this question will be ignored.

(Non) performativity in economics

Aditya Chakrabortty writes:

Economists didn't just fail to spot the financial crisis – they helped create it. They provided the intellectual framework and drew up the policies that helped caused the boom – and the bust.

He gives the example of how (some) academics made the case for big bosses' pay.

What he's getting at here is the concept of performativity. Academic economics does not merely describe the world, but also helps create it. Markets in options, and index tracker funds, for example, are academic creations; see the work of Donald Mackenzie, such as his book, An Engine Not A Camera.

However, economics is not always performative.

Let's take Aditya's example - that economists have described "how markets work best when they are left alone."

There is a large, old and powerful body of theory which shows that, under some (restrictive) conditions, this is true. Back in the 1950s, Gerald Debreu (pdf) and Kenneth Arrow showed that a set of complete state-contingent markets can be Pareto optimal. The converse is also true. As Greenwald and Stiglitz showed (pdf), an economy with incomplete markets will be sub-optimal.

If economics were always per formative, you would therefore expect there to be at least widespread markets in major contingencies.

And there are not. There's a market for my labour (I hope), but not a market for my labour, contingent upon there being a great depression. Although I can insure my house losing value because of fire, I cannot insure against it losing value because of a fall in demand for houses in Rutland. I can insure against inflation, thanks to index-linked gilts, but not against recession or inequality. As Robert Shiller pointed out in his wonderful books, Macro Markets and The New Financial Order, markets for coping with major economic risks are lamentably under-developed.

This poses the question. How come economics is performative in some regards (option pricing, bosses' pay) but not in others, such as contingent markets?

It's certainly not because Arrow-Debreu theory is new or marginal. It is much older, and far more widely taught in universities than the work of Jensen and Murphy cited by Aditya.

Nor is it because state-contingent markets would be an obviously bad idea. Yes, we know from the theory of the second best that it is not necessarily efficient to remove a single market distortion, so it's theoretically possible that the introduction of a few such markets would be sub-optimal. But whether this would be the case in practice takes some proving. And anyway, plenty worse ideas than these have been turned into economic reality.

There is, of course, a simple answer to this question. Economics is performative when it serves private interests, but not (necessarily) when it serves public ones. Traders immediately saw the usefulness of the Black-Scholes option pricing formula, and bosses quickly saw the use of Jensen and Murphy's work. But the benefits of better state-contingent markets accrue to millions and cannot so easily be captured privately. They are an example of a Nordhausian innovation - one with high social benefits and low private benefits and which do not therefore exist. Paradoxically, markets are incomplete because of a market failure - that there's a positive externality to creating complete markets.

I could, of course, put this more crudely. Economics is performative when it serves the interest of the powerful, and not performative when it doesn't. In this sense, the problem is not with economics, but with a class structure that causes the "real world" to be a corrupted and perverted form of a market economy.