Monday, 16 February 2015

Let clear thinking blossom

I love Lesley Riddoch's Blossom. It contains lots of ideas that I really want to spend time thinking about on the interplay between local autonomy and productivity. Eventually I may write a proper review... However, even towards things that you really like, it's often easiest to react to aspects you don't like. And I don't like the confusion between investment in human capital, and the use of capital spending as countercyclical fiscal policy. So I'm going to react...

As Nick Rowe makes clear in "Human Capital" and "Land Capital", the term capital is used to capture a concept related to time. Spending on early years' intervention, in the sense that it produces a "return" 20 years + later in the form of a more productive and educated next generation, is capital spending. Spending on childcare, in the sense that it allows parents to improve and maintain their skills in the workplace, which will boost their income into their 40s, 50s & 60s, is capital spending. No doubt about it.

However, Riddoch says "when capital investment is under discussion, childcare is rarely mentioned. ... Scottish politicians and civil servants have backed construction projects as the best way to kick start the economy, restore optimism and provide jobs. ... in 2013, Scotland's Finance Secretary, John Swinney, published a list of preferred 'shovel-ready' projects including £34 million worth of trunk road schemes, a £5.7 million revamp of ferry ports, £308 million for NHS buildings and £65 million on college upgrades. ... 2013 could just as easily have been the Year of the Soft Hat - with £394 million invested in human capital, not road junctions."

The rationale for using "capital spending" as countercyclical fiscal policy is that it can be lumpy, not that there is something magical about capital spending relative to revenue spending in terms of boosting the economy (at the margin). If the government wants to build a public physical asset which has a lifetime of 40 years, it doesn't really matter whether it does it this year or next year, therefore it is best to do it when private demand is low to stabilise overall economic activity. However, if a programme of early years' intervention is deemed valuable, then we cannot wait for the economic cycle to implement it - it has to be done at specific ages of the children. Childcare programmes could be shut down in a booming economy - but this wouldn't be consistent with expectations of parents, and would likely be very politically unpopular. The inflexibility over time of the spending decisions on such programmes means that they are very properly regarded as revenue spending programmes - even if they do build human capital.

Lesley Riddoch is absolutely correct to argue for such spending programmes, but not to present them as alternatives to construction projects for countercyclical fiscal policy: such programmes cannot be used countercyclically.

Sunday, 1 February 2015

End January Links

# Several great posts from Chris Dillow:
   - The Diversity Paradox: "there are (at least) three distinct meanings of the term [Diversity]. One is ethnic and gender diversity - ensuring that women and minorities are fairly represented in positions of power and prominence. A second is cognitive diversity - giving space to different intellectual perspectives. And a third is ecological diversity: having a variety of strategies and business models. I would argue very strongly for diversity in the last two senses.A multiplicity of perspectives ... can be a solution to the problems of (tightly) bounded knowledge and rationality; ... And ecological diversity can protect economies from shocks... In a changing environment, mixed strategies help ensure survival." He's not arguing against the first type of diversity, but making the point that the other two are very important and are given much less attention.
   - In praise of complexity economics which has a lot of good links
   - Who bears risk? "it is workers rather than capitalists who are risk-takers"
   - Heterodox economics and The Left
   - Basic Income: Some issues

# Interesting post from Interfluidity on economics of Uber: economists' knee-jerk assumption that rationing taxi-cab space using price is the optimal mechanism is, at the very least, dodgy.

# Interesting research highlighted by RES: Inequality in big cities: Why urbanisation makes the world more unequal

# I like the whimsical way Nick Rowe thinks, and his Did inflation targeting destroy its own signal? post with apples, bananas and inflation targets is a good example (followed up with A simple model where NGDP targeting beats inflation targeting)

# Some economics in the Hari Seldon/Psychohistory mould from globalinequality: Can Black Death explain the Industrial Revolution?

# The "Carbon Bubble" is in the news: Most fossil fuels 'unburnable' under 2C climate target, & Fossil fuels: The 'untouchable reserves' - I need to get my paper published!

# Simon Wren-Lewis discusses When central bank losses matter: "the effectiveness of QE is highly uncertain compared to the effectiveness of direct transfers to citizens or public works [as a means of stimulating the economy in the short run]. We seem to be stuck with an ineffective form of stimulus, because something more effective is taboo, or goes by a different name. To repeat it in a simple but more provocative way: a central bank giving money to people or governments is out of the question, but a central bank giving money to parts of the financial sector is just fine. That is a very convenient taboo for some."

Bitcoin revealed: a Ponzi scheme for redistributing wealth from one libertarian to another: "The key here is that the math problems the miners have to solve get harder the more of them there are. If there's a big influx of miners, say, because of a big bubble that pushes prices into quadruple digits, then there's even more pressure on everybody to upgrade to the latest supercomputers to stay competitive. The thing about the latest supercomputers, though, is that they're expensive to buy and expensive to run. .... So miners had to borrow lots of money to try to keep up in the Bitcoin arms race. But all that borrowing hasn't paid off now that Bitcoin prices are free falling. In fact, it's part of the reason that they're doing so. Bitcoin prices are so low, you see, that miners are spending more money running their supercomputers than they're making from new coins. So why are they still going? Well, they have dollar debts that they need to pay back, and where else are they going to get the money? They're stuck, in other words, in a catch-22: they can't afford to keep mining, but they can't afford to stop mining, either. (This, coincidentally, is the same dilemma that oil drillers who borrowed a lot during the boom face now during the bust). This has already forced one big mining group into default. And it's forced the rest to sell the only assets they have—Bitcoins—to pay back their dollar debts. That, of course, only pushes the price of Bitcoin down even further, which makes even more miners sell their Bitcoins to pay back they owe as mining becomes more unprofitable. And so on, and so on."

# Two opposing views of impact of inflation on real wages: MR asks Why is deflation continuing in Europe and Japan? and notes that "Most countries have labor market incumbents with sweet real wage deals, deals which could not be renegotiated anew today because the world has seen a repricing of labor downwards for the wealthy countries. Higher rates of price inflation would cut into those deals and thus high rates of price inflation are unpopular.", whereas Chris Dillow notes that "in the longer-run, real wages aren't affected by inflation. If they were, we could achieve higher wages by (credibly) reducing the inflation target - but nobody believes this". To the extent that expansionary policy would benefit real GDP in a demand-constrained world (without impacting upon the labour share), it has to be the case that average real wages would be boosted by inflation. But I think MR is right and there is a large cohort of incumbants who would be worse off. Rather, expansionary policy is likely to benefit the young, new hires, and the newly promoted.

It’s Scotland, Wales and Northern Ireland that can deliver the New Deal we need "the government [should] capitalise investment in the economy by buying bonds issued by regionally controlled investment banks in Scotland, Wales, Northern Ireland and the English regions. Those investment banks would then work with regional governments, local authorities, housing associations, NHS trusts and others to deliver the infrastructure this country needs. Part of that would be green green energy driven, I am sure. Part would be straight need: much of that would be housing. All would be local. And without exception it would create jobs in every constituency in the UK. This could be the economic stimulus Scotland needs on top of its new borrowing powers."

# Harry Burns say Social failure, not lifestyle, has made Scots sick "widening health inequality in Glasgow is due to the recent emergence of socially determined causes of early death. What happened to cause this? During most of the 20th century traditional industries, such as shipbuilding and steel, provided secure, meaningful employment for Glasgow. These industries declined in the 1970s as companies shifted production abroad. Skilled people left and those who remained struggled to find jobs. At the same time, communities changed as inner-city tenements were replaced by peripheral housing estates which lacked the same social cohesion. From this emerged a society with a deep sense of alienation. ... what we are seeing in Scotland is the consequence of austerity in the 1970s and 80s, when social change and joblessness led to a breakdown in family life and a cycle of alienation."

# A fantastic principle through which to think about the Greek situation: Debt restructuring: a proposed principle "there should be no significant increase in unemployment above its natural rate ... as a direct result of having to pay interest on any government debt. Unemployment above the natural rate when there is no excess core inflation is a waste of resources as well as being damaging to most of those unemployed, so any deal that creates such unemployment, or allows it to persist, should be regarded as the result of creditors acting against the social good. ... it involves creditors acting against their own self-interest, because the more of an economy’s resources you waste, the less is available to pay its debts."

Saturday, 20 December 2014

HMT says it has has no intention of allowing a workable system of real autonomy for Scotland

The IFS's David Phillips has a post at the Future of the UK and Scotland site, which like the post by my colleagues David Bell and David Eiser at Scottish Fiscal & Economic Sudies, describes the Byzantine, labyrinthine, systems needed to implement a system that maintains the Barnett Formula whilst implementing significant devolution of revenue powers.

There is a simpler way to do things: declare some expenditure items as UK responsibilities, with the others as devolved; declare a set of UK taxes to pay for these UK expenditures, and allow the devolved administrations to raise taxes to meet their responsibilities. The UK expenditure responsibilities would include UK debt repayments, any equalisation payments that were agreed, and fiscal transfers in response to business cycle fluctuations and asymmetric shocks.

The first step to implementing such a system (which might have a chance of being stable in the long term) is for the UK Government to recognise that it wears (at least) two hats: as the sole level of government responsible for UK functions; and as the government of England (and also the government of Wales & Northern Ireland for those areas in which Scotland has devolution but they don't). It needs to know what hat it is wearing at any one time, and what policy levers are associated with that hat.

In David Phillips' post he notes: "But what if the UK government wanted to spend more money on defence or state pensions, or wanted to increase taxes to reduce borrowing. ... One interpretation of the Smith proposals would be that the UK government could not use an increase in income tax – one of the main taxes it levies – to fund these policies. This would be absurd and the Treasury has informed us that it was not the intention of the Smith Commission to constrain the UK government in this way."

Contrary to David Phillips, I don't think that a recognition that some taxes are for funding devolved services, whilst others fund UK services, is absurd. On the contrary, it seems like a pre-requisite for a functioning system. Note also that such a recognition would not preclude the use of income tax for the funding of UK services: for example in my submission to the Smith Commission [*], I recommended that the UK Government have as one of its revenue streams the top rate of income tax (because such a tax base is likely highly mobile in response to differences in the rate). But there would have to be two income taxes: one levied by the UK government for UK expenditure, and one levied by devolved government (which in England may well be just the UK government wearing its English government hat) for devolved expenditure.

But in any case, the first step towards a workable system is for some self-awareness on the part of HMT.

[*] Shorter, and better written version is Chapter 8 of 'Beyond Smith' ebook 

Sunday, 30 November 2014

End November Links

# Chris Dillow makes good points in The Heritability Red Herring, on how cross country evidence shows that the success of the children of rich and bright parents cannot just be due to heritability. In particular the point that "The correlation between parental education and children's education is higher in more unequal countries. This is consistent with income inequality buying unequal access to education - for example, because rich parents in unequal countries buy private tuition."
This is not just private tuition or private education though. I suspect that there will be greater variance in property values in unequal countries as rich seek to cluster and so buy access to higher than average quality public education. If I'm correct about this, then it will be a multiple equilibrium effect:

either
   1.  house prices are highly unequal reflecting a large amenity values from good local schools, and so rich will be willing to pay (thus supporting high prices in such areas); or
   2. house prices are much more equal as are schools, and so no-one is willing to pay any house price premium for access to a specific school.

I further suspect that equilibrium 2 is more fragile, in that the dynamics around it have a much narrower or shallower basin of attraction. But not so shallow that it cannot be stable, given a relatively narrow spread of incomes: as Lesley Riddoch and others have commented, the segregation by income is much less strong in more equal countries, which I suspect means that these countries are even more equal relative to the UK than their lower GINI coefficient would suggest.

Nick Rowe is also thinking about this area, in Reverse Regression and the Great Gatsby Curve


# My Smith Commission submission is reported in the Modern Scotsman and my article in the Conversation

# Some interesting posts on English devolution:
   - The Greater Manchester Agreement is only a small step towards greater devolution in England
   - The ‘Devo Manc’ proposals represent centralisation on steroids

# Krugman resurrects a fantastic post of his from 1998 on Networks and Economic History. Basically Zipf's Law offsets Metcalf's Law meaning that increasing returns are limited. I suspect that this is relevant in domains other than the profitability of communication networks.

# On oil prices and prosperity is a generally good article. But I'm more pessimistic than the following paragraph since the rate of innovation must be related in some way to the price of fossil fuels. "The only real concern ... is in regard to the viability of alternative energy. Renewables have become significantly more competitive ... in a world of expensive fossil fuels. ... But the falling price of solar energy is ultimately a long-term trend driven by technology. ... cheaper oil prices could push adoption back to some degree, especially in regard to electric vehicles. But it can't hold back the broad strokes of history, either." I think it is possible that these broad strokes of history could either feature or not feature the adoption of alternative energies. It is possible that, as a species, we may make catastrophic choices, and the current state of incentives for the development of alternative energy technologies is in no way helpful.

Thursday, 30 October 2014

Is regional policy inefficient?

The basic argument for centralising decisions over public investment, for example the UK's £300bn plus National Infrastructure Plan, is that projects across the country can be assessed, and scarce funds then directed, on the basis of which are most valuable compared across the whole portfolio of potential projects.

A further advantage for centralised decision making is that interregional spillovers can be consider. For example, a project that should be high on Scottish priorities list is upgrading the A1 trunk road in Northumberland north of Newcastle, but it would be hard for Scotland to act on this preference if it only controlled spending in Scotland.

Centralised spending decisions are current practice in the UK. But what are the arguments against this centralisation, and instead having both a regionally balanced portfolio of public investment (which must, at the margin, lead to lower expected return projects being invested in at the expense of higher expected return projects), and local decision makers?


# Congestion:

If factors are complementarity but there are costs of congestion, then a project can easily have the highest expected return (measured by willingness of the beneficiaries to pay for this improvement divided by its cost) but not be the efficient choice. Congestion (of fixed non-reproducible factors, typically land; and also of hard-to-adjust-in-the-short-term factors like space on a road, or bandwidth on a network) causes real losses in economic output, and a project that in the absence of congestion would be highly valuable (because it is complementary with all the other factors located in the congested region) may not yield greater real output than a similar cost project in a less congested region which is less valuable in terms of the willingness of the beneficiaries to pay.

A recent article in the FT, 'London’s $8.5bn traffic jam slows down growth' viewed further investment in the South as the solution to congestion in the South. It cites Edmund King, president of the AA, claiming support for this from those furth of the region: "“Anyone who regularly commutes on the M25 ..., knows it’s an absolute nightmare, ... But it’s a key link to airports and ports – and not just for drivers in the south. If you ask Scottish hauliers what’s the most important road in the UK it’s the M25.”" And obviously, once the airports and the ports are in the South, the value of the road network in the South is increased. But instead of constantly increasing capacity in the South to deal with the use of this network by those not from the South (and to deal with the population growth in the South induced by everyone crowding round these assets), it may be more efficient to invest in capacity elsewhere. Project evaluation should not always take demand as given, but instead should countenance that supply lead demand. And project evaluation should not always be conducted on a marginal basis: investing in infrastructure in the North may lead to increased values on future investment in the North, and perhaps some of this additional value should be recognised when evaluating the first project.

If congestion's economic impact is high enough then this could strengthen the case for targeting public infrastructure investments in highly productive and congested areas, precisely to limit congestion problems. However - this simply may not be possible in the medium and long run. If you alleviate the congestion through public investment London then, given the income differentials across the UK, London's population will grow until the congestion is recreated. If the costs of fighting congestion at a given location are convex (this may or may not be true, but it's certainly true that the level of congestion given fixed infrastructure is convex in the number of users), then this is, eventually, an inefficient use of public capital.


# Network effects and lock in:

This complementarity between factors of production can lead to "lock-in" when the situation changes (technological changes, changes in the terms of trade, etc). A great example is Michaels & Rauch (2013) (described in VoxEU) which discusses the positions of medieval towns in England and France.  Three facts underpin their analysis: (1) Both England and France had urban networks created by the Romans, based on complementarity with the Roman road network; (2) Roman civilisation collapsed much more strongly in England than in France; (3) The dominant transportation technology of the middle ages was by boat. They find that medieval urban locations in England were sited much more appropriately with the prevailing technology than those in France were. This suggests that France suffered from lock-in: it was never worth it to rebuild all their infrastructure at a more appropriate site because every new investment must be optimal conditional on the locations of all existing assets with which they are complementary. England benefited, in the sense that it could re-optimise, from having its slate wiped clean.

Perhaps a diversity of locations should be maintained, and their varying idiosyncratic characteristics can provide insurance against secular changes. By having multiple centres that each have a full suite of infrastructures and assets, the costs of switching focus from one to another as external changes occur are minimised and so we do not become locked in to using a location that is eventually sub-optimal.


# Information

The power of markets to aggregate widely dispersed knowledge is justifiably lauded. Given this ideal however, we should not want the projects assessed by a single body with monopoly power to decide which get funded or not. This single decision making body will have a particular set of preferences, a particular information set, a particular expertise, and a particular method of analysis. As Chris Dillow says "Let's suppose that we want to find the best possible policy, according to some objective criteria ... Suppose too that there is bounded rationality and limited knowledge and that each individual selects the best option using his own information set and decision rule. In these conditions, each individual, if s/he is moderately competent, will find a local maxmimum - the best option, given his/her information and decision rule. But local maxima aren't necessarily global maxima. ... experts might well not find that global maximum because their decision rules and information sets might not be wide enough to encompass the best option: this might be because of deformation professionnelle, or groupthink or simply because their Bayesian priors limit the number of options they search for. Instead, widening the population of searchers increases our chances of finding that global maximum, because doing so brings more decision rules and information sets to bear on the problem. Cognitive diversity - in the sense of different ways of thinking - can therefore beat experts. It increases our chances of finding the best option."

In this context, multiple decision making bodies, each finding their own constrained local maxima, may bring us closer to the global maximum than a single decision maker (who does admittedly operate with fewer constraints).


# Fiscal transfers and stability

Presumably public investment opportunities in the highest yielding projects are lumpy over time. This could represent a big swing in fiscal transfers, and there is always a balance of payments (even if no-one is measuring it regionally). Any sudden positive (negative) impact on fiscal transfers would need compensating outflows (inflows) of private capital, increases in net imports (exports), appreciation (depreciation) of land values & other fixed assets, or labour in(out)-migration - all of which can be destabilising with associated losses. Conversely, if public investment were stable regionally then it would contribute to the automatic stabiliser effect of public spending and countercyclical policy.


# Distribution of gains

Even ignoring all the points above and assuming that a single decision maker can accurately select the highest yielding projects, everyone agrees on these, and there are no negative effects from congestion, then it is still not the case that we should automatically use public funds, raised from general taxation, to invest in a regionally unbalanced portfolio of projects. This is because the returns are not necessarily equitably shared. The obvious case is that of land-owners: those situated around the newly created public capital likely capture some of the value; but this is also true of workers. It is clearly the case that public funds can be used to systematically and predictably favour citizens in one part of the country over another. That public funds should be so used must be a matter for democratic debate, not necessarily the outcome of a spreadsheet calculation.

And the sums involved are not small: Wings Over Scotland estimates that investment in Scotland under the NIP will be £1bn from a publicly funded total of £136bn, to which Scotland will have contributed approximately 1/11th from tax revenues. If the populace as a whole agrees with these priorities and recognises these regional transfers, then fine. However, dressing this decision in the language of cost-benefit analysis overestimates how sure we can be that the selected projects are the optimal choice, and obscures the important distributional decisions that have to be more democratic than technocratic.


Conclusion


Given these points, there is clearly a case to be made in favour of some local decision making, and for reasonably regionally balanced public investment, on efficiency grounds. I believe that the balance in the UK at the moment is far too far away from regional balance, and towards centralised decision making. There is scope for benefits from a presumption in favour of a regionally balanced public investment portfolio. A centralised decision making body which has such a regionally balanced portfolio objective, would deal with all the headings other than "Information". Given this information point, there is definitely space to enhance local control over some public capital spending. Regional balance should not be perfect, since there is some value to picking high marginal value projects, and local control of investment budgets should not reach 100% since there is value to considering interregional spillovers.

End October Links

# Another in Vox´s series of maps: 38 maps that explain Europe

# Fracking's not a bridging fuel: Fracking May Be Worse Than Burning Coal; and true low carbon investment may be best for the economy:  Want to grow the UK economy? Invest in green energy

# Interfluidity on The political economy of a universal basic income

# The IMF has produced a couple of politically charged research reports, showing:
    - public investment really is a free lunch: a dollar of spending increases output by nearly $3
    - lower inequality is robustly correlated with faster and more durable growth, and redistribution appears generally benign in terms of its impact on growth

# The BBC reports that
"Chancellor George Osborne says the figures [UK inflation fell to a five-year low of 1.2% in September from 1.5% the month before] are a "dose of good economic news""
In what way is this good news? The BoE has a symmetric target - below target is as bad a policy failure as above target. And low inflation is only good news for individuals to the extent that their incomes are unaffected. If low inflation is accompanied by a lack of wage growth, which it is, then this is in no way good news. Given high debt levels, lower than expected inflation and income growth is unambiguously bad economic news.  

"[To t]hose dismayed by Britain’s wide disparity of individual wealth ... The overriding reason is the gulf between the prosperity of London and the provinces. This must in part result from a shift in power from local to national government, a perverse consequence of a “single state” constitution. Every year 30,000 graduates flow from provincial universities to jobs in London. Barely 11,000 go the other way. This crippling drain of talent and earning power is one reason why cities in Germany and elsewhere in Europe are richer and more robust than in Britain. Inequality starts with power."


# Henry Overman of the LSE's Spatial Economics Research Centre in his post, Why are the poorest regions in the UK the poorest regions in Northern Europe?, comments on data similar to my post, A conversation, between economists, on the economics of independence. He looks at the NUTS2 regions of Northern Europe and points out the problem of splitting inner and outer London, but his main critique of the claim that there's something unusual about all the poorest regions of Northern Europe being in the UK, is that this is to be expected given that the UK is the poorest country in Northern Europe. My chart was based on NUTS1 regions, and still the UK has the highest region inequality. But also we have to ask why the UK is the poorest country in Northern Europe, when London and the South East manage to be compare well with this group. It's not soil fertility, remoteness, or population density, or else the rest of the UK would not be getting beat by Ireland and Scandinavia. My conjecture is that it's about power, and Henry Overman's piece does not change my view.

Thursday, 23 October 2014

Economic journalism cop-out extraordinaire

BBC Scotland today reports on developments at Grangemouth. I have no quibble with the content of their piece. However it states "Grangemouth is already said to be responsible for about 10% of Scotland's gross domestic product (GDP)" - note the weasel-words "is said to be"; translation: "I overheard someone say this, it may or may not be true, but sounds impressive and I can't be bothered investigating". This is unacceptable journalism.


Let me help the BBC out: I have no idea about the profit and loss accounts that could be attributed to the Grangemouth plant; but I can at least do back of the envelope calculations.

# Scotland's GDP is approximately £150bn so 10% is around £15bn

# Country GDP, as a concept, is analogous to Company operating profit (before depreciation). Wikipedia makes this clear in 2nd paragraph on GDP.

# Grangemouth has 800 employees and so its wage bill is highly likely to be substantially less than £100m. Simply the payments to capital would then have to be approaching £15bn for this plant to be "responsible" for 10% of Scotland's GDP.

So whilst Grangemouth may be "said to be responsible" for 10% of Scotland's GDP, this is only "said" by people who don't know what they are talking about. Business and economics journalists do not (or should not) have this excuse.


Now perhaps the value of Grangemouth's sales approaches £15bn (this may or may not be true). So what? It will have paid £14bn-odds for the raw materials and its value added (operating profit before depreciation) will be much lower. Even if it is true that Grangemouth's revenues are 10% of Scotland's GDP, comparing these figures is meaningless. This is like saying there are roughly the same number of nano-meters in 10cm as there are miles in the Earth-Sun distance: it's a true statement, but comparing these numbers without noting that they measure different things adds no information.