The OBR, productivity and policy failures

Chris Giles had an article in the FT yesterday about the UK’s continuing dreadful productivity performance, and the implications this might have for forecasts of the public finances. It has the following chart comparing successive OBR forecasts and actual data.

I want to make two points about this. The first is about the OBR’s forecast. [1] It is easy to say looking at this chart that the OBR has for a long time been foolishly optimistic about UK productivity growth. Too often growth was expected to return to its long run trend shortly after the forecast was published but it failed to do so. Expect lots of articles about how hopeless macro forecasts are in general, or perhaps how hopeless OBR forecasts are in particular. It was obvious, these articles might say, that trend productivity growth in the UK has taken a permanent hit following the financial crisis.

Anyone saying this is ignoring the history of the UK economy for the 50 years before the GFC. After each downturn or recession, labour productivity growth has initially fallen, but it has within a few years recovered to return to its underlying trend of around 2.25% per annum. This means not just returning to growth of 2.25%, but initially exceeding it as productivity caught up with the ground lost in the recession. In a boom sometimes growth exceeded this trend line, but it soon fell back towards it.

This made sense. Productivity growth reflects technical progress and innovation, and they tend to continue despite recessions. A firm may not be able to implement innovations during a recession, but once the recession is over experience suggests they make up for lost ground in terms of putting innovations into practice.

Given this experience, OBR forecasts have always been pretty pessimistic. They have assumed a return to trend growth, but no catch up to make up for lost ground. If they had also forecast, in 2014 say, that given recent experience they expected productivity growth to be almost flat for the next five years that would have been regarded as extreme at the time. Why would UK firms continue to ignore productivity enhancing innovations when the macroeconomic outlook looked reasonable?

And of course in 2014 UK productivity growth was positive. This brings me to my second point, which follows from this quote from the FT article:

“In the Budget, both the OBR and Mr Hammond are likely to stress that the downgraded forecasts do not reflect a new assessment of the damage to the UK economy from Brexit, but a reassessment of likely productivity growth after so many recent disappointments.”

Chris may be right that they will say this, but is it remotely plausible? As my recent post tried to suggest, UK productivity growth can be seen as suffering from three large shocks: the recession following the GFC, the absence of a normal recovery as a result of austerity, and then Brexit. The first two of those shocks led to a period of intense uncertainty, causing UK firms to put on hold any plans to innovate. Just as they thought things had returned to a subdued version of normal they were hit by the third, Brexit. During periods of intense uncertainty, productivity stalls or may even decline a little, as firms meet any increase in demand by increasing employment but not investing in new techniques. [2]

This story involving uncertainty seems to fit the data. Once the recovery (of sorts) finally began in 2013, productivity growth picked up. That sustained growth came to a halt when the Conservatives won the 2015 election, and the possibility of Brexit began to be an important factor for firms. [3]

These two points are related in the following way. The experience of the 50 years before the GFC suggested that you could hit the economy with pretty large hammers, but it would eventually bounce back. However that may have been contingent on a belief by firms that if policymakers were wielding the hammer (using high interest rates for example) they would take it away fairly soon, and replace it by stimulus. That belief was shattered in the UK by the GFC and austerity, where policymakers decided to keep using the hammer. What little confidence remained was destroyed by Brexit.

Discoveries are still be being made in universities around the world, and we know innovations are still being implemented by leading UK firms. It seems completely far fetched to imagine the GFC is still having some mysterious impact on the remainder of UK firms such that they refuse to adopt these innovations. A much more plausible story is that we are seeing what happens when most firms lose confidence in the ability of policymakers to manage the economy.

[1] I am on the OBR’s advisory panel, but as our job when we meet once a year is to be critical of OBR assumptions, and as we have no role in producing their forecasts, I think what I say here can be completely objective.

[2] Productivity can initially fall because new employees are not as productive as those who have been working in the firms for some time, for example.
Postscript (7/10/17) For evidence on the impact of Brexit on productivity, see work by Bloom and Mizen here.

[3] An alternative story is that the UK has settled into a new slow growth ‘equilibrium’, where the majority of firms are so pessimistic they hardly innovate at all.      

Productivity and monetary policy

The Bank are warning of imminent rises in interest rates. As Chris Giles points out, we have been here before, and before that, but that shouldn’t mean we should dismiss this talk, because one day it will happen. [1] They (the MPC) certainly sound serious. But why when current growth is so slow are they even contemplating it? Here is a clue from Mark Carney’s latest speech (my italics).

“On the supply side, the process of leaving the EU is beginning to be felt. Brexit-related uncertainties are causing some companies to delay decisions about building capacity and entering new markets. Prolonged low investment will restrain growth in the capital stock and increases in productivity. Indeed, if the MPC’s current forecast comes to pass, the level of investment in 2020 is expected to be 20% below the level which the MPC had projected just before the referendum. Net migration has also fallen by 25% since the Referendum.

As a result of these factors and the general weakness in UK productivity growth since the global financial crisis, the supply capacity of the UK economy is likely to expand at only modest rates in coming years.”

When people, like me, say how can the Bank be thinking of raising rates when demand is so weak, the response from the Bank would be that supply has been at least as weak.

This pessimism about the supply side comes straight from the data. If I hear people talking about the UK being a ‘strong economy’, I know they either have not seen this chart or are just lying.

UK Output per hour, whole economy (ONS)

The red line is a trend that pretty well matches the trend in the data until the end of 2007, with the amount you can produce with an hours worth of labour increasing by 2.2% a year. Since the global financial crisis (GFC) there has been almost no growth at all. If you want to know the main reason real wages have stopped increasing, this is it. [2]

I hear some people say this is just oil and financial services. It is not, as this table from a recent Andy Haldane speech shows.

Start at the bottom: total average growth has been non-existent since the crisis. The rest of the table looks at the contribution of each sector to that total. To see what productivity growth would be excluding financial services, just add that figure to the total: 1.8% 1998-2008, 0.4% 2009-2016. That table makes it clear that the productivity crisis is economy wide.

It is worth looking at aggregate productivity since the GFC period in more detail (same data). I often hear people say the productivity slowdown started before the GFC. From the chart below, it clearly did not. (We have just seen the tenth anniversary of Northern Rock going bust, and the UK productivity slowdown started shortly after that event.)

We could describe this data as five phases. 1) Productivity in the recession fell, as it often does in a recession for various reasons. 2) As the economy begins to grow again, so did productivity growth. 3) As it becomes clear, in 2011, that the ‘recovery’ is going to be very weak because of austerity, productivity growth stops growing. 4) By the end of 2013, with stronger growth under way (although still no catch up to previous trends, so not a true recovery) productivity starts growing again, although rather slowly. 5) Since the 2015 election, with the prospect and then the reality of Brexit, even that modest growth disappears. (My data does not include 2017Q2, which saw a very slight fall.) I could shorten the description as follows: recession, modest optimism, pessimism, even more modest optimism, uncertainty.

That is my gloss on the numbers, but I’ve done it to make a point. Productivity growth invariably requires an investment of some kind. It may not be physical investment, but just training someone up to be able to use some new software. Whether a firm incurs that cost will depend, in part, on their expectations about the future. There is a regrettable tendency in macro (I blame RBC theory) to treat productivity growth as manna from heaven. But the idea that potential improvements in technology stopped after the GFC, and just in the UK, is simply ridiculous. The problem is that firms are not investing in new technology. What I call the ‘innovations gap’ has emerged in the UK because of weak growth and the consequent pessimistic expectations of most firms. [3]

The idea that the economy could get itself in a low growth expectations trap is increasingly being put forward by economists: here is George Evans, for example. The UK has got itself into that trap because on the two occasions that a recovery of sorts appeared to be under way, the economy has been hit with terrible policy errors (austerity and Brexit). But the idea that UK firms are incapable of upgrading their production techniques is nonsense. They will do so initially if they can be confident that the demand for their products will increase, or subsequently when the innovation pays for itself even though demand is flat.

Which is why an increase in interest rates right now would be very bad news. It would confirm the pessimistic expectations of most firms that demand is not going to grow fast enough to make innovation worthwhile. Formally, the job of the MPC is not to worry about productivity but to control inflation. But elsewhere, where the same process may be happening to a lesser extent (the productivity slowdown is worldwide, just most acute in the UK), central banks are puzzled at why inflation just refuses to rise. 

The concept of an innovations gap is one solution to that puzzle. Expanding demand allows firms to invest in more productive techniques, and so there is less incentive to choke of demand by raising prices. I suspect in an alternative world where Brexit had not happened the Bank of England would also be puzzling over why prices were not rising. As a result, if the MPC do finally raise interest rates this year, it would be one more mistake to add to the growing list under the heading Brexit.

[1] On each occasion I also wrote a post saying that they should not raise rates, starting I think at the beginning of 2014.

[2] I discussed in earlier posts why real wages are falling by even more than output per head.

[3] Or perhaps the pessimism of the bank manager lending money to those firms. The Haldane speech shows that productivity growth has remained strong among the top, frontier companies. Why? Because these companies, given their position, will be seeing growth relative to the average, and have got to the frontier through a culture of innovation.

In defence of George Osborne over Brexit

This by Fraser Nelson in the Spectator (HT Tim Harford) starts well: “Sometimes, George Osborne’s dishonesty is simply breathtaking.” Who could disagree with that? Except that the statement Nelson objects to is the following:

“Britain would be permanently poorer if we left the European Union, to the tune of £4,300 for every household in the county. That’s a fact everyone should think about as they consider how to vote.”

Nelson does not object to the economics behind the number, set out clearly in a Treasury study released yesterday. (For an excellent review of the study, which makes both of the points I make below, see Chris Giles here.) Instead he has two objections:

1. With economic growth we would not be poorer under Brexit, just less richer than we would have been if we had remained in the EU
   
   
2. The household figure is derived by dividing the GDP ‘loss’ by the number of households in the UK.
   
   

Nelson makes the point that household after tax income is only about two thirds of GDP/households. So implicitly he is saying is that we shouldn’t count lower taxes (and therefore government spending) and investment (future incomes) when assessing whether people would be poorer. But that seems silly. We all benefit from total government spending and investment, so we would feel less well off if we lost some of that. [1]

Indeed I have done exactly as the Chancellor has done when assessing the impact of 2010 austerity. I calculated, using OBR figures, that austerity cost each UK household at least £4000. The two figures appear comparable, but in fact they are not. My figure is a total one-off cost, on the (admitted very optimistic) assumption that the UK economy had completely recovered from 2010 austerity by 2013. The Brexit cost is a continuing loss each year.

Alas for Fraser Nelson dividing any GDP loss by the number of households is standard practice among economists (see John Van Reenen here for example), and we do it to make our analysis more relevant to those who do not commonly think in terms of GDP. It is also common practice to think about counterfactuals: if we did X (Leave) rather than Y (Remain) how much better/worse off would we be. It is just much clearer to do things that way. Who knows how much richer we will be by 2030: that would be a pretty unreliable forecast, because it depends on pretty well everything. In contrast we can be much surer (although still uncertain) about what the impact of just one change (leaving the EU) will have.

Now if you wanted to avoid any ambiguity, you could rewrite the first sentence of the Chancellor’s statement as follows:

““Britain would be worse off if we left the European Union compared to if we stayed in, to the tune of £4,300 for every household in the county by 2030, and for each and every year after that.”

If this is honest, does that make the original version dishonest. I do not think so.

If this report illustrates anything, it is that it would have been much more effective to have launched a 2003 joining the Euro type exercise immediately after the 2015 election victory, consulting widely among outside experts, and perhaps getting some of them to write key parts of the report. That would have produced a wider range of numbers for the cost, and the Chancellor could have then chosen the higher one, simply inserting ‘up to’ in front of it. But here I am, defending George Osborne and advising him on spin. I think I better go and lie down for a while.

[1] Slightly pedantic economic point: we should really use GNP rather than GDP, but it makes little difference here.  

Politically impossible

An article in the Financial Times recently said of me: “He has opposed deficit reduction when the economy was weak and when it was strong.” Ah yes, this would be the same economist who has suggested the left aims to reduce the current deficit (all current spending less revenue) to zero, that pre-crisis fiscal policy in the Euro periphery should have been much more contractionary, and has championed fiscal councils as a way of eliminating deficit bias.

Should I have demanded a retraction? I didn’t: life is short, maybe it was a kind of joke, or even a misprint, and if not perhaps it said more about the writer than it did about me.

But I was reminded of it last week when I was discussing pre-crisis fiscal policy. As I noted in one of those earlier posts, I am repeatedly told that pre-crisis fiscal policy in Spain could not have been tighter. It was ‘politically impossible’, given the budget surpluses at the time. I heard a similar point made about Ireland last week. (While a big part of Ireland’s post-crisis fiscal problems were down to socialising its financial sector’s debts, a significant part was also due to relying too much before the crisis from receipts based on an unsustainable housing boom, as was the case in Spain.)

It occurred to me (and yes, I know it is obvious) that such complaints are just the mirror image of those who say we have to have austerity because running up higher government deficits is just ‘politically impossible’. The argument that governments cannot run very large surpluses because voters would demand that they be spent relies on the same logic which says that governments need to tighten their belts when the private sector is doing the same. In other words you cannot complain about austerity on the one hand and then say that it was politically impossible to run larger surpluses in a boom.

Equally it makes no sense obsessing about the need to reduce deficits in a recession and then turning a blind eye when surpluses are spent in a boom. Unfortunately just that kind of inconsistent thinking became hard-wired in the form of the Stability and Growth Pact (SGP), with its focus on a limit of 3% for deficits. Those who say that all that was wrong with the SGP is that it was not enforced have learnt nothing. This is why we need to move influence away from the Commission and towards independent national fiscal councils.               

Mediamacro myth makers fight back

This may also be the first in a series!

In a recent blog, David Smith of the Times writes

“One of the most enduring claims about the British economy in recent years is that the then coalition government abandoned austerity in 2012. It is a claim that gives comfort to those who see everything that has happened to the economy through the lens of fiscal policy. Only when austerity was abandoned in 2012, some argue, did the economy begin to recover. Unfortunately it does not fit the facts. It is a myth.”

Chris Giles of the FT tweeted: “The shocking thing about this excellent post is the misinformation that forced @dsmitheconomics to write it”.

Now the reference to myths might make you think David Smith is having a go at yours truly, but I would never be so narcissistic. I know this cannot be the case because I have never said that austerity was abandoned in 2012. In fact I cannot think of anyone who did, but clearly I’m not reading the right people. Of course this could be another example of the straw man trick: to defend position X (plan A continued) against position Y (the pace of austerity slowed), create a third position Z (austerity abandoned) which is a silly exaggeration of Y, and show that Z is false. Ergo X must be true. Remember how critics of austerity had to be wrong because they claimed a recovery would never happen.

What David concludes, of course, is that the pace of austerity slowed from 2012 onwards, which is obvious if you just look at the data. So why does he think this is such a problem for critics of austerity? Again we need a straw man: someone who “see[s] everything that has happened to the economy through the lens of fiscal policy.” Now I’m sure I have never met anyone like that, but if such a person existed then the 2013 recovery would be inexplicable, because austerity was continuing (albeit more slowly).

This is terrible stuff. Every macroeconomist besides those of David Smith’s imagination knows that the economy is influenced by all kinds of factors, or which fiscal policy is but one. So a recovery is perfectly compatible with austerity being a drag on growth, particularly if monetary policy is highly expansionary.

One way of thinking about the impact of a fiscal contraction is that it has its maximum impact on the level of GDP when it happens, but this impact dies away as other forces, like monetary policy, bring GDP back to its ‘natural’ level. Whether that is the right way to model the impact of fiscal policy in a liquidity trap is debatable, but that is how the OBR treats the impact of fiscal policy, and from his post I’m glad to see that David thinks the OBR is an authority on these matters.  

Here is a chart from this OBR document.

The orange bars show the impact the original 2010 plan would have had, and the blue bars what actually happened (and what will happen) as seen in March 2014. The blue bars are the basis for my conservative estimate that austerity cost every UK household on average £4000 worth of resources. Even though in both cases austerity continues through 2012 and 2013, the impact on growth dies away (or even becomes positive), because the negative effect of any new austerity is offset by the impact of earlier austerity dying away.

Harmful austerity does not need to be abandoned before a recovery can happen. Slowing down austerity clearly makes a recovery easier, but that is not the main reason why the mediamacro myth that ‘Plan A’ continued is important. As I wrote here: “Not making it clear that the plan had changed was a serious failure. If that call had been made, the Chancellor would have had to account for why he had allowed deficit reduction to stall, and that in turn would have established quite clearly that previous austerity had delayed the recovery.”

It really is very simple. George Osborne campaigned in 2010 that Labour’s plan to cut the deficit by half in five years was much too slow, and so began a much tougher austerity programme. More rapid deficit reduction was at the centre of that plan. But deficit reduction was allowed to slow from 2012. Why did the media not challenge Osborne on why this was happening? Why did it go along with the fiction that the plan was unchanged? The media has no problem asking Labour politicians to account for why they borrowed too much (allegedly), but when George Osborne borrows much more than he planned, having previously stressed the importance of cutting the deficit quickly, this suddenly becomes unimportant. Strange that.  

Greece: of parents and children, economists and politicians

Not part of the mediamacro myths series, but in a way related.

Chris Giles has a recent FT article where he describes how non-Greek policymakers (lets still call them the Troika) see themselves like parents trying to deal with the “antics” of the problem child, Syriza in Greece. He splits these parents into different types: those that want to act as if the child is grown up (though they believe they are not), those who want to be disciplinarians etc. As a description of how the Troika view themselves, and present themselves to the public, the analogy rings true. It certainly accords with the constant stream of articles in the press predicting an impending crisis because the Greeks ‘refuse to be reasonable’.

In FT Alphaville Peter Doyle writes about a recent meeting at the Brookings Institution in Washington, the highly respected US social science research/policy think tank. In that meeting Wolfgang Schäuble and Yanis Varoufakis, finance ministers of Germany and Greece, gave back-to-back presentations. He describes how “Schäuble was avuncular, self-effacing, and Germanic, and was tolerated rather than warmly embraced by his hosts.” In contrast “when Varoufakis spoke, eyes burning with anger, his hosts were animatedly engaged.” The audience actively sympathised with the position of Greece, and asked “how it felt to be right but penniless”. He writes “There was no doubt where the hosts’ sympathies lay between their two guests.”

I am not surprised at all by this account. The arguments that many of us have made about how far Greece has moved and what agonies it has endured in order to satisfy the unrealistic wishes of their creditors are I think widely shared among our colleagues. We know that if Greece was not part of the Euro, but just another of a long line of countries that have borrowed too much and had to partially default, its remaining creditors would be in a weak position now that Greece has achieved primary surpluses (taxes>government spending). The reason why the Troika is not so weak is that they have additional threats that come from being the issuer of the Greek currency.

It is important to understand what the current negotiations are about. Running a primary surplus means that Greece no longer needs additional borrowing - it just needs to be able to roll over its existing debts. Part of the argument is about how large a primary surplus Greece should run. Common sense would say that further austerity should be avoided so that the economy can fully recover, when it will have much greater resources to be able to pay back loans. Instead the creditors want more austerity to achieve large primary surpluses. Of course the former course of action is better for Greece: which would be better for the creditors is unclear! The negotiations are also about imposing additional structural reforms. Greece has already undertaken many, and is prepared to go further, but the Troika wants yet more.

As Andrew Watt points out, from the perspective of the Eurozone and IMF, this is all extremely small beer. [1] You would think the key players on that side had more important things to do with their time. The material advantages to be gained by the Troika playing tough are minimal from their perspective, but the threats hanging over the Greek economy are damaging - not just to investment, but also to the very primary surpluses that the Troika needs. So why do the Troika insist on continuing with brinkmanship? Can it be that this is really about ensuring that an elected government that challenges the dominant Eurozone political and economic ideology must be forced to fail?

In a recent post that I (jokingly) entitled ‘Should economists rule?’ I suggested that much of the debate about the delegation of economic policy to economic experts was really an issue about political transparency rather than diminished democracy. Elected politicians normally always have ultimate control. Sometimes ‘delegation’ amounts to little more than making the advice they receive transparent: contracting out the fiscal forecast to the OBR would be an example. [2] All that democracy loses in this case is the ability of politicians to conceal or manipulate the advice they receive, and to fool the public as a result. Greece may be (unfortunately) a good example of how far politicians are prepared to go in misleading their own electorates to cover-up their mistakes and achieve their own political ends.

  

[1] The IMF mainly consists of hundreds of economists, but it is run by politicians, and on issues like this the politicians tend to take control.

[2] With central bank independence they do lose control, but normally with the power to take back control in some way. Furthermore, if the undemocratic central bank persistently made bad decisions, taking back control would be popular. An exception is the ECB, which may help explain why many of its words and actions are seriously problematic.

Rollercoasters and rules

Chris Giles says today that “there is a gap [between Labour and Conservatives plans] of more than £30bn a year in public spending by the end of the decade, at least 1.4 per cent of national income. This is a bigger political divide seen in any election since the days of Margaret Thatcher.” Chris is absolutely right to focus on this fact, and it is really important that other journalists (including those on the political side) do the same. The reason is that neither Labour nor the Conservatives want to admit this. Labour wants to appear as if they are being ‘tough on the deficit’ and the Conservatives want to turn this into a ‘Labour would put up taxes’ election. With all the noise that these phoney debates throw up, it is important that someone tells people what the consequences of their vote will be.

Chris may also be right that the rollercoaster for public spending set out in the Budget (sharp cuts followed by increases) will not happen. However I think it would be wrong to expect a smooth ride under the Conservatives either. They will have won an election based on an initial two years of substantial spending cuts (particularly to public investment), followed by later years when the overall pace of fiscal consolidation slowed substantially (in part because of Budget tax cuts). If that wins them this election, they will want to repeat that pattern. [1]

The term rollercoaster was coined by Robert Chote, head of the Office for Budget Responsibility. But if the rollercoaster will never happen, was Robert wrong to use this word? Absolutely not - in using that term he was doing his job in a very effective way.

As Chris explains, the reason why the numbers given to the OBR generate a rollercoaster profile is the revised fiscal rule, which says that there should be (cyclically adjusted) balance within three years. Like the old rule, this is a rolling target (but now for three years ahead rather than five), so it means in effect that governments can keep putting off the date balance is achieved as each year rolls past.

If governments start planning their fiscal actions with this in mind, the rule becomes largely worthless: it means reducing deficits mañana. As I explained here, rolling targets are a good idea because they allow policy to be flexible in the face of shocks. But rolling targets can also be abused by an irresponsible government to forever put off deficit reduction.

As I argued here, there was no good reason for Osborne to switch from a five to three year rolling target, and good reasons to stick to five years. The move to three years looked like a political ploy to embarrass the opposition. When politicians start messing around with fiscal rules for political ends, and these rules then produce silly results which politicians have no intention of sticking to, it is important that an independent institution with the words ‘budget responsibility’ in their title calls attention to what is going on. Robert Chote did that very effectively by using the term rollercoaster. 

[1] Where I think Chris is wrong is in describing plans to decrease debt slowly as risky. The opposite is the case. With interest rates near their floor, sharp austerity puts the economy at risk from adverse macroeconomic shocks. 

Mediamacro and responsibility

The Chancellor gives a huge pre-election bribe to the moderately wealthy over 65s, and describes the fact that everyone who can is trying to get hold of the bribe (and completely overwhelming the NS&I as a result) as a great success. [1] Chris Dillow describes this as corruption. To their credit, right wing think tanks have also condemned it for what it is. But the Chancellor says this is all part of his economic plan.

I suspect the penny is beginning to drop in mediamacro. This was supposed to be a government where deficit reduction was the overriding priority. It was of such importance that it was worth the risk (which materialised) of delaying the recovery until 2013 to achieve. Hard, sometimes painful choices had to be made to achieve the goal of reducing the deficit. A Chancellor who was prepared to do unpopular things for the greater good. The essence of responsibility.

Unless you were a top rate tax payer, of course. Or, following the Prime Minister’s conference speech last year, a moderately well off taxpayer. And now if you are moderately well off and over 65. Penny dropped? But this last example also tells mediamacro a difficult truth. Its modus operandi is that it can rely on the opposition to expose such things, but Labour appears to have been silent on this. Obviously, because these kind of bribes work because those that receive it are thankful and the much larger number who pay for it are not so fussed. [2] So it needs to seek out those who will call a spade a spade. It has a responsibility to do so. This time it could use right wing think tanks. Next time it may have to resort to economists who write blogs.

Chris Giles, economics editor of the FT, wrote an interesting opinion piece a few days ago. It appears at first sight to be an attack on Labour’s record in opposition. But it ends with “the intriguing thing about Mr Miliband’s Labour party is that its broad economic prospectus for the 2015 general election is perfectly sensible.” In contrast “the Tories’ plans appear ideological and border on calamitous for many public services.” If you want more detail on this, see my debate with Oliver Kamm in Prospect magazine. So his article is a form of puzzle: how did responsible Tories and reckless Labour change places?

One possibility, of course, is that there never was a puzzle. Chris lists many alleged failings by Labour, but a lot look superficial and presentational to me. Furthermore (and I know Chris will not want to admit this) when Ed Balls said Osborne was cutting too far too fast, he was right. In particular, public investment (school repairs, flood prevention) was cut immediately when there was no need to do so to meet the coalition's fiscal rules. Those who think it had to be done to appease the market should reflect on the fact that Britain lost its AAA rating because of weak growth, and pretty well everyone thinks that public investment has the largest GDP multiplier.

It is the media’s responsibility, which Chris for his part has grudgingly fulfilled, to point out - one way or another - who has the more responsible macroeconomic plan post 2015. The opposition will not make that case, because it has become terrified of being labelled spendthrift. Yet it is hard to find a macroeconomist who does not think Labour has the better macro policy from 2015, whatever their views about 2010 austerity. A responsible media needs to get this point across, just as it needs to point out pre-election bribes.

[1] Once upon a time NS&I was just a way that the government could sell its debt to ordinary people at slightly below market rates because it was safer than banks. However after the financial crisis, when it became clear how risky banks were, the government seems to have contracted the range of products that NS&I sell, I guess because of lobbying by these same banks. Once you could buy indexed linked assets from NS&I - no longer. Now it has become a vehicle for giving bribes to selected groups of savers.

[2] This is the ‘common pool problem’, one of the reasons economists give to explain deficit bias, which is of course being irresponsible about the deficit. 

What the Financial Times got (very) wrong

When an academic, or student, thinks they have found a mistake in an academic paper or book, what do they do? Check their calculations again and again, or course. Ask someone else to do the same, maybe. But then they will write to the authors of the original work, and ask them to comment. What they will not do, in that letter or email, is to give the original author a deadline of one day to respond. That was how much time Chris Giles of the Financial Times gave Thomas Piketty to respond to his long list of alleged errors and unexplained adjustments.

I think it might have been very different if Chris Giles had written a piece about the difficulty of interpreting wealth inequality data, and had wanted to get clarification of what Piketty had done and why. I suspect in that case the paper would have given Piketty more time to respond (what was the urgency?), and the article would have benefited greatly from that dialog.

But that was not the article that Chris Giles chose to write and the Financial Times chose to publish. Instead they wrote an exposé, in much the same way as you would expose some wrongdoing by a politician. (Is an academic making a spreadsheet error the equivalent of a politician having an illicit affair?) The phrase they use in football is playing the man and not the ball.

Now, in the unlikely event that I ever warranted a headline story, I know I would not want to be treated in the way Giles treated Piketty. There were only two possible justifications for writing a story of that kind. One was if the paper had clear evidence that Piketty had fiddled the numbers to get the results he wanted, and it is obvious they did not have that evidence. The other is that they had found so many simple mistakes that this discredited Piketty as an academic. Again this was not the case. [2]

I also get very cross with academics who suggest that, because his book had become a bestseller and he had accepted invitations to talk to White House staff, he somehow deserved this kind of treatment. This seems to me like hypocrisy at its worst. Given this treatment, both Thomas Piketty’s initial response and his more detailed response issued yesterday are remarkable and impressive in their restraint.

So the mistake the Financial Times made was not that they allowed one of their best investigative journalists to look at Piketty’s spreadsheets (which Piketty had, to his great credit, made publicly available). As I said in my earlier post, a FT article that looked at the alternative sources for UK wealth inequality data, and questioned the idea that wealth inequality was inevitably rising in most countries, would have been an interesting piece. [1] The paper’s mistake was to write the story as an exposé.   

Why did the Financial Times want to run a ‘gotcha’ piece in the first place? Of course Piketty has become something of a celebrity, and tabloids love to knock celebrities down. But the FT is no tabloid, and to think it was just about celebrity may be politically naive. As Henry Farrell and Mike Konczal noted in a typically acute pair of posts, a focus on inequality as a central issue in economics is very threatening to some, and many of those who feel threatened will read the Financial Times. 

[1] It is worth noting that if we look at the Atkinson and Morelli database, among the six European countries where there was recent data for the top 1% wealth share, I counted three where there seemed to be an upturn in wealth inequality over the last few decades, and three where data showed no clear trend over the same period.

[2] Chris, in a first response to his critics, says that “Academic economists have got themselves into a bad spot if undocumented data, errors and tweaks are considered by some acceptable research practice.” As my original post pointed out, the best academics make mistakes, although in this case it is not clear any were made. So do the best journalists, and at the end of that post Chris acknowledges one of his own. If you want academic research in economics to scrupulously document every detail, you will either get a discipline that is so narrow as to be useless, or you will have to give academics a lot more resources!

Mistakes

My guess is that the majority of pieces of empirical work by economists will contain at least one error somewhere. Errors become almost inevitable when large and diverse data sets are involved, like those constructed by Reinhart and Rogoff and Thomas Piketty. So finding these errors is not headline news. Nor, for this reason, is it particularly embarrassing for the economists concerned when these errors are found, particularly if they have made their data public or available to others.

If you think that shows up empirical economists in a bad light, the best economic theorists can also make errors. One celebrated paper from my youth, Does Fiscal Policy Matter? by Alan Blinder and Robert Solow, contained an algebraic error (pdf). And if you think this shows up all economists, probably the most famous mathematical event of the last few decades - the Andrew Wiles proof of Fermat’s Last Theorem - contained what a journalist would call an error in its original form.

It is also often necessary to adjust data for a number of reasons. In an ideal world each adjustment would be carefully documented, but they rarely are. Of course official data series often involve many similar adjustments before they are published. If you can, it is always a good idea to talk to the statisticians involved in constructing your data before you use it, although it can put you off doing any empirical work ever again!

Errors and adjustments only matter if they influence key results. The Blinder and Solow algebraic error was not critical to the main results in their paper. The gap in the original Andrew Wiles proof was critical, but after what must have been an agonising year, he found he could bypass the problem and the revised proof was sound. The Reinhart and Rogoff spreadsheet error had a relatively minor impact on its own - the really important issues lay elsewhere.

With all this in mind, I have very mixed feelings about Chris Giles’s Financial Times splash. I applaud a journalist who is unwilling to take academic results or official figures on trust, and is prepared (and I guess has the resources) to get their hands dirty with data. Chris has consistently done this. For example, when David Cameron claimed mysteriously that George Osborne’s first austerity budget would increase public sector employment compared to Labour’s plans, Chris got to the bottom of how this trick was achieved. Yet I groaned when reading his latest FT article, with its emphasis on “mistakes and unexplained entries”. As far as I can see (read Ryan Avent here, and the longer Chris Giles post here, and Jonathan Hopkin here), the only issue of substance involves trends in the UK wealth income ratio, but of course an article headlined ‘Data sources on UK wealth income ratio differ’ would not have had the same punch.

Now you might say, as journalists always do, that people who become famous - including economists like Reinhart and Rogoff or Piketty - have to accept having their work treated in this way. They become ‘fair game’. I actually think that is wrong. Misleading reporting and commentary - by journalists or bloggers - is what it is: misleading. The fact that it can be commonplace does not excuse it. I understand the temptation to hype up simple spreadsheet errors even when they have no significant consequence, but I’m glad to say I did not succumb to this temptation in the case of Reinhart and Rogoff spreadsheet affair.

It is perhaps worth noting one other point. The Reinhart and Rogoff affair became notorious because governments had used this work to justify their austerity policies. The spreadsheet error was brought to light as a result of work by academics rather than by any journalist. In the case of Piketty, no policies have yet been implemented using the results in his book as justification. In that rather important sense, the two stories are different. Whether this asymmetry reveals anything of interest I will leave you to judge. 

Hawkery, or is the Bank biased

An interesting contrast in my evening reading yesterday. In the US, Matt O’Brien in the Washington Post’s Wonkblog making fun of reporting that inflation is just around the corner. There is one particularly nice line: “Well, there's always demand for pieces about why we need to raise rates — mostly from 60-year-olds who think it's always 1979 …” The contrast is with the Financial Times’s Chris Giles, who in yesterdays FT accuses the Bank of England of ‘institutional dovishness’, which he compares to institutional racism. The Bank is “institutionally biased against higher interest rates.”

Now, lest I be misunderstood, let me say three things before addressing Chris Giles’s charge. First, I’m pretty sure Chris is well short of 60. Second, Chris is no fool who blindly follows some party line: this piece on the Treasury’s exercise in dynamic scoring is as good as economic journalism gets. Third, central banks can suffer from what I and others prefer to describe as ‘groupthink’. Laurance Ball argued that this happened at the Fed when it came to not trying what I call forward commitment (promising higher inflation and a positive output gap in the future to combat the zero lower bound).

Having said that, Chris can occasionally pursue a line that, while popular in some quarters, makes little macroeconomic sense. The idea that UK austerity did not matter much had him clash with not just the usual suspects (including me), but also US academics Alan Taylor and Oscar Jorda. (I discussed an earlier version of their paper here: their latest version is here). In a similar way, over the last few months Chris has relentlessly pursued the idea that UK interest rates should rise very soon.

Chris’s charge against the Bank is that they keep moving the goalposts. For example, they say they will think about raising interest rates when unemployment dips below 7%, but when unemployment does go below 7% they decide that there is no reason to raise rates, and so on. But for the Bank the goalposts are the inflation target, and inflation is below target.

In the past I have made the point that, given uncertainties about the size of the output gap, it is best to err on the side of expansionary policy. This is because the Bank can easily deal with inflation if it does begin to rise, but because of the lower bound the opposite is not true. Chris responds that “no one should expect that an overheating economy will quickly set prices and wages on the climb”. “As the pre-crisis period showed, economies can overheat and develop dangerous imbalances without displaying the usual warning sign of inflation.” He is of course talking about house prices. But raising rates is a very inefficient way of dealing with a housing boom, which is why we now have the Financial Policy Committee at the Bank with its macroprudential tools. It is also very inefficient for the Bank to be trying to undo effects caused by the Chancellor’s policies (Help to Buy).

To see what can happen in this situation, we just need to look at Sweden. Sweden raised interest rates from almost zero to 2% beginning in 2010, because they were worried about overheating in the housing market. They now have deflation: inflation was -0.6% in March. As a result, the central bank has had to bring interest rates back down again. Lars Svensson, one of the world’s leading macroeconomists who resigned from their equivalent of the MPC while this happened, can only say I told you so.

While we are on the subject of premature interest rate increases, let us not forget the ECB raising rates just before the second Eurozone recession. And let us not also forget that the MPC almost followed their lead - not much evidence of institutional dovishness there.

I suspect and hope that the Bank and MPC have their eyes on the big picture. UK GDP per capita is currently around 15% below the level we might have expected it to be at if it had followed pre-recession trends. At no time since WWII has the economy not come back to this trend. We have no even half decent theories about why this trend should have dramatically changed. In these circumstances, starting to put on the brakes when we have only just begun to catch up lost ground, and when inflation is below target, just seems dumb and dangerous. 

Austerity, journalists and the financial sector

The argument that current growth (since 2013 in the UK and maybe from 2014 in the Eurozone) vindicates austerity is ludicrous. Anyone who comes to the debate without existing baggage can see that developments in the UK and Eurozone have been entirely consistent with what academic critics of austerity have been saying. So rather than go over the arguments yet again, let me ask why some people continue to make or support this ludicrous argument.

In some cases asking this question does not tell you a great deal. For George Osborne, for example, you could simply say ‘he would, wouldn’t he’. Still I think there are two interesting points to note: first, here is a Chancellor who feels no inhibition in allowing sound bite to trounce economic logic, and second, he feels confident that he can get away with it, which tells you a great deal about the UK media.

Which brings me to the Financial Times (ex Martin Wolf). Now, to be pedantic, the FT tends not to say outright that current growth vindicates austerity, but instead that George Osborne is justified to claim that it does. Yet this subtlety aside, why do they pursue this line? It would be easy to lump them in with the politicians, but I think that would be both wrong, and miss some important points.

I thought about this partly because of the latest Chris Giles article on the issue (HT Alan Taylor), but also because of Paul Krugman’s comment on my earlier post that discussed the weakness of the European left on macro policy. He makes the point that Obama also showed similar weakness on austerity, and explains this in terms of the influence of what he terms ‘Very Serious People’ (VSP), “whose views on economics tend in turn to be driven largely by the financial industry.” Now at this point I usually add a caveat that there are some good economists who work for financial institutions, but generally the sector’s view on austerity is that it is necessary, and often that it is unlikely to have much impact on domestic output.

Why does the financial sector (the City, or Wall Street, or whatever the equivalent name is in other European countries) have this view? There are probably many reasons, but one that I think is very important is the 2008 recession. This recession should have been disastrous for the influence of finance: the activities of part of the financial sector brought the economy as a whole to its knees, and parts of that sector had to be bailed out with huge amounts of public money. Economists, the public and possibly some politicians began to question whether the continuing financialisation of economic activity might be detrimental rather than helpful to economic growth. No amount of expensive hospitality should have been able to repair that blow to its reputation and prestige.

Of course attempts were made to blame it all on US monetary policy, or global imbalances. The intellectual basis for these alternative stories was pretty thin, but also beyond the academic debate they did not resonate. What was really required was to change the story. The 2010 Eurozone debt crisis was therefore a godsend to finance. The focus was now on the dangers of high government debt, and the necessity of austerity to end this new crisis. Here was a story that certainly did resonate (just look at Greece), and was also an ideal distraction from the problems caused by the financial sector.

I’m not suggesting that one crisis was manufactured to distract from the other. What I am suggesting is that those working in finance understood the importance of changing the story. There was a clear party line, which fitted the dominant ideology. The state bailing out banks is terrible for neoliberalism, while a story based on the evils of excessive government spending fits the ideology perfectly. For VSPs, economic journalists or politicians it was natural to turn to the prophets of finance during the debt crisis, and so any distrust VSPs might have had of these prophets as a result of the financial crisis faded away. Although the level of economic analysis within the FT is generally high, they were perhaps also bound to follow the City/Wall Street line.

On Chris Giles’s article specifically there is much to say, and Jonathan Portes has the patience to say it once more. So let me make just one point. Chris as a good economic journalist recognises that the ‘growth vindicates austerity’ line is nonsense, so instead he tries to accuse the other side of equal mendacity. To see how silly this idea is, consider the following quote:

“It was precisely the chancellor’s fiercest critics who were themselves unable to distinguish between correlation and causation during the period of stagnation and have thereby legitimised Mr Osborne’s rhetorical victory lap. They have only themselves to blame. The lesson to learn is that the economy is complicated and everyone should be deeply sceptical of anyone drawing strong conclusions from simple links that appear momentarily true.”

Of course it is completely the other way around. If there is a simple idea here, it belongs to those who support austerity, and it is the view that monetary policy can always control the level of activity. It was austerity’s critics (beginning with Paul Krugman) who emphasised the complication of nominal interest rates hitting a lower bound. Analysis of austerity based on complex macro models almost always supports the critics view (e.g. here). Criticisms of austerity are rooted in long established theory, while the idea of expansionary austerity or the 90% critical debt level relied on simple correlations.

So Chris, there is no symmetry here between Osborne and most of his economist critics. One of the reasons I started this blog is that I found, perhaps for the first time in my adult life, finance ministers arguing positions which directly contradicted the received wisdom I was teaching undergraduate and graduate students. In an ideal world economics journalists would also recognise when this happens, and tell people about it.